Good morning. And welcome to the Office Properties Income Trust Fourth Quarter 2018 Financial Results Conference Call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Olivia Snyder, Manager of Investor Relations. Please go ahead..

Thank you, and good morning, everyone. Thanks for joining us today. With me on the call are OPI's President and Chief Executive Officer, David Blackman; and Chief Financial Officer and Treasurer, Jeff Leer. In just a moment, they will provide details about our business and our performance for the fourth quarter of 2018.

We will then open the call to your questions. First, I would like to note that the recording and retransmission of today's conference call is prohibited without the prior written consent of the company.

Also note that 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 OPI's beliefs and expectations as of today, Thursday, February 28, 2019, and actual results may differ materially from those that we project. 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.

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

In addition, we will be discussing non-GAAP numbers during this call, including normalized funds from operations, or normalized FFO, and cash-based net operating income, or cash basis NOI.

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 also can be found on our website. And now I will turn the call over to David..

Thank you, Olivia. Good morning. Welcome to the first earnings call for Office Properties Income Trust, which is the culmination of the merger between Government Properties Income Trust and Select Income REIT.

On today's call, I will provide an overview of OPI and an update on our capital recycling program before turning the call over to Jeff Leer to provide an overview of financial results.

Before I begin, I would like to highlight that due to the merger closing on the last business day of the quarter, fourth quarter results reflect a combined balance sheet but only GOV's operating results.

To help rectify this, we provided pro forma consolidated results as if the merger had closed on October 1 instead of December 31 in our earnings release and supplemental disclosure package. Our operating strategy for OPI will differ from our operating strategies for GOV and SIR as stand-alone companies.

One material difference will be our plan to actively recycle capital through asset sales at OPI, first to manage leverage but ongoing to shape the portfolio. In doing so, we expect to reduce the average age of our properties, increase our weighted average remaining lease term and to reduce future capital requirements.

Another strategy shift will be to focus on favoring the acquisition of first-generation buildings. We believe this will increase the likelihood of tenants renewing leases, which should have a positive impact on OPI's occupancy and reduce ongoing leasing capital.

These two strategies are expected to create long-term cash flow accretion and contribute to maintaining a well-covered dividend. Entering 2019, OPI has a broader investment strategy to foster growth and is a company with increased scale and greater diversification. We believe we have reduced risk at OPI by lowering our concentration of U.S.

government tenants, increasing geographic diversification, lengthening our weighted average remaining lease term, creating a more well-laddered lease expiration schedule and reducing our exposure to floating rate debt.

We have also increased the size of our board, adding two independent trustees, which increases the number of female trustees to 38% and the total number of independent trustees to 75%.

On December 31, 2018, OPI's portfolio consisted of 247 buildings containing 31.9 million square feet that were 91% occupied with a weighted average remaining lease term of 5.7 years and an average building age of approximately 17 years.

64.9% of our annualized rent is paid by investment-grade rated tenants, which we believe is one of the highest percentages of rent paid by investment-grade rated tenants in the office REIT sector. The U.S. government is our largest tenant, accounting for 25.6% of annualized rent.

This is a reduction from 45.6% pre-merger, and no other tenant accounts for more than 2.7% of annualized rent. We have also reduced the percentage of leases expiring through the end of 2021 from 47.4% of annualized rent pre-merger to 27% at the end of the quarter.

OPI's investment strategy will focus on office properties and markets that have strong economic fundamentals to support growth and will include properties leased to single tenant and multi-tenant properties leased to high credit quality tenants like government entities.

Key criteria for acquiring single-tenant properties will include the evaluation of how strategic a property is to the tenant's business, focusing on corporate headquarters, build-to-suit properties and buildings where the tenants have invested meaningful capital.

Single-tenant building acquisitions will also include a minimum remaining lease term of seven years. Properties leased to government tenants will include both single-tenant and multi-tenant buildings and will focus on agencies that have high security needs or a mission that is strategic to the building's location.

We expect to acquire primarily first-generation buildings where there is a reasonably high probability of renewing the tenant in place and where ongoing capital needs are expected to be relatively modest compared to older buildings. Turning to our capital recycling.

In addition to initially selling properties to reduce leverage, we plan to have an ongoing capital recycling program of $100 million to $300 million annually to shape our key portfolio metrics and to manage ongoing capital requirements. As a reminder, we recently announced the completion of the sale of 34 buildings in the metro D.C.

market for gross proceeds of $198.5 million. This completed the disposition plan associated with our acquisition of First Potomac Realty Trust in the fourth quarter of 2017. In aggregate, we sold $520 million of properties to permanently finance the acquisition.

Today, OPI has 36 buildings in a disposition plan to permanently finance our merger with SIR. Two of these properties are under agreement to sell for approximately $77 million in gross proceeds, and the balance of the buildings are in various stages of marketing.

In aggregate, we are selling approximately 5.9 million square feet of buildings that we believe will generate more than $750 million in gross proceeds.

Considering our progress on this disposition plan since completing the merger, we remain confident that OPI will substantially complete the sale of these properties before announcing second quarter earnings.

This will position the company to comfortably re-enter the acquisition market in the second half of 2019 while continuing to shape the portfolio with a capital recycling program. In summary, we are excited about the opportunities available to OPI as a stronger company with greater scale and financial flexibility.

We also look forward to executing on our capital recycling plan and returning to growth in the second half of 2019. I will now turn the call over to Jeff to provide an overview of financial results..

an underlying non-cash loss of $48.2 million from OPI's investment in The RMR Group Inc.; a non-cash loss of $18.7 million on the sale of SIR shares in Q4; and $10.7 million related to the transaction costs associated with the merger.

These items were partially offset by the reversal of GOV's previously accrued business management incentive fee expense of $17 million. As a result of the timing of the merger and the impact to overall results, I plan to focus the remainder of this discussion covering Q4 2018 pro forma results as if the merger had occurred on October 1, 2018.

Pro forma normalized funds from operations would've been $49.6 million or $1.03 per share for the quarter and includes a $25.8 million business management incentive fee incurred by SIR as of December 31, 2018, that was subsequently paid by OPI.

Our first, second and third quarter normalized FFO calculations exclude accrued business management incentive fees and are included in the fourth quarter when the amounts are determined.

As a reminder, the ending share price used to calculate the total return for the incentive fee is the highest 10th consecutive day average closing price over the final 30 days of the measurement period. Pro forma consolidated cash basis net operating income, or cash basis NOI, would've been $119.9 million for the fourth quarter.

On a pro forma same-property basis, cash basis NOI would've been $97.1 million, which equated to an increase of approximately $500,000 or 0.5% as compared to the same period of the previous year, which is primarily driven by higher rents in the legacy SIR portfolio.

Excluding the net impact of business management incentive fees, our pro forma run rate for G&A expense is expected to be within a range of $10 million to $12 million per quarter.

On a pro forma basis, capital expenditures would've been $25.6 million, of which $12.5 million related to recurring building improvements and $13.1 million was attributable to tenant improvements and leasing costs. As of the quarter end, we have approximately $58.4 million of unspent leasing-related capital obligations.

Pro forma debt to adjusted EBITDA was approximately 7.6 times. However, when including the debt repayment from the $198.5 million of asset sales that closed in February 2019, our debt to adjusted EBITDA would have been 7.2 times.

As we begin to execute on our disposition strategy to delever the portfolio, we expect to achieve our target debt to adjusted EBITDA ratio to be between 6 to 7 times by the second half of 2019 by using proceeds from our target asset sales to pay off all floating rate debt and current fixed rate debt obligations that are due in 2019.

As a reminder, in January, we declared a quarterly dividend of $0.55 per share. This rate is approximately 75% of our expected cash available for distribution for 2019, a level which is expected to provide us with greater financial flexibility and the ability to increase the dividend over time. Operator, that concludes our prepared remarks.

We are ready to open the call up for questions..

Thank you. [Operator Instructions] The first question comes from Bryan Maher with B. Riley FBR. Please go ahead..

Yes. Good morning, guys. When it comes to CapEx, I think you mentioned $25.6 million, with $12.5 million recurring and $13 million tenant improvements.

What should we be thinking about for the combined entity for the full year as it relates to CapEx?.

Bryan, that's a good question. I guess what I would tell you is we expect to lease about 1.5 million square feet of space during 2019. And we think that the average leasing capital per square foot is going to be around $2.65 per square foot..

Okay..

Jeff, building capital?.

And then in addition, for building capital, we have a range of approximately $60 million to $80 million in building capital..

Did you say $60 million to $80 million?.

Correct..

And that would be just recurring regular CapEx for the portfolio?.

Correct..

Okay. So moving on to your lease renewal rates that you reported. Just to be clear, I think it was like down 7.8% below prior rents for those properties that had renewals for the fourth quarter.

To be clear, that was just GOV? Or was that GOV and SIR?.

That was just GOV. But with that said, Bryan, I think we only have one lease renewal..

SIR..

At SIR, and it was small. So it would not have a material impact..

And as you look out to 2019, and I'm not really sure you want to give this number, but directionally and magnitude-wise, what should we be thinking about for lease renewal rates?.

Well, we think that both new and renewal leases for 2019 will be roughly flat compared to leases in place today..

Okay. Great. That's exactly what I was looking for. And then just lastly, after you get done with the - I think in the press release, I saw like a $700 million number of the new sales, and on your prepared comments, you said $750 million.

Is it closer to $700 million or $750 million in sales?.

The expected sales for 2019, we expect to exceed $750 million..

Okay. And then just to be clear, after this current round of sales, as we look at kind of the back half of 2019 and 2020, other than the $100 million to $300 million of capital recycling, you are pretty much done with dispositions.

Is that correct?.

Well, I think the important thing, Bryan, is to focus on the fact that we expect to have an ongoing capital recycling program. The more than $750 million of dispositions for 2019 will right-size our leverage. Beyond that, it becomes a portfolio shaping exercise and an opportunity to create CAD accretion through dispositions..

Right. That's what I said. After the $750 million, it's pretty much $100 million to $300 million on a regular basis but no other material portfolio dispositions or, I would expect in the near term, meaningful acquisitions.

Is that the way to think about it?.

Yes. We expect to be back in the acquisition game in the second half of 2019. So we'll see how the market looks in the second half of the year..

Okay. Thanks. That's all from me..

Okay. [Operator Instructions] The next question comes from Adam Gabalski with Morgan Stanley. Please go ahead..

Hey, guys. This is Adam on for Vikram. I just wanted to talk a little bit more about the planned dispositions.

Are you guys going to be selling stabilized assets? I'm just trying to get a sense of what this $700 million to $750 million in dispositions is going to mean for portfolio occupancy once it's completed?.

Well, Adam, it's a good question, Adam. Well, I think what I would tell you on that is we - and we ended the year at 91% occupancy. We expect occupancy to be, in the fourth quarter of 2019, about 91.5%. We expect it to get higher than that throughout the year but then kind of reduce to 91.5% by the end of the year.

The average occupancy of the buildings that we are selling is just under 80% because it includes a handful of vacant properties to include a large land parcel that's vacant..

Got it. That's very helpful. Thank you. And then just one more. As far as the dividend moving forward, in the merger documents, you guys outlined a 75% target CAD payout ratio.

Just now that the portfolio is integrated, do you guys see that as sort of an achievable target moving forward with the way you've set the dividend out of the gate?.

Yes. We specifically set the dividend - or the dividend we declared in January was based upon what we expect to be around a 75% CAD payout ratio for 2019..

Got it. Thank you..

Okay. Seeing no further questions, this concludes our question-and-answer session. I would like to turn the conference back over to David Blackman for any closing remarks..

Great. Thank you. And thank you for joining us today. We look forward to updating you on our first quarter activity in a couple of months. That concludes our call..

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