James Farrar - CEO Anthony Maretic - CFO.

Craig Kucera - Wunderlich Rob Stevenson - Janney Steve Shaw - Compass Point.

Good day, and welcome to the City Office REIT Inc. Second Quarter 2016 Earnings Conference Call and Webcast. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation [Operator Instructions]. As a reminder, this conference call is being recorded [Operator Instructions].

It is now my pleasure to introduce you to Mr. Anthony Maretic, the Company's Chief Financial Officer, Treasurer, and Corporate Secretary. Thank you, Mr. Maretic. You may begin, sir..

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

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.

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 these 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 second 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. 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. During the second quarter, we celebrated the two-year anniversary of our initial public offering.

Since that time, we have made significant progress by growing our portfolio with high-quality investments at attractive yields, internalizing management, and executing on a number of key operational initiatives that have increased our in-place and committed occupancy. Our target markets continue to outperform.

These select cities, excluding Houston, have achieved 3.1% employment growth during the 12 months ended May 2016. This is more than twice the national average of 1.4%. We believe that solid office fundamentals in our markets, combined with our desirable locations, will continue to drive results for our shareholders.

Our near-term pipeline is robust, and we will continue to focus on value-enhancing acquisitions and growing our portfolio's net operating income for the remainder of 2016 and beyond. We'd now like to update you on our accomplishments during the second quarter. As I mentioned on our last few calls, the successful and timely buildout of St.

Luke's 148,000 square foot space at Washington Group Plaza in Boise was one of our top priorities. Focused execution in the second quarter has been critical for us. I'm happy to report that on July 1st, as originally scheduled, St. Luke's lease commenced on a 10-year term.

Delivering their space will normalize our revenue during the third quarter, and we expect that it will provide a material contribution to our bottom line. In terms of our investment activity, in June we closed the divestiture of our Corporate Parkway property, and generated gross sale proceeds of $44.9 million.

This resulted in a $15.9 million accounting gain on sale. There is a short case study on our Web site that provides more details but the transaction was completed at a 6.6 cap rate, and a healthy $252 per square foot. We're very pleased with this result, which enables us to focus exclusively on our target markets going forward.

We also continued to execute on our strategy of buying quality properties within our target markets. Our purchase of Carillon Point during the quarter, and the Florida Research Park Collection in early July, continued to build our scale across the Tampa and Orlando markets.

These two purchases totaled $76 million, and were completed at an expected combined cap rate of approximately 8.3%, including our planned capital improvements. Both properties provide a strong roster of tenants, are well-located, and we believe are positioned for long-term NOI growth.

In addition, we continue to build a solid pipeline of acquisition opportunities that we're advancing. Moving to our overall leasing activity, we completed 55,000 square feet of new and renewal leases during the quarter, and an additional 32,000 square feet of leases that will commence subsequent to quarter end.

While occupancy at June 30th was temporarily at 88.2% due to the build-out of St. Luke space, including committed leases, it ended the quarter at a healthy 92.8%. And finally, I'd like to highlight that our decision to raise equity in April has not only allowed us to grow our business, but it has greatly improved our stock's liquidity.

It positioned the Company for inclusion in various Russell indices in June, which has also been additive to our shareholder base. These have been important steps in our Company's evolution. 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 second quarter was $9.9 million. This represents $0.2 million decrease over the $10.1 million achieved in the first quarter.

The decrease was primarily a result of the sale of our Corporate Parkway property which occurred late in the quarter, as well as a slight adjustment to the CAM charges at our 190 Office Center in Dallas. We reported core FFO of $5.3 million or $0.22 per share.

Our core FFO adjusts NAREIT-defined FFO for acquisition fees and expenses, change in the fair value of the Central Fairwinds earn-out, costs of the internalization of management, and the amortization of stock-based compensation.

Our core FFO ended the quarter $0.1 million higher than Q1, as the decrease in net operating income were offset in savings to interest expense as a result of the pay-down of debt which occurred with the proceeds of our common stock offering, which closed on April the 5th.

The sale of Corporate Parkway resulted in a net accounting gain of $15.9 million, which is the primary reason for the positive GAAP net income attributable to stockholders of $11.5 million in the quarter. Our second quarter AFFO is $3.1 million, or $0.13 per share.

AFFO was negatively affected by several straight line rent adjustments totaling $1.7 million, all of which were known and described in our outlook, which we provided at the beginning of the year.

The Dun & Bradstreet Corporate lease at Corporate Parkway contributed $0.6 million to the total, and the United Healthcare lease at 190 Center contributed $0.9 million. Our Q3 AFFO will reflect two months of free rent related to the St.

Luke's lease commencement on July 1st, after which the straight line rent adjustments will return to much lower levels. Our leasing activity and capital expenditures are clearly laid out on pages 17 and 19 of the supplemental package. 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 quarter. Further details are disclosed on page 19 under non-recurring capital expenditures. From a liquidity standpoint, we closed on the 91.8 million common stock offering on April 5th.

At June 30th, we had cash of about 7.7 million, and approximately 53 million in restricted cash, which includes 38.9 million of cash on the sale of Corporate Parkway that we subsequently used to acquire the Florida Research Park Collection post quarter end in a like-kind exchange pursuant to Section 10(31) of the Internal Revenue Code.

We also have 75 million authorized under our current credit facility, of which only 17 million was drawn at June 30th. Our total debt net of deferred financing costs at June 30th was 289.8 million, or 282.8 million when deducting the non-controlling interest share of certain indebtedness.

Our net-debt-to-enterprise value was 46%, based on our share price at June 30th. Lastly, we have updated our full-year guidance to reflect the equity raised during the quarter and subsequent acquisitions. We have also assumed that we execute on another approximately 60 million to 70 million in transactions prior to the beginning of the fourth quarter.

Based on these assumptions, we are estimating core FFO between 23.8 million and 24.2 million for the full year ended December 31, 2016. Further details on how we arrived at that outlook, including a more complete discussion of our assumptions, can be found in our press release. That concludes our prepared remarks.

And we will open up the line for questions.

Operator?.

We will now begin question-and-answer session. [Operator Instructions] The first question is from Craig Kucera with Wunderlich. Please go ahead..

Okay, thanks. Good morning, guys. I appreciate the color on the acquisitions. It sounded like you're doing another 60 million to 70 million this quarter.

Can you give us some thoughts on sort of the markets that look more appealing at this point within the pipeline?.

Sure, Craig. So, overall our pipeline is north of 400 million today at various stages. So we think we've got a really solid pipeline. The most value and opportunity that we continue to see is in the markets that we're primarily located today, so Dallas, Denver, Tampa, Orlando, as well as Phoenix. So that would be at the top of the list.

We are looking at some transactions in Seattle, Portland, and Austin. But for us, finding and executing on what we think is a great value play is our main priority..

Got it.

And where are you currently seeing debt funding rates as far as the quotes you're getting from various sources?.

Hey, Craig its Tony here. So we are working on some financings as we speak on some of the recent acquisitions. And in terms of spreads and rates, it's come down considerably so for seven year money, 3.5% to 3.75%; and for 10-year money, also kind of just in that higher end of that range, so sub 4 percentage rates..

Are you more inclined to go with the shorter term, or kind of how do you think about managing that sort of maturity?.

Yes, I mean I still think we're at the kind of numbers I just quoted. It's still very attractive to put on long-term financing. So I think you'll see us continue the trend seven or 10-year terms, just to take advantage of those ultra-low rates.

We may start using our line of credit a little more, and have maybe somewhere in the neighborhood of 10% to 20% on our line to balance that out and take advantage of further changes..

When we look forward to 2017, you've got a bit of a pickup in lease expirations.

Can you give us some color on any concentrations in markets or any large chunks of space with particular tenants? And how are discussions going regarding potential renewals?.

Sure. So looking at 2016 just briefly there's nothing that's really individually material. So, you're right. 2017 there is three worth discussing. There's GSA, the Idaho State Tax Commission at our Washington Group Plaza property in Boise, which is just over 110,000 feet. That rolls June 2017. We're in the course of a renewal discussion with them.

So, I think that's moving along well. The next largest would be ProBuild Holdings in Denver, which is just over 90,000 feet. That's October 31, 2017, so towards the back half of the year. They likely, as we expect, want to downsize. So we are having some discussions with them about an extension. There is a fair bit of activity within the market.

And so we are currently looking at some potentials of a take back of the space early and bringing in a new tenant. So, that market is very strong within Denver as well. And the final one which we've discussed in the past is the Fairwinds Credit Union, which rolls June 30, 2017. That's just under 40,000 feet in downtown Orlando.

As we discussed on prior calls, we did effectively a one year extension. We'll know by the end of 2016 if they would be moving to a new build. Right now it's not under construction. And if they do not choose to move there by the end of this year, their lease automatically rolls an additional nine years.

So I think putting all of them together, we're in good shape..

Our next question comes from Rob Stevenson with Janney. Please go ahead..

Tony, just to be clear on the acquisition comments that you made; you're planning on $60 million or so closing in the third quarter, so that's under contract today?.

That is not under contract, Rob, that's our estimate of the top end of our pipeline, the deals that we're working on. That's what we -- consistent with the range we gave on the last call where we talked about $140 million to $160 million, we've executed about $75 million to-date.

And so we're expecting to execute in that same guidance that we gave before. But I don't want to give the impression that that's under contract today..

Yes. So, just for clarity, Rob, that was at the start of the fourth quarter is our latest expectations..

Okay.

So if you guys close anything in the fourth quarter, you would expect at this point to go over the acquisition guidance for the year, unless something slips?.

So just making sure we're clear, we closed on 75 million to date. The guidance was effectively with the raise we did somewhere between 140 million and 160 million in total. We expect today, based on kind of the stage of where we're at on the pipeline that we will close the balance above the 75 million by the start of the fourth quarter..

Okay.

And then Tony, I mean, what beyond-- once you get that closed, what's your level of dry powder to do additional acquisitions over and above that at this point, given the balance sheet?.

Yes. So given the balance sheet, I mean the numbers that I've thrown out there would target a lower leverage than we ended the year at last year. And so if we execute on 60 million to 70 million by the end of the year, that really takes us up to a level that we're comfortable with because we do have a very small acquisition on top of that yet.

But really, that takes us to a level that we're comfortable at..

Okay.

And then just lastly Jamie, over and above the 17 expirations that you just went through, I mean what's the-- and the stuff that you've essentially put to bed from a leasing standpoint, but are commencing here in the third quarter-- I mean what's the leasing conversations that you're having to take the occupancy over and above the sort of 92.8 these days? How robust is that?.

You know, when you go through each of the markets, Rob, leasing activity has been very, very strong in all the markets where we're owners in. So we feel good. We're having discussions on a number of spaces. One of the large vacancies that we still have remaining is in Portland. When Cascade moved out, Kaiser has taken part of the space.

We're having discussions with a large credit tenant on a long-term basis to take a significant amount of the remaining space. So we're feeling good from that standpoint. And I'd say across the board, our leasing activity has been pretty strong..

[Operator Instructions] Our next question is from Steve Shaw with Compass Point. Please go ahead. .

Hey, Jamie, did you say the St.

Luke's lease started paying rent July 1st?.

So, the lease commenced on July 1st. So the impact to revenue, it will commence. There is two months of free rent. So the actual cash, which will be part of our AFFO, commences September 1st. So what you'll see if from a core FFO, we'll start to recognize revenue in the third quarter. It will impact positively AFFO as well.

But we'll get the full benefit of AFFO in the fourth quarter..

This concludes our question-and-answer session. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect..