James Farrar - Chief Executive Officer & Director Anthony Maretic - Chief Financial Officer, Secretary and Treasurer.

Craig Kucera - Wunderlich Securities Rob Stevenson - Janney Montgomery Scott.

Good morning, and welcome to the City Office REIT Inc. First Quarter 2016 Earnings Conference Call. At this time, all participants are in a listen-only mode. [Operator instructions] It is now my pleasure to introduce you to Tony Maretic, the company’s Chief Financial Officer, Treasurer and Corporate Secretary. Thank you, Mr. Maretic. You may begin..

Good morning. Before we begin, I would like to direct you to our website at cityofficereit.com where you can download our first quarter earnings press release and a supplemental information package.

Certain statements made today that discuss the company’s beliefs or expectations or that are not based on historical fact may constitute forward-looking statements within the meaning of the Federal Securities laws.

Although the company believes that the expectations reflected in such forward-looking statements are based upon reasonable assumptions, we can give no assurance that these expectations will be achieved.

Please see the forward-looking statements disclaimer in our first quarter earnings press release and the company’s filings with the SEC for factors that could cause material differences between forward-looking statements and actual results.

The company undertakes no duty to update any forward-looking statements that may be made in the course of this call. The earnings release and supplemental package both include a reconciliation of non-GAAP measures that will be discussed today to their most directly comparable GAAP financial measures.

I will review our financial results after Jamie Farrar, our Chief Executive Officer, discusses some of the quarter’s operational highlights. I will now turn the meeting over to Jamie..

Thanks for joining today. I’m pleased to report that we had a strong start to the year operationally. Our focus has been on taking steps at our properties to unlock additional value by extending lease terms, securing strong credit tenants and driving property-level net operating income.

As we’ve communicated on our last few calls, the first half of 2016 will be a transitional period. 181,000 square feet of space is under construction for St. Luke’s and Kaiser Foundation at our Washington Group Plaza and AmberGlen properties. No rent was received from these tenants during the first quarter, while their space was being completed.

Despite this, we maintained strong core FFO of $0.32 for the quarter, which was slightly ahead of our expectations. Also, excluding the two properties that I just mentioned, our same-store net operating income from our other properties grew an impressive 3.6% over the prior quarter. In terms of the build out of Kaiser and St.

Luke’s space, both are progressing well. Subsequent to quarter end, Kaiser’s 33,000 square feet of space was delivered and the rent term commenced. St. Luke’s 148,000 square feet, which involves renovating an entire building is progressing well and is tracking for delivery at the start of the third quarter.

Moving to our overall leasing activity, we completed 75,000 square feet of new and renewal leases during the quarter. While occupancy at quarter end is temporarily at 87.3% due to the build-out of the two tenants that I just mentioned, when including committed leases, it ended the quarter at a healthy 93.2%.

Other noteworthy leasing activity included completing a one-year 39,000 square foot renewal with the Fairwinds Credit Union at our downtown Orlando property. This lease was completed at a $33.51 blended per square foot rate with no TI and the term was extended until June 2017.

The lease will automatically extend an additional nine years at market rents unless the tenant elects to move to a specific new development.

Given that this new development has yet to commence construction and due to the fact that the tenant must exercise their option to move during the fourth quarter, we believe there’s a good likelihood that the tenant will stay long term.

Regardless, the amazing building signage on Interstate 4 across from Orlando’s Amway Center Stadium, as well as the high-quality space, positions us well if we need to backfill it. Turning to our acquisition pipeline, we have over $400 million in attractive opportunities within our target markets that meet our preliminary investment criteria.

This has given us a tremendous opportunity to thoughtfully invest the capital that we raised in our April stock offering. Our target markets are performing well and have been posting strong growth in both rental rates and occupancy.

We’ve also seen fewer groups competing with us in our $20 million to $50 million purchase price range, resulting in a strong buying dynamic. This has allowed well-capitalized groups to patiently secure acquisitions at attractive prices.

We are conducting our due diligence on a number of properties, but have not made any non-refundable deposits or waved our due diligence conditions on any of these as of today. We expect to begin making announcements during the second quarter once these conditions have been met as has been our practice in the past.

And finally, I’d like to update you on the status of our Corporate Parkway sale in Allentown. We have entered into a purchase and sale agreement for $44.5 million, exclusive of closing costs or working capital adjustments. This implies a 6.6% forward cap rate.

We currently have a $2 million deposit, of which $300,000 is non-refundable to the buyer in the event that they fail to complete the purchase. Closing is currently scheduled to occur in mid June. However, we reiterate that until a sale closes, there can be no assurance that a transaction will be completed on the terms or the timing that we expect.

I’ll now turn the call over to Tony Maretic to discuss our financial results..

On a GAAP basis, our net operating income in the first quarter was $10.1 million. This represents a $0.8 million decrease over the $10.9 million achieved in Q4 of 2015. AmberGlen and Washington Group Plaza decreased a combined $1.1 million on a sequential basis over the prior quarter.

This decrease is primarily attributable to the downtime associated with the two new major leases Jamie described earlier. When you exclude these two properties, our remaining portfolio saw a $0.3 million increase in NOI due to scheduled step-up in rents or improved occupancy.

Q1 also benefited from a $51,000 termination fee payment received at one of our properties. Excluding AmberGlen and Washington Group Plaza, we experienced a same-store sales quarter over quarter NOI increase of 4.2%, and 3.6% when excluding the one-time termination fee payment. We reported core FFO of $5.2 million or $0.32 per share.

Our core FFO adjusts NAREIT defined FFO for acquisition fees and expenses, changes in the fair value of the earnout, costs of the internalization and the amortization of stock-based compensation. Our core FFO ended the quarter ahead of our budget.

However, we ended the quarter $0.7 million lower than Q4 on a sequential basis for the same reasons described earlier. Added back to core FFO are the full and final payment and costs associated with the internalization which closed on February 1. The full internalization payment is the primary reason for the net accounting loss in the quarter.

Our first quarter AFFO is $3.6 million, or $0.22 per share.

AFFO was negatively affected by the straight-line rent adjustments of $1.1 million, of which the Dun & Bradstreet Corporation lease at Corporate Parkway and the United Healthcare lease at 190 Center represents $0.7 million and $0.4 million, respectively, due to anticipated free rent periods that were disclosed on our guidance on our last earnings call.

These amounts will continue into Q2. And by Q4, the straight-line rent adjustments will return to much lower levels. Our leasing activity and capital expenditures are clearly laid out on pages 15 and 17 of the supplemental package.

You will note that our portfolio increased by 21,000 square feet due to the BOMA re-measurement at Washington Group Plaza as a result of the recapture of additional space upon the AECOM departure. Consistent with our definition of AFFO, we have excluded some first generation leasing costs.

We have also excluded those costs associated with the major repositioning of Plaza One at Washington Group Plaza as we did in the prior quarters. Further details are disclosed on page 17 under non-recurring capital expenditures.

As you may recall, as part of our IPO and the formation transactions, the Central Fairwinds property located in downtown Orlando included a future earnout liability linked to achieving leasing and cash flow milestones.

During the fourth quarter of 2015, the NOI threshold associated with 80% occupancy was achieved and accrued for in the financial statements. $3.8 million of earnout consideration was paid in common stock and operating partnership units in Q1 on March 3, 2016.

A corresponding amount was reduced from the earnout liability on the balance sheet and this liability now stands at $1.9 million. From a liquidity standpoint, we closed on a $91.8 million equity raise after quarter end on April 5. And as such, the impact is not reflected in our March 31 numbers.

At March 31, we had cash of approximately $8.2 million and approximately $21 million remaining undrawn and authorized under our current $75 million credit facility. Additionally, we had $14.8 million of restricted cash that is available to fund future TIs, LCs and capital projects.

Our total debt net of deferred financing costs at March 31 was $345.1 million, or $338.1 million when deducting the non-controlling interest share of certain debts. Our net debt to enterprise value was 64% based on our share price at March 31.

The net proceeds from the follow-on offering was used to pay down all of the floating rate debt and contributed approximately $18.7 million to our cash balance. Utilizing our current capital structure, we expect to execute approximately $140 million to $160 million in total acquisitions over the coming few quarters.

That concludes our prepared remarks, and we will open the line for any questions.

Operator?.

[Operator Instructions] Our first question comes from Craig Kucera of Wunderlich..

For this quarter, we expected the drop in occupancy, but your operating expenses actually were lower than kind of what we were looking for.

How should we think about your NOI margins for the rest of the year? I mean, should we expect sort of something similar or will we see NOI margins sort of trail down as we lose a bit more occupancy?.

We did – the same-store sales NOI that I spoke about was – a contributor was the expenses. We do expect it to tick higher, but not all the way back. We’ve been undertaking a number of cost savings initiatives, including a number of insurance savings that we’re anticipating.

So if you’re going to trend it out for the balance of the year, it’s probably half of it will be given back and half of it will be a permanent savings..

I want to talk a bit about your acquisition pipeline and how you’re seeing things.

Which markets are looking more appealing to your right now? And how long do you think it’s going to take to acquire that $140 million to $160 million?.

So if you look at where we’re seeing the best value today, top would be Dallas, Denver, Tampa, Orlando and Phoenix. And we’re very pleased with how our pipeline is building and the stage that we’re at. So we mentioned we’ll expect some releases most likely in the second quarter.

So timing wise, we’ve guided it’ll be done by the end of 2016, but we’re confident we can accelerate that a bit..

And as far as Denver goes, I mean, just given your existing concentration there, are you sensitive or how do you think about a maximum amount of assets in a given market? Is it a percentage or would you just continue buying in Denver because you like the market and see some value in building some critical mass?.

We do like the market in Denver a lot, Craig, but we are being cognizant of that. So Denver would be, of the five I mentioned, from a priority standpoint, at the back. However, we’re looking for some really good value opportunities where we think we can create a lot of long-term cash flow. So we know Denver well.

We’re seeing a lot of opportunities there and we’re still focused there. But the other markets would be trending higher in our priority list..

And one last one. I guess I’d like to ask your thoughts on Houston, I know that you’ve been kind of watching it, and would be curious to get your thoughts on how that market is evolving..

We’re still just watching, Craig, just given the volatility in the energy price, the dark space. It’s an interesting opportunity at some point. It’s just we’re a long ways in our mind from being ready to execute there..

Our next question comes from Rob Stevenson of Janney..

Jamie, just on that last question, I mean, when you take a look at acquisition yields right now in these markets and the type of assets that you’re pursuing, have you seen a deterioration to the point where you’re back into the mid to high 7%s, or what should be expectations for the $140 million plus, more like low 7%s, high 6%s?.

It really depends on the asset and the specific attributes of it. I’d say in general, we still are comfortable in that 7% to 8% cap. And I think based on what we have in our pipeline, the mid to high level is probably where we’re going to shake out initially.

But again, when you look at certain attributes, if there is a property that has really low in-place rents and it’s fabulous real estate, it’s going to be at the lower end, maybe even a little bit less than that. But over a period of time, accelerate and be higher or above that. So you kind of have to look at it as a pool.

But I think in general from a modeling standpoint, if you look at what we have, the mid to high of that range is probably where we’re going to shake out..

And then, Tony, when we go through and do all the math and we add back the Kaiser space being delivered, the G&A and the internalization mechanism, the shares issued, et cetera, I mean, where do we really get to before you start delivering St.

Luke’s and before you make any acquisitions? Where do we really sort of flush out to on a core FFO run rate basis?.

So that’s a good question. As you mentioned, Rob, we have a number of moving parts here. So depending on which parts you want to exclude, I think the first one is Jamie talked about Corporate Parkway. Our guidance that we issued at December, on our last earnings call assumed no acquisitions and no dispositions.

And so if we start with Corporate Parkway, you’d have to subtract that out. We indicated on the call how much of free rent is applicable. It was $0.7 million. So that would have to be deducted out of the numbers to get to your starting point.

The next thing you should do is, in terms of acquisitions, $140 million to $160 million is what we’ve talked about in terms of adding in acquisitions. Jamie just gave you the cap rate range, so you’d have to add those two amounts in. And then by Q4, we still believe we’re going to be kind of very close to the levels that we ended 2015.

We are going to be operating or anticipating operating at a lower leverage levels that we did at March 31. So there are a few moving parts. And I’m not sure if I answered your question completely..

I guess another way to phrase it is, the $0.32 of core FFO in the quarter, I mean, obviously there’s a deduct for the shares outstanding until you deploy that capital. And then there’s the partial quarter change for the G&A and the internalization and such.

If we think about it, what sort of out of that core, is it everything in the core is continuing here except for Corporate Parkway potentially and the add-back for the Kaiser space? Is that the other way to think about it?.

Yes, that’s exactly right. I mean, you have the higher share count obviously beginning in Q2 as well that you have to factor in. But yes, you’ve got all the pieces..

As there are no additional questions, we will terminate the call at this time. Thank you for joining today. Have a great day..