Sarah Byrnes - David A. Helfand - Chief Executive Officer, President and Trustee David S. Weinberg - Adam Scott Markman - Chief Financial Officer, Executive Vice President and Treasurer.

John Bejjani Michael Bilerman - Citigroup Inc, Research Division Emmanuel Korchman - Citigroup Inc, Research Division.

Greetings, and welcome to Equity Commonwealth's Third Quarter Financial Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Sarah Byrnes, Vice President, Investor Relations. Thank you, you may begin..

Thank you, Brenda. Good morning, and thank you for joining us to discuss Equity CommonWealth's third quarter results. Our speakers today are David Helfand, our President and CEO; David Weinberg, our EVP and Chief Operating Officer; and Adam Markman, our EVP, CFO and Treasurer.

Please be advised that certain matters discussed during this conference call may constitute forward-looking statements within the meaning of federal securities laws.

These forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results of the company to differ materially from historical results or from any results expressed or implied by these forward-looking statements.

The company refers you to the documents filed by the company from time-to-time with the SEC which refer to these and other factors that could adversely affect the company's results. The company assumes no obligation to update or supplement any statements that become untrue because of subsequent events.

Today's remarks may also include certain non-GAAP financial measures. Please refer to yesterday's press release announcing our third quarter 2014 results for a reconciliation of these non-GAAP performance measures to our GAAP financial result, which is available on our website. Now, I will turn the call over to David Helfand..

Good morning, and welcome to Equity CommonWealth's Third Quarter 2014 Earnings Call, our first call since gaining control of the company. We know this is a busy time and a travel day for many of you heading to NAREIT in Atlanta, so we appreciate you taking the time to join us.

I'll make some introductory remarks and turn the call over to David Weinberg, our COO, who will address the October 1 transition, our partnership with CBRE, and provide an update on our operations and leasing results for the quarter.

Adam Markman, our CFO, will wrap up our prepared remarks with an update on our results and address the progress we've made with our balance sheet. As most of you know, EQC is in the midst of transition. There's still a tremendous amount of work to be done as we build an industry-leading company.

That said, we have achieved a number of objectives in a relatively short period of time that we are proud of. We've assembled a new Board of Directors with deep real estate, capital markets, legal, accounting and operations experience.

We've recruited a talented team of 60 professionals, more than half of whom are equity alumni, a significant benefit given the importance of culture to our future success. In addition, we have completely revamped the company's corporate governance, including our Declaration of Trust, bylaws and committee charters.

And we've canceled the company's poison pill. Finally, we've completed the sale of more than $900 million of noncore assets, including EQC's entire stake in SIR with the proceeds used to fortify our balance sheet. Our current focus is an in-depth asset-by-asset review of our portfolio.

The portfolio as it stands today is a disparate collection of assets scattered across the U.S. and Australia. It includes feeders, flex, industrial, vineyards and a storage facility in Hawaii.

This portfolio deep dive benefiting from access to asset-specific information and detailed submarket data will enable us to make more informed and thoughtful capital allocation decisions.

In addition, as part of our portfolio review, we are evaluating the competitive position of each property and formulating leasing and capital plans that will serve to maximize a return on invested capital. The next phase of the transition will be executing on our disposition strategy.

We've previously discussed our view that virtually all of our properties smaller than 150,000 square feet are noncore, and we'd be positioned for sale over the next 24 to 36 months. In addition, we're evaluating the timing of the sale of our Australia portfolio and our industrial assets.

Finally, I'd like to touch briefly on the current operating environment in the real estate capital markets. Given the number of markets we operate in, it's probably no surprise that we see a mixed bag in terms of fundamentals. In terms of demand, Seattle, Denver and Austin are notable bright spots.

And generally speaking, we don't see much in the way of new supply across our markets with the exception of Austin and Chicago. The economy appears to continue to plod forward and post slow-yet-steady growth. If this trend persists, it should be a decent operating environment for us.

As we previously mentioned, we expect to shrink significantly given the large number of noncore assets in our portfolio, the strength in the investment sale market and the significant challenge in finding attractive investment opportunities, both on a yield and per-pound basis. Repositioning our portfolio will take time, patience and discipline.

With that, I'll turn the call over to David Weinberg, our COO..

Thank you, David, and good morning, everyone. It's a pleasure to speak with many of you for the first time today. As David mentioned, on this call, I plan to cover the transition, our partnership with CBRE, leasing results for the quarter and update you on our operations.

Over the past 6 months, we've spent a considerable amount of time planning and organizing an operating platform that is best suited for meeting the challenges we face. It starts with an asset and investment management team that has grown from 5 professionals to 18.

This group, working closely together, has been primarily focused on preparing for the transition. This included walking our properties, engaging with our third-party leasing teams and understanding the local capital markets, many of which we have experience in. We are now digging deeper.

This includes a more in-depth analysis of our vacant inventory, examining upcoming lease wall [ph] and identifying ways to maximize the value of our portfolio.

In addition to rounding out our investments and asset management team, we have worked hard the past 6 months recruiting people for other key roles, including financial reporting, accounting, legal and investor relations. On October 1, we shifted property management to CBRE.

With respect to CB, let me begin by clarifying our partnership is limited to property management services in the United States. It does not cover leasing, investment sales or Australia. We will continue to engage the best-available third-party leasing teams on an asset-by-asset basis.

And while CB is our property manager, we are responsible for all key decisions. There are 350 property-level employees, and we consider these employees to be an extension of our team. We have direct contact with our property teams, and we'll work with them to ensure our assets are getting best-in-class property management services.

Now let me turn to third quarter performance. Occupancy declined 80 basis points during the quarter, half of which was largely due to move-outs in Chicago; Norfolk, Virginia; and a property outside of Pittsburgh. With respect to leasing, during the quarter we renewed 792,000 square feet with average cash rents down 2.8%, and GAAP rents up 0.4%.

This included a 386,000-square-feet, 16-year early renewal of John Wiley at 111 River Street in Hoboken, New Jersey. 317,000 square feet of new lease deals were signed in the third quarter with average rents on new deals declining 2.9% on a cash basis and 1.6% on a GAAP basis.

Total tenant improvement in lease costs for new leases were $13.83 per square foot, driven by a 137,000-square-feet expansion of an industrial tenant at our property in Victoria, Australia. Our largest near-term rolls is at 1735 Market in Downtown Philadelphia.

The Bank of New York Melon leases 231,000 square feet, which expires in 2015, and we expect them to downsize. As has been previously reported, FMC is also vacating their space at 1735 Market in 2016.

Another large tenant, Level 3 Communications has a portion of their space, approximately 117,000 square feet, rolling in 2015 at 600 West Chicago, which we do not expect to renew. The balance of their lease rolls in 2025 and 2026, and they are currently utilizing this space.

Finally, I'd like to update you on our operations, which currently is a focus on responsiveness and execution. We're working to be more responsive to tenants and brokers. We're reviewing our vacant inventory, making sure it's priced appropriately, and we're undertaking capital reviews of all our assets.

We believe we have the right team in place, and I'm excited to be part of it. With that, I'll turn it over to Adam Markman, our Executive Vice President, CFO and Treasurer..

Thanks, David. Good morning. It's a pleasure to be cohosting our first earnings conference call. I'm going to cover results for the quarter as well as provide additional color regarding transition expenses and our progress to-date on the balance sheet. I'll start off talking about same-property NOI for the quarter.

As I look at which metrics to measure us by, given the amount of asset sales and subsequent dilution we may have as we reposition our portfolio, I think same-property NOI is the right metric to focus on. In the third quarter, same-property cash NOI increased 7% to $114.6 million.

$2.7 million of this increase was generated by a litigation settlement received during the quarter. So backing out this onetime event, same-store NOI increased 4.4%. This increase was driven by higher cash flow income due to a burn-off of free rent, lease termination fees and lower operating expenses that primarily stemmed from tax rate reductions.

FFO for the third quarter 2014 was $207.2 million, or $1.61 per basic share and $1.59 per diluted share, which included the gain on sale from SIR of approximately $1.33 per basic share and $1.31 per diluted share.

Normalized FFO, which primarily differs from FFO due to the exclusion of both the gain on sale from SIR and nonrecurring shareholder litigation and transition costs, was $57.3 million, or $0.44 per basic and diluted share, compared to Normalized FFO in the third quarter 2013 of $63.6 million or $0.54 per basic and diluted share.

The decline in Normalized FFO was largely due to an increase in G&A of almost $0.06 per share attributable to the overlap as we've established our internalized structure while still making payments to the formal external adviser.

This quarter's results are also largely without a contribution from SIR, which was sold in early July and had a $0.09-per-share impact on Normalized FFO. The negative impact of higher overhead and the SIR sale was partially offset by a $4 million decrease in interest expense and the previously discussed litigation settlement.

G&A expense for the quarter included approximately $29.9 million of shareholder litigation costs, transition-related costs and a business management incentive fee that was part of the deal RMR struck prior to our control of the company.

Year-to-date, these onetime costs have totaled approximately $51.9 million, and we anticipate an additional $5.5 million in transition costs in the fourth quarter of 2014. We've been evaluating what our stabilized G&A level will be.

We think our stabilized overhead will come in at around $55 million per year through -- although, 2015 will also have transition-related cost of approximately $6.5 million and there's $9.8 million of potential Related/Corvex expense above the $7 million we accrued this quarter. So turning to the balance sheet.

The company has made significant improvements to its capital structure over the quarter. Cash and cash equivalents increased $375 million to $597.4 million. In addition, the company repaid $551.2 million of debt. As a result, net debt to annualized adjusted EBITDA has improved to 4.6x from 5.1x last quarter.

In the fourth quarter, we will repay an additional $132.8 million of debt with a weighted average interest rate of 7.4%, and we expect to continue to delever our balance sheet. We're focused on improving our capital structure and extending term on our debt to ensure we're nimble and financially flexible as we move forward.

Over the last several months, we've been evaluating an appropriate dividend policy that reflects the transitional nature of our portfolio and maximizes optionality over time as we sell assets and likely redeploy cash into what may be lower-yielding but higher-quality properties.

We believe this should generate higher shareholder returns in the long run but will also result in earnings dilution compared to current levels. Based on this, we will not pay an additional common dividend in 2014 but will discuss with the board a quarterly common dividend in the first quarter of next year.

Thank you for joining us today, and we look forward to having these calls each quarter to provide updates on continued balance sheet improvement, our capital structure and our plan for creating value. Operator, we'll now open up the call to questions..

[Operator Instructions] Our first question comes from the line of John Bejjani with Green Street Advisors..

I guess, first question.

As you're looking at asset sales across your market, have you started putting stuff on the market? Or which markets would you anticipate looking to get out of first? And related to that, would you do this on a one-off basis? Or are both portfolio deals likely?.

This is David Weinberg. Let me respond to that. The answer is we're looking at everything. What we're not going to do is cut and run. So we're reviewing all our assets one by one, trying to determine what is the best value maximization strategy for each asset. So to-date, yes, we have 2 smaller assets on the market.

But at the same time depending on the region and the type of real estate, we'll consider selling those as portfolios if it make sense..

Okay.

And related to that, as you sell some of these smaller assets across your markets, given your use of third-party property management and leasing, would you expect to see any material G&A reduction over time as you exit these assets, or not really?.

John, this is Adam. So, the property management expenses are property-level expenses, so we won't see a change at the G&A level because of the sale of any specific asset. It is, though, one of the great things about having CBRE as a third-party manager for us.

It allows us the flexibility to exit these markets as we've talked about without the huge disruption to our culture. Because, again, those are folks that are employed by CBRE. So no G&A savings, but we think there's this other benefit, which is simply the fact that we can get through the transition with less disruption..

Right. [indiscernible] And I guess, one last question on operation. On Page 11 of your supplemental and I think in a couple other spots, it'll put [indiscernible] the Arizona Center are going from $8 million in 2014 to $225,000 in 2015 and some comment about direct financing lease.

Can you elaborate on that or put into layman's terms what's going on there?.

Well, it's a good and hard question. We've been struggling with it. This is obviously something that was inherited by -- the Arizona Center was developed by Rouse, and when they were looking for an anchor tenant, they signed up a utility company in Arizona, and they provided them with a long-term lease extension, which was exercised.

And when that lease extension was exercised, which goes out to 2045 if memory serves, the lease term then exceeded the useful life per accounting terms of the asset itself. So it no longer was counted on our books as real estate but was really turned into this capital lease.

The most important in layman's terms to think about is that cash goes -- cash which -- receiving today is about $8 million per year, but what we'll receive after 2016 is down to something like $200,000. That's what's in the footnote. And the bad news is that, that $200,000 is going to be in place to 2045..

And our next question comes from the line of Manny Korchman with Citi..

It's Michael Bilerman here with Manny. I guess, just at the start, if you think about -- I can't remember what you had said about relocating, especially buying assets -- low-yielding assets in better quality markets, better quality buildings, and obviously, the solution that will come from that.

And it sounds like from a portfolio evaluation of what you currently own, it's a building-by-building approach. You don't know yet which markets you want to focus on, which buildings you want to keep, which buildings you want to get out of.

I guess, how should we think about what your acquisition strategy is? Have you identified certain markets? Is it more CBD? Is it suburban.

And how do you see yourselves competing in the acquisition market?.

This is David. I think we are focused on the markets we're in and trying to understand the dynamics for the purpose of evaluating the existing portfolio and the disposition. At the same time, we're mindful and we're engaged on the acquisition front to determine if there are opportunities to deploy capital at attractive returns.

I would say generally speaking, we don't see a lot of opportunity on the acquisition side. Markets are very liquid. There's lots of interest in on a per-pound basis and yield basis, as I mentioned. The stuff we've been underwriting, we've not been close to the market-clearing price.

So we'll continue to evaluate acquisitions in markets that are attractive, principally the markets we're already in, maybe a couple of others.

And if we can find acquisitions that make sense, we will deploy capital that way, but we want to be clear that generally speaking, we think the overall trend will be to get smaller to sell into what we think is a good market, a liquid market.

On the disposition side and the husband capital for what we would expect to be a better opportunity to acquire assets moving forward..

Outside of the markets that you're already in, what new markets have you looked at in terms of acquisitions?.

In terms of which markets we've looked at, I would say markets that we've had experience in previously where we have relationships, where we like the fundamentals, and I really don't want to get into the specific markets we've evaluated because our real focus is on the transition and on evaluating the portfolio as we discussed.

But within our team, we have extensive experience in a number of markets, both our existing markets and other markets, and we're constantly evaluating what's going on and trying to ascertain whether there's an opportunity to buy specific assets. We recently looked at some assets on the West Coast.

They were actually previously EOP assets, and again, we weren't close. So we're going to spend most of our time looking at our existing portfolio, but we will continue to evaluate acquisitions..

If you think about sort of your dividend comment in terms of you need to evaluate it. One of the big drags that this company had before was the significant amount of CapEx just given the prior management's strategy of buying high-yielding FFO assets that were older and needed a lot of CapEx.

And so this company was spending almost $200 million, $155 million a year on CapEx, and it's an improvement to leasing cost -- building improvements, and you're still on that same sort of track right now.

I guess, how should we think about the capital plan? And as you think about when Corvex and related had started their proxy contest, big part of that strategy was sustained capital lease up the buildings, even more capital, and a little bit [ph] company was spending before for value.

So I'm just curious how you guys are thinking about, and whether you're holding back CapEx for now? Have you -- do you do anything differently?.

And this is Adam. The future capital is a tough thing to answer, and it's going to be highly dependent on our asset-by-asset review, which we've mentioned now already on the call and discussed.

So that's going to help us determine where to spend and how much to spend but probably most importantly what's going to matter to the capital budgets going forward is what we end up owning and what we end up disposing it. And so we're in the middle of that analysis now. And an output of that will be a better understanding of our future capital needs..

And this is David. Can I add to what Adam said, I think your question is thoughtful in the sense that how we deploy capital and the return that we can generate from it is a key consideration in everything we do.

And so, as we talked about the deep dive, one of the ways we'll determine whether assets should be disposed or be held will be whether or not we think we can invest capital at attractive rates of return and create value over the long term. If we can't, then we'll be a seller of those assets..

And then just want to -- in terms of geography, in terms of income statement, as we think about prior management, new management and the CBRE, I think David had mentioned all the CBRE cost or operating expenses, which would have replaced beyond RMR property management fees that they were earning.

I don't know if there was a positive or negative spread between those. And then, like if I was -- I guess, maybe I was surprised that the G&A is still going to be at the $55 million level, which is effectively where it was previously, maybe a hair under.

Can you just walk through some of the dynamics between what's in OpEx, what's in G&A and sort of given the size of the company, the $55 million seems like a lot?.

Sure. This is David Weinberg. Let me start with OpEx at the property level. I think there are actually a couple components embedded in your question. First, we're still finalizing 2015 budgets.

But what I've seen so far suggests that our salary and benefits, which is a function of CB's property management and the reimbursable expense, will be coming in lower than historical comparable expenses. The other item that you're going to see rolling through our expenses will be historically RMR's charged a prompt 3% property management fee.

CB's blended property management fee will be less than that. Of course, that means our overall operating expense level should be lower, which will be reflected in higher operating margins. Then in terms of G&A, perhaps Adam can speak to that..

Yes. Well, the G&A that you're referring to from the press release, don't forget that there's detail there that included in that are some expected nonrecurring items, so....

I thought the $55 million was -- I sort of [indiscernible]. I thought the $55 million was sort of the ongoing..

That's right. I was pointing to the paragraph in the press release where we talked about a range for 2015, and then for your point, note that the $55 million is the recurring number. And what we've done there is started with 0-base budgeting and gone department by department and built up a budget.

And, obviously, it included noncash compensation as a piece of that, and our rough estimate is that number. I think it was important to get something out, just again, given as you know how much nonrecurring CapEx -- excuse me, G&A has been hitting the numbers over the last year through this pipe [ph]..

Right. The third core was what Corvex [indiscernible] what Adam [ph] was running through was that $55 million. They were making the argument that it actually was a discount, and I was making the argument that I'm paying for a fiscal's G&A, doesn't matter that you're being efficient. We're not getting the full benefit of the people that we're employing.

And I guess if you were to look at what the company was before, they were running about at that $55 million, $57 million core number. And I'm just curious if you sort of looked at what the company was spending and what you're going to spend, I guess I'm just surprised it's the same number..

42 million feet and 156 properties. So it's spread out. Each individual asset requires focus and staffing and manpower. And I can tell you that we're focused on the G&A level. We understand that it's a drag on return, and we'll be mindful of it going forward.

But I would also ask that people focus on the performance over the next few quarters and over the next few years to determine whether the G&A investment is worthwhile..

[Operator Instructions] And our next question is a follow-up question from the line of Manny Korchman with Citi..

It's Manny here.

Just -- as you sit back and think about timing for both putting the plan in place and then executing that plan, where are you thinking those -- both of those events could happen? Is it going to take a couple quarters, a couple years, longer than that?.

David mentioned in his opening remarks that 24 to 36 months were kind of what we were thinking about to get from where we are today to where we need to be in the future. So it takes time. And it's the one thing that we've tried to impress on everyone we've met with. We're starting from scratch. There's a lot of work to do here.

We're working hard to get it done, but it's a series of steps. And we need to get through this one before we can take the next one..

Thank you. And it seems that we have no further questions at this time. I'd like to turn the floor back to Mr. David Helfand for closing remarks..

Thank you. I want to thank everyone for joining us today. As I mentioned previously, team is well aware here that there's a tremendous amount of work to be done, and we're committed to the task. I do want to take a moment to acknowledge the work of our team over the past 8 months. Their commitment, passion and dedication are remarkable.

An old friend of mine once told me that the ethos of the equity company is that we don't know what we can do, and the EQC team's accomplishments to date are proof of that.

Finally, we've received advice, assistance and encouragement from Equity Residential and Equity Lifestyle as well as a number of lenders and investors, all of whom are rooting for our success. We're grateful for their support. We look forward to a continuing dialogue and will provide regular updates on our progress.

We appreciate your interest in Equity CommonWealth. Thank you..

Ladies and gentlemen, this concludes today's teleconference. You may disconnect your lines at this time. And thank you for your participation..