Easterly Government Properties, Inc. (DEA) Q1 2016 Earnings Report, Transcript and Summary

Greetings and welcome to the Easterly Government Properties First Quarter 2016 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] As a reminder, this conference is being recorded. I would now like to turn the conference over to Meghan Baivier, Chief Financial and Operating Officer. Thank you. Please go ahead.

Good morning. Before the call begins, please note the use of forward-looking statements by the Company on this conference call. Statements made on this call may include statements which are not historical facts and are considered forward-looking. The Company intends these forward-looking statements to be covered by the Safe Harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995 and is making this statement for the purposes of complying with those Safe Harbor provisions. Although the Company believes that its plans, intentions, expectations, strategies and prospects as reflected in or suggested by those forward-looking statements are reasonable, it can give no assurance that these plans, intentions, expectations or strategies will be attained or achieved. Furthermore, actual results may differ materially from those described in the forward-looking statements and will be affected by a variety of risks and factors that are beyond the Company's control including, without limitation, those contained in Item 1A, Risk Factors, of its annual report on Form 10-K for the year ended December 31, 2015, filed with the SEC on March 2, 2016, and its other SEC filings. The Company assumes no obligations to update publicly any forward-looking statements whether as a result of new information, future events or otherwise. Additionally, on this conference call, the Company may refer to certain non-GAAP financial measures such as funds from operations and cash available for distribution. You can find a tabular reconciliation of these non-GAAP financial measures to the most comparable current GAAP numbers in the Company's earnings release and separate Supplemental Information Package on the Investor Relations page of the Company's Web-site at ir.easterlyreit.com. I would now like to turn the conference call over to Darrell Crate, Chairman of Easterly Government Properties.

Thank you, Meghan. Good morning, everyone. Welcome and thank you for joining us for our first quarter conference call. Today I am joined by Bill Trimble, our CEO, and Meghan Baivier, our CFO and COO. DEA remains the only internally-managed public REIT focused on United States government leased real estate. Our portfolio is young, generally a generation younger than other REITs, and our leases are backed by the full faith and credit of the United States Government which provides a foundation for strong recurring cash flow. Our acquisition strategy is executing above the expectations that we set during the IPO. Turning to the quarter, we were pleased with the first quarter acquisition of ICE, Albuquerque. Our team is strong and we have the resources to execute. Our internal management team has meaningful expertise in originating, underwriting and servicing our target assets. We believe our balance sheet supports our earnings growth strategy with low leverage and limited exposure to interest rate fluctuations, with our assets and liabilities generally matched in terms of duration. We are focused on containing costs with our general and administrative expenses and they are well-positioned to grow more slowly than our NOI after financing costs. Lastly, our incentive structures are designed to meaningfully align us with shareholders, with emphasis on longer-term incentive compensation tied in large part to our performance and shareholder appreciation. We're very proud of our team at Easterly. We look forward to delivering between $75 million and $125 million in acquisitions in 2016 and are already well on our way following our first acquisition of the year. We continue to execute upon our goal of delivering strong earnings growth year-over-year. Lastly, I would like to post you on other good news. In addition to our Annual Meeting this week, we will welcome over 60 institutional limited partners to our list of public shareholders as we extinguish the private equity funds on which we were established. These investors are stable, long-term shareholders from some of the largest pensions and endowments. Some have been investors in this portfolio since 2010, under the exact investment discipline we are executing each day. They understand that our dividend yield and growth opportunities are very attractive, particularly on a risk-adjusted basis. When they originally invested with us, the investor expectation was for no opportunity for liquidity until the year 2020, and while we've gone public, little about their investment thesis has changed. The transformation into a REIT last February preserved for their cash flow stream while also delivering them double the property diversification and access to additional attractive capital as well as lower management fees. They are happy, stable shareholders. Today, the Company has a market capitalization of approximately $750 million and float of approximately $255 million. This float can be expected to increase by at least $200 million. We believe this event and our growth will continue to reduce the cost of entry and exit into our common equity and further enable us to broaden our shareholder base. With our objectives of consistent dividend growth and long-term compound FFO as-adjusted growth of approximately 7%, we believe we will continue to attract and curate a strong set of equity partners that will be part of our shareholder value creation journey. We target the long-term return profile of the Russell with far less. We are very enthusiastic about the next chapter of our growth. And now, I'll turn the call over to Bill to provide more color on the developments within Easterly that drive shareholder returns.

Thanks, Darrell, and good morning. I would like to spend a few minutes discussing our first quarter of 2016. We are very pleased to acquire the 71,100 square foot Albuquerque, New Mexico Immigration and Customs Enforcement facility, which combined with our other properties represent a portfolio of 37 buildings from which 96% of its rental income is derived from the full faith and credit of the United States Federal Government. ICE, Albuquerque represents well our focused investment discipline. With a new facility built in 2011, it serves a critical mission for an important agency of the Federal Government. The building's hierarchy of mission makes it an integral part of ICE's ability to provide enforcement in the busy Southwest Border region. The development team remains active in responding to all opportunities that would fit within the strict criteria of our portfolio metrics. While there has been very little in the way of projects that we would consider, we are actively engaged in several opportunities. Additionally, our asset management and development teams are currently engaged in a number of value-added projects to our existing portfolio. 22 of our 37 properties have seen mission enhancing projects by the government at government expense, which serves in keeping our tenant able to perform mission while keeping our already young buildings updated. Our acquisition pipeline remains robust and we are looking at a number of single-facility and multi-facility portfolios. These buildings are very similar to our existing portfolio of properties. They are leased to a single tenant of the U.S. Federal Government, are the result of a Design-Build Award, and they are usually over 40,000 square feet in size. It is important to note that we underwrite the agency and the hierarchy of mission of the prospective building before performing the deep dive on the actual bricks and mortar. We see a number of opportunities, over 200 million, that are actionable in the near to mid-term, and we'll continue to maintain our rigorous underwriting standards so as to do as well or even better than the current 93% to 95% renewal for this class of federally leased building. I will now turn it over to Meghan for a discussion of the quarterly results and earnings guidance.

Thank you, Bill. Today, I will touch upon our current portfolio, discuss our first quarter results, provide an update on our balance sheet, and review our 2016 guidance. Additional details regarding our first quarter results can be found in the Company's earnings release and Supplemental Information Package. As of March 31, we owned 37 properties comprising nearly 2.7 million square feet of commercial real estate. The weighted average lease term for the portfolio is 6.9 years and our portfolio occupancy remains at 100%. In addition, 96% of our annualized lease income is backed by the full faith and credit of the United States Government. For the first quarter, FFO per share on a fully diluted basis was $0.30, FFO as-adjusted per share on a fully diluted basis was $0.29 and our cash available for distribution was $0.26 per share on a fully diluted basis. GAAP measures and reconciliations to GAAP measures have been provided in our Supplemental Information Package. For the 12 months ending December 31, 2016, the Company is reiterating its guidance for FFO per share on a fully diluted basis of $1.19 to $1.23 per share. This guidance assumes acquisitions of $75 million in 2016, including the ICE, Albuquerque acquisition we completed in the first quarter, spread evenly throughout the year. This guidance does not contemplate dispositions or additional capital markets activities. Let me walk you through this guidance in more detail. As of December 31, 2015, given acquisitions that were completed through 2015, run rate FFO on a fully diluted basis was approximately $1.17 per share. This increase to $1.17 already included approximately 9 million of cash general and administrative expenses for the year. This amount provides the resources which we believe will support robust growth for the Company this year. A portion of this increase is compensation for our team, based on Easterly meeting or exceeding our communicated growth targets. As you know, a disproportionate amount of management's total compensation is incentive-based. To be clear, if we do not meet our growth targets, our cash G&A expense will be lower. As I said, the run rate FFO for the business at year-end was approximately $1.17 per share. We would expect the impact from $75 million of acquisitions spread equally across the year in 2016 to add $0.01 per share to our run rate FFO on a fully diluted basis, bringing run rate FFO to $1.25 by the end of 2016 and FFO for the year to a range with a midpoint of $1.21. Now turning to the balance sheet, at quarter end we had $184 million outstanding on our revolving line of credit and total debt of $267 million. Availability on our line of credit stood at $216 million. In terms of leverage, net debt to total enterprise value was 26.3%. Finally, as previously announced this week, our Board of Directors declared a dividend related to our first quarter of operations of $0.23 per share. This dividend will be paid on June 23 to shareholders of record on June 8. When we came public, our first full quarter dividend was $0.21 per share. We increased our dividend to $0.22 per share one quarter later, and now two quarters after that, we have increased it further to $0.23 per share. This is in line with our aligned expectation of consistent dividend growth. I'll now turn the call back to the operator for questions.

[Operator Instructions] Our first question comes from the line of Manny Korchman with Citigroup. Please go ahead with your questions.

Bill, in your prepared remarks you spoke about some multi-facility portfolio that you guys are looking at. Are any of those included in the 200 million near-term opportunities? And I guess whether they are or not doesn't really matter to the next question, but sort of what the size of one of these multi-facility portfolios look like?

First of all, the answer is, of course, and we have been looking at multi-building portfolios since we went public. Our overall pipeline remains at about 700 million. But 200 million, as I've said, is sort of what we'd like to have from an active standpoint.

Maybe, Manny, to bite-size, for us the portfolio can be $50 million to $100 million. That's the way to think about it. It's a couple of buildings rather than the building a quarter sort of tempo that we have tried to establish since going public.

Got it. And Meghan, just on G&A, sort of what's going to be the cadence of that over the rest of the year? It looked a little bit high in 1Q compared to the guidance for the year.

The first quarter, if you were to annualize that number, you would see it come in a little higher than our communicated 9 million rate. That's due to just the corporate activity associated with the business in that first quarter. But you can expect that to [indiscernible] and grow consistently from a run rate basis over the remainder of the year.

Great, thanks.

Our next question comes from the line of Michael Carroll with RBC. Please proceed with your questions.

Bill, can you kind of give us some additional color on the investment pipeline? I know you mentioned you have numerous activities that are actionable in the near and mid-term. What do you consider the mid-term? Is that sometime in 2016 or 2017?

I think the message is that the Company continues to do what we said we're going to do. It continues to grow. We see a very actionable pipeline going forward. And I can just reiterate that we have a terrific team here that are able to mine wonderful opportunities from a big list of properties, and I think you can expect us to do just what we've done in the past, and we're looking forward, as we said, to acquiring $75 million to $125 million in properties this year.

And have you noticed any changes with the competition in the market? Who are you meaning to competing against and has that activity picked up recently?

No, and as I said before, we really have not seen any change in the competition, as I mentioned I think last quarter, and we continue to do what we do. We think the middle sector of this market is a good place to play and I would say there are no changes.

Okay. And then I believe you touched on this earlier, but has there been any improvement in the GSA build-to-suit activity and what do you think will be the catalyst that will drive that activity higher for the government?

I think that there has not been any change. We came off in 2007-2008 when we saw a lot of activity. Obviously, the federal government is not doing as much development today. And changes would be, as these buildings become older, not our buildings because we are some of the newest in the federal government inventory, but as some of those buildings need to be replaced, the government will be forced to start building again.

And do you think after the elections, the activity will pick up, is that a good I guess marker in the future that could change that type of level?

I mean, I think the bottom line is, the spending is due to the Congress of the United States, and if you can tell me what they're going to do, I'll be very gratified, but I don't think there will be much change at this point.

Okay, great. Thank you.

Our next question comes from the line of [Helen Crowe with Crowe Family Trust] [ph]. Please proceed with your questions.

I understand that very soon now the quiet period will be changed for initial investors and I understand that the Partnership is doing very good job of managing the flow of many of these funds into the market, but I don't have any information yet on units. Is that information coming soon?

If you're a limited partner, then yes, on May 11, you will get your specific unit amount.

All right. Thank you.

Thank you. We have no further questions at this time. I'd like to turn the floor back over to management for closing remarks.

Again, thank you everyone for today spending time with us. We're very excited about our growth strategy. As we look back to February of last year, going public always has a set of challenges. The Company functioned very well as a private company. This year we have demonstrated that it functions in an extraordinary way as a public company. We continue to attract outstanding talent. We are the recipient of inbound phone calls for folks who own buildings. And we believe, with the capital formation exercises that we have and the team we have to execute, that we can continue to exceed expectations as we move forward.

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