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Armada Hoffler Properties, Inc

Q2 2013 Earnings Conference Call

August 14, 2013 10.00 AM ET

Executives

Brad Cohen - ICR

Louis Haddad - President, Chief Executive Officer and Director

Michael O'Hara - Chief Financial Officer and Treasurer

Eric Smith – Vice President of Operations and Secretary

Analysts

Matt Spencer – Robert W Baird & Co.

Jonh Guinee - Stifel, Nicolaus & Company, Inc.

RJ Milligan - Raymond James

Armada Hoffler Properties, Inc (NYSE:AHH) Q2 2013 Earnings Call August 14, 2013 10:00 AM ET

Operator

Greetings and welcome to Armada Hoffler Properties' Second Quarter of 2013 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. It is now my pleasure to introduce your host Brad Cohen of ICR. Thank you, Mr. Cohen. You may begin

Brad Cohen

Good morning. We like to thank you for joining us today for Armada Hoffler Properties' second quarter 2013 earnings conference call. In addition to the press release we shared last evening, the company has filed the Form 10-Q with the SEC and posted a quarterly supplemental package with additional details on the company's website on the Investor Relations section at www.armadahoffler.com. On today's call management's prepared remarks and answers to your questions may contain forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Forward looking statements adjust matters that are subject to risks and uncertainties that may cause actual results to differ from those discussed today. Examples of forward looking statements include those related to revenue, operating income, financial guidance as well as non-GAAP financial measures such as FFO and core FFO.

As a reminder, forward-looking statement represents management’s current estimate. Armada Hoffler Properties assumes no obligations to update any forward looking statements in the future. We encourage listeners to review the more detailed discussion related to these forward looking statements in June when the company is filing with the SEC and the definition and reconciliations of non-GAAP measures contained in the supplemental package available on the company's website.

This morning's conference call is hosted by Louis Haddad, Armada Hoffler's President, Chief Executive Officer and Director. Michael O'Hara; the Chief Financial Officer and Treasure, and Eric Smith, Vice President of Operations and Secretary.

I will now turn the call over to Louis.

Louis Haddad

Thank you and welcome to our first earnings conference call as a publicly traded company. I will begin with a brief overview of our company and our strategy. I'll then review our second quarter results and update you on current company development. Mike, will follow with some additional details on a quarterly results and review of our balance sheet. After our prepared remarks, we will open up the call to your questions.

Let me state at the beginning that our results for the second quarter reflect the fact that we are public for only 48 days. We are proud of our team's efforts including continued execution of our corporate initiative, as well as the completion of our successful initial public offering in May 2013, that generated both gross proceed of $218 million. With that backdrop let us move ahead.

This is our first conference call as a public company, and I would like to provide a quick overview of our Armada Hoffler. We are full service real estate company with extensive experience in the development, construction and management of high quality institutional grade office, retail and multifamily properties in attractive markets throughout Mid Atlantic United States. Our target market primarily in Maryland, North Carolina and Virginia, have diverse like economies, favorable supply demand dynamic and in many cases fewer well capitalized competitors.

Our results are a reflection of the hard work and dedication that our team has put into building this company since our founding 34 years ago, we have built a reputable performance in service. And that has earned us trust of tenant, community leaders and business partners alike. While our development expertise includes a full spectrum of commercial real estate property type including hospitality, institutional and industrial facility. Our current portfolio consists of office buildings, grossly anchored retail centers, town centers and luxury apartments.

We have proven over the last three decades that our development expertise, extensive corporate relationships and long standing track records in executing large public-private partnership provides unique competitive advantage in our markets which we can – we’ll expect, will continue and accelerate as we move forward.

Another important factor that Armada Hoffler is our general contracting business. Well it may not be fully appreciated externally; it continues to be a considerable source of value, profit and opportunity for growth. And having our own general contractor, we are able to better control cost of delivery time frame for facilities best thing to be added to our portfolio. Thereby largely mitigating the risk of the development process. Beyond that by acting as a third party general contractor on such project as the Swedish Embassy, Mandarin Oriental Hotel and Inner Harbor East in Baltimore, we benefit from the high visibility many of these engagements bring including the positive public relations perspective created in building a well respected brand.

This projection of our footprint is an important ancillary source for additional portfolio opportunity. For the moment, it is important to understand that we view construction revenue primarily as a pass through expense. And focused on the gross margin and profitability contribution it is made to our bottom line year in and year out. To that end even though even through one of the worst real estate and capital corrections in the country's history, our backlog carried us through that period.

In our general contracting and real estate services segment, we are currently engaged in 17 constructing contracts with an estimated contract value of approximately $117 million with roughly $58 million worth of work remaining to be completed.

Although, overall net income attributable to this segment of our business is quite small, for the reasons I just stated, we continue to believe that our construction expertise with a competitive advantage that is unparallel in our market.

As a public company, we will continue to execute the successful growth strategies we have pursued for many years. While we will continue to maximize the profitability of our mid 90% lease portfolio. We will also pursue opportunities to expand and deepen our footprint with ongoing developments and select acquisitions that provide attractive returns for the company.

Turning to our results specifically at the end of the quarter, our office property operating portfolio was 93.4% occupied. Retail was 94.6% and multifamily 91.2% occupied. During the quarter, we executed seven office leases totaling 33,800 square feet and 13 retail leases totaling 46,400 square feet. For the same store portfolio which includes seven office properties, 13 retail centers and one multifamily community representing an aggregate about 90% of our overall portfolio on an annualized rent basis. Same store net operating income decreased $441,000 for the three months ended June, 2013.

A decrease in NOI was attributable mostly to a decline in occupancy. Given the performance of long-term leases, the low levels of lease expirations evidenced by the lease expiration schedules on pages 17 and 18 in our supplemental package. And consistent occupancy level, we expect these small quarterly occupancy changes to offset each other overtime.

Speaking deeper, while our office and retail portfolios are leveled review as stabilized. We did have some anticipated temporary pressure on the multifamily segment. Specifically, our cosmopolitan community which is across from two of our development sites Main Street Office and Main Street Apartment is experiencing temporary softness which we expect to persist until the construction activity of that site is completed. And our other asset (inaudible) the second quarter is historically the community's occupancy [rent center] given its proximity to Virginia Tech. But as of today's call it is back to being 100% lease.

While our same store portfolio is a stable cash generating entity; the primary source of our growth will come from our development pipeline and to a lesser extent, select and complimentary acquisition.

In addition to acquiring a 197 units in the Apprentice School Apartment as stated in our prospectus and now ph[Christine] Liberty Apartments in Newport near Virginia. We have a total of six projects underway including two office and two retail properties totaling 384,600 square feet. And two multifamily properties with 491 units. All of our development projects continue to move forward as planned, we expect to complete them in May 2014 and couple on 2015. Additionally, , we have the financial capacity to fully fund the project.

With that let me turn the call over to Mike to provide more details on our balance sheet and quarterly results. Mike?

Michael O'Hara

Thanks, Louis and good morning everyone. Let me begin by discussing the impact of the IPO on our balance sheet which closed on May 13. Dues approximately $150 million of proceeds to pay down debt on unencumbered nine properties. In conjunction with the IPO closing, we closed on a $100 million credit facility which contains according feature which will allow us to increase the borrowing capacity up to $250 million. For the property that are unencumbered our collateral for the credit facility and the other five are available to add to the borrowing date of the credit facility should we choose to increase the borrowing capacity. This facility has a three year term with initial maturity in May 2016 includes a one year extension option.

We entered the quarter with approximately $244 million of debt including $25 million outstanding on the credit facility. Following these initial transactions, our debt EBITDA is now less than 8%. Our weighted average interest rate is 4.9%, and our average term to maturity of these loans is 9.6 years. Approximately 63% of our debt was fixed at June 30, and since the end of the quarter, we've put in place a $40 million LIBOR interest rate cap at 1.5%.

Including these new interest rate cap approximately 79% of our debt is fixed or hedged. On July, we closed on a $63 million construction loans to fund the Main Street Office and Main Street Apartment projects. A loan term is for 42 months, interest only at LIBOR was 1.95%. [Up on] July we paid up first loan secured by Columbus Tower which is located in the Virginia Beach Town center. Beside the six properties that's available that we added to the borrowing base for the credit facility.

We utilized $15 million of proceeds from our credit facility to fund this transaction and now have $40 million outstanding on the credit facility. We are also in the process of addressing one of our loans that matures in early 2014. We have a commitment for a HUD for a 35 year loans for refinance business meaning apartments which is expected to close this quarter.

Now we turn to our second quarter results. We believe a Pro Forma core fund from operations results are most reflective of a company's performance that does not include one-time items from the company's IPO and Formation Transactions, as well as non cash compensation and impairment charges.

Our Pro Forma results reflect the second quarter result is just the company's IPO and a Formation Transaction was completed at the start of the second quarter. Pro Forma core fund from operations for the second quarter of 2013 was $6.5 million or $0.20 per share.

Finally, turning to our dividend we paid a partial dividend based on being public for 48 days of $.08 per share for the second quarter in July. Yesterday, we announced $0.16 per share dividend for the third quarter payable on October 10 to shareholders of record October 1.

I will now turn the call back to Louis for some concluding remarks.

Louis Haddad

Thanks Mike. Again thank you all for joining us today for our first call as a public traded company. Our strategy is built on many years of success. As we move ahead, we believe our stable portfolio, depth of experience and strong capital base position us to identify and execute on attractive long-term growth opportunity, which should result in enhancing our valuation overtime. Before we open the call for your question, let me reiterate three key points of Armada Hoffler and the opportunities we have to grow this company and its cash flow. First, we understand our markets and have built deep relationship that have and will continue result in attractive opportunities to grow our portfolio. Second, we are well capitalized with a strong balance sheet and multiple capital leverage at our disposal, and third and perhaps the most importantly, our management team with ownership of approximately a third of the company is highly motivated and completely allowing the shareholder. We look forward to continue to build on our success of over 30 years during the coming year.

With that operator, let's open it up to questions

Question-and-Answer Session

(Operator Instructions). Our first question is from the line Dave Rodgers, Robert W Baird, please proceed with your question

Matt Spencer – Robert W Baird & Co.

Hey, good morning, Matt Spencer and [Jonathan Bourn] here with Dave. As a Smith's Landing Asset I know you mentioned in your prepared remarks that the asset is now over I believe but I was wondering if you talk a little bit about the rate you are able to achieve on the asset. I believe you said you had 5% sequential increase in Q2

Louis Haddad

Right, Eric, can you handle that?

Eric Smith

Sure, thank you for the question. You know despite the historical trends in the Smith's Landing project that we’ve enjoyed the opportunity to increase the average rental rate per unit year-over-year other than the seasonality and the occupancy that you see every some during the summer time each year. That property is fully leased out obviously with its proximity to campus and Blacksburg and its track record we have been able to achieve those high occupancy rate and that will amend itself to the annual consistent growth year-over-year in the rental occupied unit that you can see on page 13 of the supplemental. You saw an increase for almost $984 per occupied unit and that is $1033 per unit range for the quarter ending 6/30/13.

Matt Spencer – Robert W Baird & Co.

So add that asset a100% leased currently with July full month as well and then how we can think about the revenue streams coming on line in the third quarter.

Louis Haddad

Now that was more August, July – even in July ours is a transition months for the leases

Matt Spencer – Robert W Baird & Co.

Okay, great and then on the development side, can you talk a little bit about the pre leasing end of progress at the terms on a prog project. Are you seeing increasing activity and is there any impact from other development side in the area around town center

Louis Haddad

That's great question, let's talking about town center. Progress is going very well with the building itself. We are a little bit ahead of where we thought we would be in terms of construction which is very important for our anchor tenant Clark Nexsen. Right now in signed leases we are little over 50% pre leased but I am very pleased with the amount of activity. We are talking with the number of signature tenant that will have one location in the market place, and the market place being Hampton Road and if we can do it successful it is going to further establish us as the premier address in the region.

Matt Spencer – Robert W Baird & Co.

Great, thanks.

Unidentified Analyst

Hey, good morning guys, it's [Jonathan Bourn] as well, typical question on G&A and I know you guys gave some color on the 10-Q but it looks like when you back up stock based comp for the quarter G&A was about 2.1 may be to talk a little bit about sort of the recurring G&A spend that's embedded there as a result of the core company or may be some one off thing that may have set the interest in this quarter

Michael O'Hara

Good morning, Jonathan. In the second quarter, G&A was run a little high because we had non-recurring expenses that was related to the IPO with that quarter. Outside of that we are still tracking on plan for the full year according to what we have laid out in perspective

Unidentified Analyst

Got it. And then may be just moving on to the development pipeline again. In both where [the joint option] redevelopment I know you guys are sort of proceeding towards sort of (inaudible) by September. Can you might help us a little bit about the timelines for construction there and sort of the capital intensity that you guys see with the project.

Louis Haddad

Yeah, it's still somewhat soft, we are hoping to finish programming the facility in the next 30 days and that will involve getting by some current what exactly to build obviously but I really don't foresee actual construction taking place until well into 2014, and that's we call that our next generation of pipeline. It's been centre piece of the next well beyond the six projects that we are working right now. But it's tracking very well to be that better piece

Unidentified Analyst

Got it, thanks guys, well, I'll hop back in a queue

Operator

Thank you. Our next question is from the line of John Guinee with Stifel. Please proceed with your question.

Jonh Guinee - Stifel, Nicolaus & Company, Inc.

Actually drilling down a little bit more on this, can you elaborate what you actually said in your prospectus Mike?

Michael O'Hara

While in perspective we said we are going to have over head of approximately $7.2 million per year G&A

Jonh Guinee - Stifel, Nicolaus & Company, Inc.

Okay, so what would be the next three quarters just that we understand what we should expect.

Michael O'Hara

John, we are not giving specific guidance at this point in time, but we are tracking accordance to the plan that we have laid out.

Jonh Guinee - Stifel, Nicolaus & Company, Inc.

So should I take 7.2 and subtract 2.8 or 2.1?

Michael O'Hara

2.8

Jonh Guinee - Stifel, Nicolaus & Company, Inc.

So we are talking $4.4 million or million and half run rate for the next three quarters?

Michael O'Hara

Yes, John.

Jonh Guinee - Stifel, Nicolaus & Company, Inc.

Okay. This also sort of implied, we should be running an FFO on this company close to $0.24 to $0.25. Am I missing something when you came at $.20?

Michael O'Hara

John, I don't have that math in front of me how do you get to $0.24, our pro forma base we are running at the $0.20 range at the current quarter.

Jonh Guinee - Stifel, Nicolaus & Company, Inc.

Okay, thank you.

Operator

Thank you. Our next question is coming from the line of RJ Milligan, Raymond James. Please proceed with your question.

RJ Milligan - Raymond James

Hey, good morning guys.

Louis Haddad

Good morning, RJ

RJ Milligan - Raymond James

Just curious on both the office leases and the retail leases signed in the quarter. What the leasing spreads look like and sort of if you could talk about expiration for the rest of the year? And what the market is and your anticipation for worst spreads would be for the remainder of the year?

Eric Smith

This is Eric, RJ, good morning. On to your question on the spread, we feel comfortable with providing new guidance incentives we talk about on the roadshow as well, the top line type portfolio with a 250 leases that we have consistently they are at market rate. And when those come up for renewal, there is not a whole lot of difference between what those folks are renewing at and what they are aspiring at across the board we are generally renewing people at market rate. On your second question about lease roll over, I would draw your attention to pages 17 and 18 in the supplemental package and we have the lease expiration information for both the office and the retail portion of the portfolio, and as you can see from those charts in that data , the lease expiration is fairly stable in both the ops and the retail portfolios for the next decade or so which is one of the contributing factors to the stability in addition to the occupancy to the stability of the portfolio.

RJ Milligan - Raymond James

Okay, and Louis, did you mention, you said for same store NOI was increased $441,000 or declined $441,000.

Louis Haddad

Decreased.

RJ Milligan - Raymond James

Decreased, and that's – what was the off the base or was the same store NOI base so that I just -- I can get on a percentage basis?

Eric Smith

This is Eric. The same store on a GAAP basis the same store for the three months ending 2012 and I’m on page 9 of the supplemental if that helps is $9,425,000 and the three months ending June 25, 2013 $8,984,000 or difference of $441. I will draw your attention while we’re on that page and on the subject that they build their GAAP numbers on a cash basis. Those numbers are actually $200,000 for the three months ending 6/30 and $400,000 ending for the six months ending 6/30 which again given the stability of the portfolio both from their occupancy and other metrics we discussed. That’s general noise and we’re not overly concerned about it if you keep up that by the occupancy pages in the supplemental.

Louis Haddad

Yes I think it’s important that we spread that and we've talked about it before. This portfolio is stable and we’ve been running this portfolio for many years. We don’t get overly concerned when it goes down the 92% occupied like it did at the height of the recession. And we don’t get overly excited when it goes up to 98% because we know it is going to come back to the centre line. These kinds of quarterly fluctuations are going to happen; you’ll see it will generally creep up on a year-over-year basis. That’s what it’s done every year but we’re going to see these things kinds of things happen for one reason or another then and that’s just a nature of running a stable portfolio. Our growth is coming from development.

RJ Milligan - Raymond James

Okay great thanks guys.

Operator

(Operator Instructions).Thank you. Our next question is a follow up from the line of Dave Rodgers from Robert W Baird. Please proceed with your question.

Matt Spencer – Robert W Baird & Co.

Hey guys its Matt Spencer again. Can we maybe talk a little bit about the trends in your construction costs and how that might impact your business through your returns?

Louis Haddad

Sure, how much time you got? There’s an awful lot going on in the construction market and generally I’d say it's stable, we're not saying we were little concerned earlier in the year about commodity prices, it looked like there is going to be particularly in plywood and copper, it looked like there is going to be a significant jump. But then it came right back to the center line, what we're seeing in the project that we're bidding now is that we're basically flat with cost as they were a year ago or so, so we feel very good about that obviously as it relates to our projects. And right now it just doesn’t seem be a whole lot of pressure industry wide.

Matt Spencer – Robert W Baird & Co.

All right, great and then lastly in your portfolio I think you released commercial lease percentages. Do you have a backlog of leases and is there any run rate or what we can expect over the next course of quarters? Leases that would commence.

Eric Smith

Yes this is Eric again, again well there is a thought I would impressed upon you is, and as you see by the lease expiration chart, they are not significant, but we have 5% to 10% of the portfolio loan over each year and that obviously includes next 12 months as well. What we're not prepared to talk about individual tenants that we're currently in discussions with, we’ll be happy to share that information as it's available on a quarterly basis. But again I would suggest to you that is in line with the historical stability that we've seen between a combination of lease terminations, lease renewals and of course new leases for new tenants work house full that the forward looking occupancy is consistent with the historical information that you see in the supplemental information.

Matt Spencer – Robert W Baird & Co.

Thanks. Great, thanks guys.

Louis Haddad

And if there isn't anything significant that, that’s in time in the current as of today. There’s going to be some really interesting things happening particularly at our home base at town center, when I say nothing really significant has happened, we pretty much filled up all the nooks and crannies in town center. Also from an office standpoint, it really close to 100% which is nice as is found, it is somewhat dangerous. We are going to be needing to shuffle some tenants around on and off to distant future as soon as we get this power online. Because we got to provide some relief for people. So it's a good problem to have, but it's going to be a problem in that, we are going to make some strategic decisions that will involve (inaudible) of money, lengthening some lease terms and perhaps awaken some tenants around just to position us better for the future.

Matt Spencer – Robert W Baird & Co.

Right, thanks for the color.

Operator

Thank you. At this time, we come to the end of our allotted question-and-answer session for today. I will now turn the floor back to management for any further or closing comments.

Louis Haddad

Well, thanks very much for joining us on our first call, and look forward to updating you on our progress in the quarters and years to come. Thanks very much.

Operator

This concludes today's teleconference. You may disconnect your line at this time. Thank you for your participation.

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