Good morning and welcome to the City Office REIT Inc. Second Quarter 2020 Earnings Conference Call. At this time all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation.

[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'd like to direct you to our website at cityofficereit.com where you can view our second quarter earnings press release and 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 reflect in such forward-looking statements are based upon reasonable assumptions, we can give no assurance that these expectations will be achieved.

We 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 obligation to update any forward-looking statements that may be made in the course of this call. I'll review our financial results after Jamie Farrar; our Chief Executive Officer discusses some of the quarter's operational highlights. I will now turn the call over to Jamie..

Good morning. Thank you for joining us today. On our last call we discussed a number of strategic initiatives that we take in to weather these uncertain economic times and optimally positioned ourselves going forward. I will begin by providing an update on this plan.

First, we stopped all new property acquisitions and continue to expect that we will not purchase any new properties in 2020. Transaction activity remains limited in our markets and we have not seen compelling opportunistic or distressed situations.

Second, as part of our defensive plan, we elevated our cash holdings and lowered our targeted leverage levels to operate more conservatively. During the quarter, we reduced our cash on hand, but we expect to continue to maintain elevated liquidity for the foreseeable future.

Third, we adjusted our dividend to a level that would allow us to generate excess cash over the long term. During the quarter, we incurred $3.9 million of costs for our previously disclosed 70,000 square foot 10-year lease at our Denver Tech property.

Normalizing for this new lease cost, our adjusted dividend was well covered on an AFFO basis at our lower leverage levels. Last, we announced our intention to repurchase up to $100 million of our own common stock. In July, we completed the repurchase program for the full $100 million at an average price of $8.80 cents per share.

I'm particularly pleased with the results of this execution, which effectively allowed us to buy part of our own properties back at a large discount to their inherent value. Over time, this will be highly accretive to our performance, while still leaving us a healthy level of liquidity.

Our focus during the second quarter continues to be on operations, collections and leasing. All of our buildings continue to be open, operational and available for tenants.

We've witnessed a recent increase in utilization of our buildings as the country continues to reopen, but utilization remains relatively low, especially as COVID-19 cases have again increased in some of our markets. Collections have been a bright spot for the company.

As I highlighted on our last call, we have a relatively low exposure to the industry's most directly impacted by COVID-19. We collected over 99% of base rental revenue during the second quarter and have collected over 98% of July base rental revenue.

We've granted rent abatement to only five tenants primarily cafe operators, which represent a total of just 12,000 square feet. We've also reached agreement on rent deferrals on a total of 48,000 square feet, all of which is expected to be repaid by the end of 2021.

In total, abatement and deferrals represent approximately 0.6% of base rental revenue in the second quarter. Moving on to leasing activity. Discussions with tenants and leasing brokers highlight the overall uncertainty regarding future space needs.

Tenants have been dealing with work from home challenges, safely reopening their offices and determining their future space requirements.

We continue to believe that over the medium term, tenants in our markets will return to the office but also balance elements of remote working and contemplation of additional regional offices closer to suburban employee housing stock.

It is early stages but the densification trends and workstation hoteling seems to be shifting to dedicated employees space and social distancing. This would help offset overall space reductions.

We continue to believe that our cities will be net beneficiaries over the long term, as companies look to relocate their workforces to high quality of living and low state tax markets. In terms of new leasing, with the exception of life sciences, which I'll discuss further in the moment, new leasing activity has been slow.

However, renewal leasing discussions remain active, particularly given the quality sub markets where we own properties. During the quarter, we executed 60,000 square feet of new leases and 266,000 square feet of renewal leases. Of the 60,000 square feet of new leasing, 44,000 square feet was expansion space for existing tenants.

The largest expansion was the state of Colorado taking an additional 37,000 square feet of expansion space at our Cherry Creek property in Denver. Once that lease commences, the state will occupy 100% of the three building campus. Before I discuss our outlook, I'd like to give an update on a major lease that was executed after quarter end.

This transaction has unlocked a lot of value in our portfolio. As I mentioned earlier, the life science sector continues to be very active and we had a lot of interest in leasing a 51,000 square foot space at our Sorrento Mesa portfolio in San Diego that rolls in November of this year. Ultimately, we renewed our existing tenant.

Their lease was set to expire on November 30 at an annual triple net rate of $15.19 per square foot. The renewal lease more than triples the rate to $54 per square foot net for a 12-year term. This will generate us approximately $2 million of incremental rental revenue per year.

In addition, the tenant will take a 26,000 square foot space in the same building after the existing tenants lease expires in August of 2021. When that expansion lease commences, it will generate a further $800,000 in annual rental revenue. Finally, this tenant also occupies another building at our campus, comprised of 59,000 square feet.

We extended the expiration of that lease from 2026 to 2032, and enhance the overall security package underpinning the lease. We'll provide further updates on this and other aspects of our life science properties in the future, but we've been successful in finding ways to enhance the value of that portfolio.

Finally, I'll turn to our outlook for the coming quarters. We continue to believe that providing our own internal guidance consideration is helpful for investors despite the challenges in forecasting today.

Even though we've achieved strong leasing and financial results in the quarter, many of the uncertainties and risks that led us to initiate strategic shifts to our business still remain. With the rising cases of COVID-19 in many U.S. states including elevated cases in some of our markets, we believe a cautious outlook is still warranted.

Further, the impact on businesses and in particular small businesses that relied on government funding for short term relief will continue to manifest throughout this year and into 2021. Taking into account our results and observations to date; we've adjusted our guidance assumptions and expectations for the balance of 2020.

The net effect of strong collections and leasing activity to date is an upward revision to our 2020 forecasted net operating income, same-store cash NOI growth and core FFO per share expectations. I'll now turn it over to Tony to provide further detail on our financial results..

Thanks, Jamie. I'll address the second quarter's results and then turn to our updated outlook for the remainder of the year. On a GAAP basis, our net operating income in the second quarter was $25.5 million, which was slightly higher than the $25.4 million we reported in the first quarter.

We benefited from the amortization of a lease termination fee payment at our Cherry Creek property. As Jamie mentioned, the state of Colorado is expanding to occupy an additional 37,000 square feet of space. The expansion space was terminated by the existing tenant, resulting in a total termination fee of $0.9 million.

We recorded $0.4 million of this income in the second quarter and the remaining $0.5 million will be amortized into the third quarter as the tenant departure date has been set for September 30.

That space will remain vacant in the fourth quarter at a loss of approximately $200,000 in rental revenue until the state of Colorado commences occupancy on January 1, 2021. Therefore, the total positive impact of the transaction is a net $700,000 tour 2020 results.

The termination fee income in Q2 was offset by rent abatements and air provisions that totaled approximately $200,000. We reported core FFO of $14.1 million or $0.29 cents per share, which was $200,000 lower than in the first quarter, primarily due to higher interest costs, offsetting the higher net operating income.

The higher interest costs were due to the draw on our credit facility we made in March to ensure we had sufficient liquidity to complete our stock buyback program and weather uncertainty. Our second quarter AFFO was $6.6 million or $0.14 cents per share.

AFFO in this quarter was lower due to the elevated costs of tenant improvements and leasing commission's incurred during the quarter tied to strong prior leasing activity. The largest leasing costs relate to the previously announced 70,000 square foot 10-year new lease with the engineering firm [indiscernible] at our Denver Tech property.

As Jamie mentioned, during the second quarter, we incurred the remaining $3.9 million of the $5 million tenant improvement allowance for this tenant. Those costs alone impacted AFFO per share by $0.8.

No further costs are expected for this tenant improvement allowance and therefore we expect to return to dividend coverage beginning in the third quarter as capital expenditures costs returned to normalize levels. We also have some continuing capital expenditures, the largest of which related to work at our Circle Point property in Denver.

We expanded the scope of the work originally, planned that acquisition to include cosmetic exterior improvements, which impacted AFFO in the quarter. Due to the relative size of our portfolio and the impact of significant leasing in any one quarter, our FFO numbers will continue to move around, some from quarter to quarter.

Our second quarter same-store cash NOI grew 2.3% versus the second quarter last year. San Diego was one of our best performing markets in the second quarter as the impact of the free rent periods for new leasing in the prior year burned off. Moving on to our balance sheet. Our cash and restricted cash at June 30 totaled $83 million.

This substantial cash balance will ensure we have ample liquidity to withstand any unforeseen negative economic impacts caused by COVID-19. Our total debt at June 30 was $705 million. Our net debt, including restricted cash to EBITDA was 6.7x.

At quarter end or total debt had a weighted average maturity of 4.6 years and 86% of our debt was effectively fixed. We have no debt maturities in 2020 and only one maturity in 2021. During the quarter, we purchased 8.8 million shares of our common stock. Subsequent to quarter end, we completed the 100 million stock buyback program.

Including amounts purchased after quarter end, the year to date repurchases were completed at an average gross price of $8.80 cents per share. Our total fully diluted share count after the completion of the stock buyback program is approximately $43.8 million versus the weighted average of $48 million in the second quarter.

The share buyback program has led to a significant accretion in our per share results in the second quarter and we expect will have a similar impact in Q3 and going forward. On a related note, on August 5, our board approved an incremental 50 million share repurchase program.

The approval for this 50 million provides us with the flexibility to evaluate and implement the full spectrum of future capital outlay allocation options. However, we are sensitive to reducing our market capitalization and maintaining conservative leverage levels. As such, we do not currently expect to activate the program in the near term.

Last, we have provided updated full year 2020 guidance in our press release. As the impact of COVID-19 on our business in 2020 comes more into focus, we have been pleased with our high rate of collections and therefore have raised our guidance for the balance of the year. The press release covers these in more details and I will highlight here.

The main driver arise guidance range is our estimate of bad debt provisions. As our second quarter previous for bad debt and total rent abatements was less than 0.5%. We have lowered our general provisions for the balance of the year for uncollectible rents to between 0.5% and 2% of revenue. Our previous guidance was based on a 1% to 3% provision.

The positive impact of the lease termination fees, which I described earlier also contributed to the increase. Based on these revised operating assumptions, our net operating income, same-store cash NOI change, and core FFO expectations have all been increased.

Our revised guidance estimates core FFO per share between $1.15 and $1.18 for the full year ending December 31, 2020. That concludes our prepared remarks and we will open up the line for questions.

Operator?.

Thank you. We will now begin the question-and-answer session. [Operator Instructions] Your first question today will come from Michael Carroll with RBC Capital Markets. Please go ahead..

Yes, thanks. Jamie, can you talk a bit a little bit about the Lake Vista Pointe property, the short term renewal that was completed. I know that's a pretty big tenant and I think that they have that lease expiration.

So what's their thought process behind the short term renewal? Is that just to tie them over until they can make their final decision or are they planning on doing something bigger there?.

That's a good question, Mike. So discussions with that tenant have been ongoing.

They did have a right to extend their lease by three months and we continue to have discussions with them and they triggered that -- I think really to take a bit of pressure off on their end, as most tenants are trying to figure out their own space needs and usage, just give them a bit more time..

Okay. Is there any property in that area that could support their needs? I mean, I think that's before they needed more space. I'm not sure if this current environment changes that for them a little bit.

But is there a brighter prospect that they're going to renew there?.

Yes, previously, one of the options they were looking at was a build-to-suit and there's a number of potential areas, but Dallas is a large market. So there are existing vacancies that they could fit to, but we think we've got a great property and a good valuation proposition on the table for them. So discussions are ongoing..

Okay, great. I know you had another big exploration at Carillon Point coming up, too.

I guess, what's the discussions going on there? And is there a prospect of them renewing the lease sometime soon?.

Yes, it's similar story all around, were tenants right now are trying to figure out long term? What do they need? Where do they want to be? Utilization is fairly low across the board. And industry were probably around an average, but we're probably in the 20% range of current utilization.

And so when you look at renewal discussions and new leasing, things have slowed down. I think we're in a good position for that particular tenant at that space. It's a great property, but they have some time to make a decision and discussions have been ongoing there as well..

Okay, great. And I guess finally, can you talk about the Sorrento Mesa renewal that you completed? I know there was a pretty big rent step ups that we've been talking about for a little while.

Is there any PI component related events or incremental investments that you need to make into that property?.

Yes, that was a big win for us over a year. Kind of in the works on that one and we kind of landed on the trifecta. So there's three elements to it. There's a 51,000 square foot renewal, which happens in 2020. Rates step up to $54 net on an annual basis. So that's going to add about 2 million to the bottom line.

The TI on that was a very reasonable $20 a foot for a 12-year term. The second piece was they're going to take down an additional 26,000 feet in August 2021, exact same terms TI, there's a free rent on that one four months of free rent, but that'll add about another 800,000 in incremental income.

And then the final piece was really extending another property that they have with us 59,000 feet, we moved it from 2026 out to 2032. The rates will step up in 2026 to market then. So, they're similar market rates that are in existence today. It'll be a healthy step up and cash flow at that time.

And then, overall, we really modified their security package to put us in a really comfortable position. So, it was a great outcome for us..

Okay, great. And then finally, Tony, can you talk a little bit about your leverage targets.

I mean, where do you want your balance sheet to be at today, and especially given the stock repurchase program that you just kind of highlight that you put into place? I'm assuming that given where leverages today that you don't really want to execute on that?.

That's exactly right. We really put it in place the initial 59 stock buyback program, more than just to make sure we have the tool for the future.

As I said in my remarks, we don't have any intention to use it or near term, to address the kind of leverage question, you know, effectively, we don't expect it to be materially different than where we were ended at June 30. We did acquire another $12 million of stock post quarter end.

So, if you just, if we take a step back, on a net debt to value basis, this is approximately 200 basis points lower than where we would have landed under original guidance the beginning of year.

Had we not buy back stock and instead completed the $360 million of properties that we originally planned; so that the pivot and strategy really allows us to operate though at the lower levels that you see at June 30..

Okay, great. Thank you..

[Operator Instructions] The next question will come from Craig Kucera with B Riley FBR. Please go ahead..

Good morning, guys. Now that you've created so much value at Sorento mesa [ph].

Do those assets now potentially become distribution candidates, are you more likely to hold on to them?.

It's something we're considering Greg. We bought them just over two years ago. We've had a lot of success as far as leasing and enhancing cash flow and there's still some work to be done there. But they certainly are much more marketable at a substantially higher value than what we bought them at.

We're going to consider our options over the next little while and continue to really drive leasing there to try and unlock additional value..

Okay, great.

And just to circle back to Cherry Creek on the expansion there that now being a basically a single tenant in those buildings, did you get a lease extension when they agreed to take that expansion space?.

No, we basically rolled the one space they took, which was going to expire about a year ish out in the future, we push that 2026 to be coterminous with the rest of the space..

Okay. And one more for me, I know you're not actively looking at transactions for 2020. But I am curious to see if you're seeing any thoughts in the transaction market and what kind of changes you're seeing in pricing in a post COVID environment..

So, kind of looking at it a nutshell, as you said, we're not really thinking we're going to execute on 2020. We do think there's going to be good opportunities. I personally think it's going to be 2021 and beyond.

And the reason being there's lots of opportunities out there, there was a lot of things being marketed pre-COVID, that stops and didn't happen. And, you know, I'm sure there's a very willing seller on the other side, whether they're going to be at a valuation expectation that makes sense in today's environment is another matter.

And so, what we've seen so far, really not massive adjustments and value from our own standpoint. You know, there's kind of two elements we need to get comfortable with.

The first element is what is the long term cash flow going to be from a property and in today's environment, when you look at where market rents are, there's uncertainty, and you look at what's going to happen on renewals, there's uncertainty, what's going to happen on certain tenants surviving in some of these properties long term again, uncertainty.

And so, for us to get comfortable, we really want to have good visibility around the cash flow at the property.

The other element which can maybe get a little bit more aggressive is if you're seeing valuations that are so compelling, you know, you're underwriting conservatively and you're still comfortable and, and neither of those elements are there today. And so, stepping back as far as what we're doing, you know, you're looking at our share buyback.

You look at us putting $100 million into our own company, we effectively bought at 8.6 cap rate on our own portfolio. When you look at kind of the midpoint of our NOI and backing up land $200 a foot, we know our assets inside and out.

We know some strong things that are happening that we've identified here on cash flow, and so we see that as a no brainer, low risk, and we preserve great liquidity we see the market today is just not being valued to a level where it's worth the risk..

Okay, just one more for me. Tony, with you guys.

Reauthorizing $50 million buyback, but not really likely to utilize it in the near-term; are you still going to likely run the balance sheet with, call it $55 million of cash today, after the third quarter buybacks or are you likely to pay down the line? Because it does seem that you have a bit more of a positive outlook, certainly, given your guidance rates and your reduction in bad debt expectations?.

Yeah, it's a very good question. Craig, back in March, when we did the draw on the line of credit, it was as much to test that the availability was there to us, we've grown our level of confidence that's certainly the case and the money is there if we need it.

And so, yes, it does make sense for us to look at our cash and pay down some of the line during the quarter given where a conference level is, but obviously will continue to monitor the situation..

Okay, great. Thanks, guys..

Thanks, Craig..

As there are no additional questions, I would now like to turn the call back over to Mr. Farrar to conclude..

Thanks for joining today. We hope that everyone has a great rest of your summer. Goodbye..

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