Office Properties Income Trust (OPI) 2015 Q2 法說會逐字稿

Good morning, and welcome to the Government Properties Income Trust second quarter 2015 financial results conference call. All participants will be in listen-only mode. (Operator Instructions) After today's presentation, there will be an opportunity to ask questions. Please note, this event is being recorded.

I would now like to turn the conference over to Director of Investor Relations, Jason Fredette. Please go ahead.

Thank you Allison, and good morning everyone. Joining me on today's call are President, David Blackman; and Chief Financial Officer, Mark Kleifges. They'll provide insight about our recent accomplishments and the results for the second quarter and they will then take your questions.

First, please note that the transcription, recording, and retransmission of today's conference call is prohibited without the prior written consent of the Company. Also 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, July 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 the SEC regarding this reporting period.

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

And finally 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 operating and financial data package, which again can be found on our website.

Now, I'll turn the call over to David Blackman to begin our review. David?

Thank you, Jason. Today Government Properties Income Trust announced another year-over-year increase in normalized FFO and a strong quarter of leasing activity in the midst of what remains a challenging government leasing environment.

As of June 30, GOV owns 71 properties containing 10.7 million square feet that are located in 31 states in the District of Columbia. Consolidated occupancy at quarter end was 94.3% and same property occupancy was 94.1%. These figures were down 120 and 110 basis points respectively year-over-year driven mainly by the FDA vacating approximately 100,000 square feet at our Rockville, Maryland property in December 2014, and then it's vacating smaller spaces at our properties in Woodlawn, Maryland and Trenton, New Jersey during the quarter.

GOV's weighted average lease term based upon revenue was 4.7 years as of June 30 consistent with the end of last quarter. The U.S. government continues to be our largest tenant and when combined with 12 state governments and the United Nations contribute nearly 93% of annualized rent at quarter end.

As I mentioned at the outset of our leasing activity was strong in the second quarter with renewals comprising the vast majority of our volume. In total we generated 316,000 square feet of leasing, a volume greater than GOV's leasing during the prior two quarters combined that are still the weighted average lease terms for the 16 leases was 10.9 years and we generated a weighted average rollup in rent of 1.9%.

Leasing capital commitments were also low compared to recent quarters at just $1.52 per square foot per lease year. Approximately 87% of our leasing was with government tenants. This included four executed leases for approximately 274,000 square feet that resulted in a 1.7% rollup in rent, a weighted average lease term of 11.7 years and leasing capital commitments of $1.26 per square foot per lease year.

Our two largest government leases were both renewals one with the Commonwealth of Virginia that extended the lease through the end of 2025 and the other with the GSA that extends a lease term into 2013. We signed 12 leases with non-government tenants encompassing 42,000 square feet for a 3.2% rollup in rent, a weighted average lease term of 6.2 years and leasing capital commitments of $4.74 per square foot per lease year.

I'm also pleased to say that our leasing momentum continues as we have over 400,000 square feet of perspective new leases that includes more than 125,000 square feet of space committed and working through documentation.

Now moving on to our capital recycling activity. As some of you may recall, in 2014 we signed an agreement to sell our property in Falls Church, Virginia for $16.5 million. For various reasons this agreement was terminated during the second quarter and shortly thereafter, we entered an agreement with a new buyer at the same price. The new buyer is conducting its due diligence and we're optimistic that this sale will close before year-end.

During the second quarter, we also made the decision to market for sale our 35,000 square foot office front relocated in Savannah, Georgia. This property is well located in the Savannah historic district, but will likely be redeveloped for something other than office use. As a result, we feel that prudent to recycle the capital and reinvest into property acquisitions consistent with our investment thesis of owning building lease to government tenants.

On the acquisition front, we have entered agreements to acquire two properties. The first is an office property located in Greensburg, Pennsylvania with nearly 83,000 square feet that is a 100% lease to the Commonwealth of Pennsylvania. The purchase price for this acquisition is $14.3 million excluding acquisition cost.

We also entered an agreement to acquiring office property located in Braintree, Massachusetts with 99,000 square feet that is a 100% lease to the Commonwealth of Massachusetts. The purchase price for this acquisition is $11.7 million excluding acquisition cost. In addition to these pending property acquisitions, in June we announced the transaction whereby GOV acquired a 5% economic interest in our manager management and research and exchange for $17.5 million and an amendment to our management agreements that extended terms for 20 years.

As a part of this investment in RMR, we issued 700,000 restricted shares of GOV valued at $13.5 million and the remainder of the purchase price was paid in cash. The shares we issued are subject to a 10-year lock-up agreement with historical owners of RMR.

As part of this transaction, we agree to distribute half of the RMR shares to GOV shareholders as a special dividend and RMR agreed to facilitate the distribution by filing a registration statement with the SEC and by seeking a listing on a National Stock Exchange. We currently expect to complete the special dividend by year-end but only after the SEC declares the RMR registration statement effective.

We believe this investment in our manager was made at the compelling price. And we also believe this transaction benefits GOV and its shareholders. Specifically we believe this transaction further aligns the interest of RMR management, ourselves, and our shareholders. It provides greater transparency into our manager and it allows GOV to continue benefiting from a low cost management structure.

On our last earnings call, we provided insight into our lease explorations through the end of 2016 or for the instilling 21 months. At that time, we identified 2.1% of rents that we expected to vacate and 1.7% of rents that we believe were at risk of downsizing or vacating. Looking ahead to the next 24 months, we have leases contributing approximately 20% of GOV's annualized rents and covering nearly 1.8 million square feet that are subject to exploration.

Based upon our latest tenant discussions, we currently expect approximately 2.4% of annualized rents to vacate with approximately 60% occurring during the remainder of this year and 40% occurring in 2016. We have not identified tenants that we expect to vacate during the first two quarters of 2017.

The tenants we've identified to be a risk of downsizing or vacating, contribute approximately 1.7% of our annualized rent, and cover 200,000 square feet. This at risk bucket is equally weighted between the next 12 months and months 13 to 24. Please note that we believe the tenants at risk over the next 12 months are at risk of downsizing rather than vacating and all of these tenants are located in multitenant buildings. As a reminder, these figures are the best information we have available today based upon current lease negotiations. As negotiations with our tenants evolve, we expect or at risk disclosures to evolve as well.

Similar to our retention rate, which we believe will remain well above the norm for our office REIT peers, we believe the level of insight that we're providing about our lease exploration schedule demonstrates best-in-class disclosure practices. Tenant retention and attracting new tenants to our building remains significant areas of focus for GOV. As I previously mentioned, we currently have over 400,000 square feet of potential new leases that include more than 125,000 square feet of space committed in working documentation.

As we have discussed on prior calls leasing to the U.S. Government has been particularly challenging in recent years. The lack of approved federal budget has forced the GSA to favor short-term lease renewals of around three years. Now that agencies are operating under an approved federal budget, we are seeing a greater emphasis on longer-term lease renewals.

In fact, the GSA and Congress have partnered to mandate longer lease terms. In May, the public buildings reform and savings act of 2015 was introduced, which is bi parse and legislation that would require a minimum 10-year firm term for all GSA leases. While this is only proposed legislation at this time, it is an encouraging sign for the future.

I will now turn the call over 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 second quarter. When compared to the second quarter of last year GOV's rental income declined by approximately $300,000 to $62.1 million. This change was primarily the result of the sale of our property in College Port, Maryland in February and the FDA move-out at our Rockville, Maryland property in December 2014, which were partially offset by the properties we have acquired over the last year.

On a same property basis, our second quarter rental income declined by about $460,000 year-over-year to $58 million. Consolidated second quarter net operating income or NOI declined by $2.1 million or $5.2% year-over-year to $38.2 million. Consolidated cash NOI for the second quarter was down by $2.5 million or 6.3% to $37 million.

Both of these figures were impacted by the sale of our property in College Port, Maryland in February, the FDA move out, and higher real estate taxes in payroll costs. As a result, our consolidated GAAP and cash NOI margins for the 2015 second quarter were both down year-over-year to 61.6% and 60.8% respectively.

From a same property perspective, our GAAP NOI declined by 5.2% year-over-year to $35.5 million and our cash basis NOI declined by 6.1% to $34.4 million primarily as a result of the 110 basis points increase in vacancy, as well as an increase in real estate taxes and payroll costs. Our same property GAAP NOI margin was 61.2% and our same property cash basis NOI margin was 60.2% for the 2015 second quarter.

On our income statement, you'll note that we took a non-cash impairment charge of approximately $203 million in the second quarter related to our investment in SIR. This is not a reflection of the change in our perspective on the investment, we believe that SIR will continue its strong track record of increase cash generation and that it shares are significantly under value.

However, when an equity investment has been trading below an investors book value for an extended period of time, accounting rules under GAAP dictate that the client should be considered "other than temporary and the investor should record a loss on impairment to adjusted book value to its current market value" We took this step in the second quarter.

At the same time, we continue to benefit from our SIR investment receiving a partial or pro rata dividend payment of $8.5 million in the second quarter. We expect to receive dividends of approximately $12.5 million from our SIR investment in the third quarter.

We paid a $0.43 per share dividend to GOV shareholders during the second quarter, which equates to a normalized FFO payout ratio of approximately 72%. Normalized FFO for the second quarter, which excludes the cash charge I spoke about a moment ago, was $42.4 million or $0.60 per share, which is up from $31.5 million or $0.57 per share for the 2014 second quarter. This increase was primarily the result of our investment in SIR, which more than offset the decline in our property level performance.

We spent approximately $1.2 million on building improvements and $3.3 million on tenant improvements and leasing cost in the 2015 second quarter. As of June 30, we had approximately $9.2 million of unspent leasing related capital commitments.

In terms of our leverage as of June 30, our debt-to-total book capitalization was 52.6%, which is up from 48% on March 31. This increase is simply a function of shareholders equity declining by more than $200 million as a result of the noncash charge that I mentioned earlier in my remarks. We remain comfortable operating the business at these leverage levels and at quarter end, we had $691 million of availability under our revolving credit facility.

Operator, that concludes our prepared remarks. We're ready to open it up for questions.

(Operator Instructions) And our first question comes from Young Ku from Wells Fargo. Please go ahead.

Great, thank you. David just wanted to go back to your leases at risk and lease expected to vacate over the next 24 months. So it sounds like the 2.4% that's going to vacate, that's risen from 2.1% previously. So I am just wondering, how do you think about the remaining 14% or so that are expiring between 15% and 16% and what kind of confidence level do you have in terms of renewing out the remainder?

Young, what we are doing with our disclosures on vacating and at risk tenants is trying to provide you with the absolute best information that we have at this time based upon direct conversations with tenants. So, what we have given you today are numbers that we are confident with.

As our negotiations with these tenants change, we will update these disclosures and again we will have confidence in those disclosures.

One other thing we should note Young just to make sure you understand is, going forward we're going to be providing you with 24 months of visibility. Last quarter we just provided visibility into the end of 2016. So, the comparison this quarter aren't exactly apples-to-apples.

Sure. Thank Mark. But in terms of the 60 explorations, have discussions begun already or I am just wondering whether the talks have begun and you guys are still in negotiation or it hasn't yet?

As we have mentioned numerous times, we tend to start our negotiations with tenants about two years prior to exploration, that is with our government tenant because it takes a long time to work through the lease exploration or the renewable. So yes, we are actually having conversations with tenants that have explorations in 2017 at this point.

Yes. We generally have better visibility out into the future than a typical commercial office we would have because of how long the negotiation process is with government tenants.

Okay, that's helpful. In terms of the 400,000 square feet of prospective new leases, which includes $125,000 that's committed of the remaining 275 what's your confidence level in terms securing all those pieces?

It's an interesting question, Young. Lease negotiations tend to take a long time. We have -- we clearly don't expect that we will sign all of those, but our buildings tend to be in very good shape that the spaces tend to be leasable and we have been willing to spend capital to put tenant in the space. So I think we'll win more than half their share, but it is very difficult in the leasing environment to say we're confident you're going to win a deal until they've signed out letter of intent.

In the majority of the perspective leasing pipeline, is that in space that's currently vacant or space that - that could potentially go vacant over the next 24 months?

Yes, so that 400,000 square feet is basically absorption. So that would be new space either to replace tenants that we think are going to vacate or space that's currently vacant.

Okay, so both. Got it. Great, thank you. And the one last question from me, on your balance sheet, weighted average interest rates pretty low at sub 2%, you have over $600 million real stocks floating rate debt at sub 2%. With the interest rate increasing, do you think there is a risk because of the variable rate component and what's your appetite in terms of how to fix that out long term?

I think we've had this conversation a few times over the last couple of years. We continue to evaluate whether to either fix some of our floating-rate debt through a derivative transaction or to refinance with long-term unsecured debt. We continue to evaluate that on a regular basis. I think we don't expect interest rates to increase dramatically in the near term, particularly at the long end. So, we don't see the 10-year market getting away from us. So we'll continue to monitor, and when we think it makes sense from a market perspective we'll take action.

Okay, thanks. And just one quick follow-up for Mark. Do you have about, call it $140 million in mortgage that's coming to over the next year. What are your plans to do with those?

Well, we have one more mortgage for about $47 million, $48 million that was coming due in October. We prepaid that at earlier this month, and then the remaining mortgages that come due in 2016, we'll initially fund those through our revolver, the pay-off of those through our revolver and then figure out what we want to do on a long-term basis.

Okay, great. Thank you.

Our next question comes from Michael Carroll from RBC Capital. Please go ahead.

Thanks. Mark. can you kind of remind us on what your leverage goals are? I believe you said that you are comfortable with the, I guess the, current metrics this quarter, but they are well above your long-term target. When do you want to I guess decrease that back to your long-term target?

What was the last part of the question, Mike?

When do you want to decrease your leverage back to your target?

Well, if we like where the stock price is trading today, we might do it today, but we obviously don't like where the stock price is. So, we're comfortable running the Company at this higher leverage into the foreseeable future and at some point we'd like to get back down into that 45% to 50% debt total book capitalization closer to the 45%.

So you're comfortable running at above 50% - on acquisition activity or anything like that?

We're comfortable -- given where the pipeline is, we have the two properties under agreement. We also have one property under agreement to sell and another one we're marketing. That is more or less a wash from a leverage standpoint those transactions. We don't have anything else in the pipeline right now. If you look at a big part of the increase in our leverage, it's been due to the write-down of the SIR investment and the impact it's had on our book equity.

If you look at our EBIT, debt-to-EBIT, and EBITDA coverage of interest, and if you look at our public debt covenant compliance, there hasn't been very significant deterioration in those metrics because under both our revolver and our public debt covenants, the SIR shares have always been valued at market value in those covenants.

So while debt-to-total book capitalization is up, the rest of our credit metrics still look pretty strong, and when you combine that with the stability of our tenant base, we feel pretty good about operating at this level of leverage for some period of time.

Okay. And then on SIR FFO contribution, it is little bit higher in the quarter compared to the first quarter, and I think SIR reported flat sequential results, what drove that increase on you guys during the second quarter?

I think part of that is due to -- we made an additional acquisition of SIR shares in March during the first quarter, early March. So we would have picked up a higher proportion of those earnings this quarter, we owned about 3.2 million, 3.3 million more shares for a full quarter

Okay. And then can you remind us what will be the impact of the RMR purchase on the P&L?

We will account for that investment under the cost method of accounting. So the only impact on our P&L as it relates to RMRs earnings will be to the extent we receive any dividends.

Okay. And then my final question to you, David, can you kind of really talk about or give us more insights on that 15.9% ADR, are you confident that those guys will renew, are you just have discussions with those, what's your confidence level with those specifically?

The 15.9% ADR, I'm not quite sure I'm following, can you repeat.

The lease expirations, I think you said you are concerned by 4.1%. So the remaining lease is that you are not concerned by?

So I think what we disclosed was we've got 20% of our leases expiring over the next two years. 2.4% of that we expect to vacate and 1.7% are at risk of downsizing or vacating and half of that 1.7%, we think are at risk of downsizing, not vacating.

So everything else that is not in either one of those buckets, we feel pretty good about our ability to renew them in place. Does that answer your question?

Yes, exactly. So I guess it's fair to say that you're confident that both tenants will renew their leases.

We are confident at this point in time based upon current lease negotiations that they will renew.

Perfect. Thank you.

(Operator Instructions) Our next question comes from Mitch Germain from JMP Securities. Please go ahead.

Good morning, guys. Just David, I'm curious about the move-out for this quarter. I know you mentioned Maryland and Trenton and then if I look at that 2.4% schedule to move out, what's the mix of tenants, is it government, or is it a bit of everything, just curious where are you seeing that weakness?

The move outs we had last quarter, we have one government tenant that represented about 0.2% of rent and we had a non-government tenant that represented 0.3% of rent. So that was the big piece of it. At least that's what I mentioned in terms of Trenton and Woodlawn.

When we are talking about on two vacate and at risk, that's the entire portfolio. So that is both government and non-government tenants, and we have our fair share of non-government tenants that have -- that we have on the two vacate list. I would say that of the 2.4%, probably 1.8% of that would be government and the rest will be non-government.

Is there anything bulky in that 2.4%?

No, we don't have anything that's 1%. I think the largest one is 0.7% of rents.

Care to share?

It's a government tenant in the DC Metro market.

Great. That's it from me. Thanks a lot David

Okay. Thank you.

This concludes our question-and-answer session. I would like to turn the conference back over to President, David Blackman for any closing remarks.

Thank you, Allison. And thank you for joining us this morning for our earnings call. Good day.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.