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Executives

Peggy Moretti – EVP, Investor and Public Relations and Chief Administrative Officer

Nelson Rising – President and CEO

Shant Koumriqian – CFO

Analysts

John Guinee – Stifel

Suzanne Kim – Credit Suisse

Wilkes Graham – Compass Point

Jordan Sadler – KeyBanc Capital

Brian Chindurly – BAM

Enrique Torres – Green Street Advisors

Patricia Fox [ph]

MPG Office Trust, Inc. (MPG) Q2 2010 Earnings Call Transcript August 10, 2010 11:00 AM ET

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the MPG Office Trust conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. (Operator Instructions)

As a reminder, this conference is being recorded today, August 10, 2010. I would now like to turn the conference over to Ms. Peggy Moretti of MPG Office Trust. Please proceed.

Peggy Moretti

Good morning. Thank you for joining us for our second quarter 2010 earnings conference call. During the course of today's call, management will make forward-looking statements regarding, among other things, projected 2010 results of operations, leasing, competitive conditions, financing and cash. The company's projections are affected by many factors outside of its control.

For a discussion of such factors, please refer to the company's most recent annual report on Form 10-K under the caption risk factors. The forward-looking statements on today's call are based on the company's current projections. MPG office trust does not intend to update these prior to our next quarterly earnings release. And we expressly disclaim any obligations to make any such update.

Our supplemental package along with information required under SEC Regulation G may be accessed in the Investor Relations section of the MPG Office Trust website at www.mpgoffice.com. And now I'd like to turn the call over to Nelson Rising, President and Chief Executive Officer.

Nelson Rising

Good morning and thank you all for joining us for our call today. First, I'll spend a few minutes dealing with our financial results for the quarter. Our net loss for second quarter 2010 was $53.5 million or $1.10 per share, which compares favorably to the net loss of $380.5 million or $7.95 per share for the quarter ended June 30, 2009.

Our earnings for the second quarter of 2010 were negatively impacted by impairment charges for the write-down of 207 Goode and the sale of 17885 Von Karman. When we look at year to date through June 30, 2010, our net loss was $34.9 million or $0.72 per share and, again, this compares very favorably to the net loss of $434 million or $9.08 for the six months ending June 30, 2009.

Shant will add color to these results during the Q&A section of our call. I'd like to spend a few minutes talking about our liquidity. As you know, this has been a very major focus for us ever since I became CEO 25 months ago.

At the end of the second quarter, we had cash on hand of $183 million, $113 million of this – of which, rather, was restricted for specific purposes, including swap collateral, prepaid rents, leasing commissions and tenant improvement reserves as well as property taxes – property tax and insurance reserves. And $71 million of this cash was unrestricted and has been available rather for us for general corporate purposes.

This is $21 million less than the restricted cash we had on hand at the end of the first quarter and that $21 million was expended again, as part of our continuing strategy to deal with debt maturities. We made a principle payment of approximately $10 million on the 207 Goode construction loan. In exchange for this, lender agreed to substantially eliminate a $47.8 million repayment guarantee and we are now marketing the property for sale for the lender.

We expended $3 million as payment made on Von Karman's construction loan to facilitate the disposition of this property. As a result of the deed in lieu of foreclosure, we were relieved of the obligation to pay the remaining $24.5 million balance due on this loan. And then $7.5 million of the unrestricted cash was used to pay down the Griffin Tower repurchase facility that had been extended during the first quarter.

So again, we ended up the quarter with $71 million in unrestricted cash, down from $92 million the previous quarter, but those funds were expended, as I said, in our existing strategy. Also during the quarter, we extended the maturity on our $109 million mortgage loan secured by Brea Corporate Center and Brea Corporate Place until May 1, 2011.

No cash was required for this pay down – no cash pay down was required rather, to obtain this extension. In addition, the lender released us from a debt service guarantee after the property achieved debt service coverage ratio for two consecutive quarters. That again is one more example of a debt service guarantee that's now been eliminated.

We have a debt maturity on Plaza Las Fuentes on September 28, 2010. We have the right to an extension under this loan and we'll be addressing this maturity later on this month.

And then additionally, during the quarter, in the continuation of our effort to focus on our core assets, we sold Mission City Corporate Center in San Diego. And the buyer assumed the $52 million mortgage loan, thereby eliminating more debt from our balance sheet.

We were really pleased with the activities we had this quarter and for the year, so to date in leasing. We were able to complete 327,000 square feet of lease renewals and new leases in the second quarter and combine that with the 300,000 square feet of leasing in the first quarter, brings our total at June 30 to 627,000 square feet.

Subsequent to the end of the quarter, we completed a renewal with the gas – southern California gas company for 350,000 square feet in our downtown Los Angeles building and the lease renewal with Disney for 160,000 square feet in Glendale and that brings our total leasing for the year-to-date to just over 1.1 million square feet.

When we look at the overall downtown market, our Wells Tower is 94.4% leased, our KPMG tower is 94% leased, our gas company tower is 92.4% leased, two Cal is 83% leased, 1 Cal, which we have a 20% interest is 78% leased, 777 is 73% leased and U.S. bank tower is 54% leased.

The leasing on the occupancy in U.S. Bank Tower is in part due to the move of Latham & Watkins from U.S. Bank tower to KPMG tower earlier in the year. And the fact that Pacific Enterprise lease expired on June 30, Pacific Enterprise owned or occupied 16% of the building.

If we look at the overall downtown market, there is approximately 21.2 million square feet of class A space and premier space of 18.1 million square feet. Direct vacancy in this premier space is 14.2%. If you total in the sublease space, it's 18.1%.

We have seen some positive signs with the overall downtown market. First, it looks to us that the downsizing of many of our tenants appears to have slowed down, if not reversed. Another very encouraging sign is that national law firms still are moving into Los Angeles and of the 150 major national law firms; we've had 10 moves to downtown Los Angeles in the last three years.

We have an example of one Chicago firm who started with 10,000 square feet and now is just completing a lease for 12,000 additional square feet. So that's an encouraging sign where growth can come. And another very encouraging sign is what's happening with tenants in B plus or A minus buildings, approximately 100 million square feet of such tenants and they are now looking to find a home in the A buildings, in large measure motivated by the rents that are in the marketplace today.

Overall, I would say the rental rates for space in downtown are in the $22 range, ranging from $20 to a $24 depending on where the location is within the building and these leases all have 4% bumps and the TI budgets for renewals have been very modest for us relative to new tenants.

So that's just a quick overview of the leasing and then one other fact just to highlight that downtown Los Angeles continues to show signs of life. Recently, the grand avenue project, which is up here in bunker hill, just broke ground for a $57 million redo of the park between the whole of the administration and the county courthouse and within the next month it appears that Eli Brown will receive the approvals to build a museum again, right up the street from where we are this morning on Bunker Hill which will involve approximately $100 million of construction and a $200 million endowment for the museum.

So there are signs of life in the economy as well as what is happening to the quality of life for tenants in our Bunker Hill locations. With that, I'll be happy to turn it over to questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Your first question comes from the line of John Guinee with Stifel.

John Guinee – Stifel

Thank you. Nicely done, Nelson. Thank you. Questions, can you give a little more color on gas company tower – the gas company lease and the Disney lease? Are they early renewals where the rent is reset immediately or is the rent reset at maturity? And can you go from the prior rent to the new rent in both cases and talk about any releasing dollars that are going to be expended?

Nelson Rising

Well, let me deal with the first portion of the question. Our gas company maturity was late November 2011. They are continuing to pay rent on 575,000 square feet between now and then. The lease renewal will be effective then at the end of 2011 and it will be on the 350,000 square feet.

With respect to rental rate, we don't disclose the specific rental rates on tenant transactions, but it is important to note, in answer to the first part of your question, that, in fact, they are currently paying rent under the existing lease through the end of November of 2011. With respect to Disney and Glendale, that was a renewal as well. The term was due – up, rather, sometime later this summer. And so it was a renewal for five years and we were very pleased to make that lease of 160,000 square feet because they were considering moving to a Disney campus not too far away from this building. So that was a renewal.

Shant Koumriqian

Shant, one question on the Disney lease, the lease was going to expire in June of '11 and as Nelson stated, it's a renewal. So the new rental rates kick in June of '11, in both cases, there will be a roll down in rents. I believe for the gas company, we've talked about in the past where in place rates are in the $36, $37 net range and Nelson disclosed where rental rates are getting done today in his earlier comments.

John Guinee – Stifel

Thank you.

Nelson Rising

Thanks, John.

Operator

Your next question comes from the line of Suzanne Kim with Credit Suisse.

Suzanne Kim – Credit Suisse

Good morning. I have some questions regarding what's for sale right now. I'm just wondering the status of the properties in default and where they are at right now. And I know that the Park Place has been being handled right now but if there is any other land and 207 I know is good as being marketed, but I'm just wondering what exactly is being marketed and how far along they are?

Nelson Rising

Okay. Shant and I will probably pick up on this together. The original seven properties we've put into default about a year ago, Park Place I and III, that was – those properties were exposed late August of 2009. Then we had the three assets that were CMBS's with CW capital and those assets were 550 South Hope and Stadium Way and 500 Orange. Those assets are – we have not, obviously, been servicing the debt and we have been leasing the properties for – for the CMBS Master and special services.

The receiver has been – we have – the receiver is not yet in place on those three assets, but we are very close to concluding an agreement on that. Park Place II, as you mentioned in your question, we were able to find a buyer for Park Place II and that closed this quarter. Shant.

Shant Koumriqian

And then the other three assets are pack arts, which is in Orange County, Quintana which is a joint venture asset, both of those are being marketed by the servicers. We did previously cut to an agreement on 2600 as well which gave the servicer the right to mark the asset and they're in the process of doing that as well. So the deals where we've cut to settlement agreements and servicers, they're either in the market today being marketed or close to. And as Nelson said, the other three were CW Capital. We continue to have conversations and we'll provide you with an update next quarter.

Suzanne Kim – Credit Suisse

Is there any other land being marketed?

Nelson Rising

Excuse me…

Shant Koumriqian

Any other land. No, there isn't any other land being marketed at this time.

Operator

Your next question comes from the line of Wilkes Graham with Compass Point.

Wilkes Graham – Compass Point

As you're thinking about longer term, potentially raising equity down the road in some form, can you sort of prioritize what the use of proceeds would be? I mean as I think about – you know, you've got the preferred dividend that is, I guess, seven quarters back now, you've got the preferred itself trading less than 50% of par and then you've got the KPMG Tower maturity in 2012.

Those, to me, seem to be the three most pressing needs. I wonder, if you can, sort of comment on how you think about those. And then I'm going to try to sneak in separately help explain the increase in the revenues on page 32 in the top tenants list for Deloitte & Touche and the Marsh USA spaces. But you are spacing like you have a square foot but the ABR has increased from the last quarter?

Nelson Rising

What we’ll do is just, we'll take the last part of that question first and let Shant answer that.

Shant Koumriqian

So, on the major tenants table, all of our tenants have either annual or periodic transactional petrol pumps. So the step you're seeing the annual rate increase on that page is because of a contractual rent increase. As long as the square footage has stayed the same, that would be a contractual right increase in the lease.

Wilkes Graham – Compass Point

Okay. Even – it looks like it was a 15% increase from the last quarter, that's contractual?

Shant Koumriqian

Again, in some instances we have annual bumps and in some instances we have bumps every so many years and those were leases that we assumed, not leases that we did originally, so it's not uncommon.

Wilkes Graham – Compass Point

Great. Thanks.

Nelson Rising

Going to your question about the maturity on the KPMG Tower loan. Obviously, we are focused on that. There are a variety of alternatives we are exploring to deal with that maturity in 2012 and – but it's more than on our radar screen and we're focused on that. We don't have anything to announce as far as a strategy at this point, but certainly as you suggest that might be a use of proceeds in order to deal with the loan balance is $400 million.

And the question is what will be required in order to extend the maturity. We don't know that yet but we are certainly focused and recognize that that must be addressed. With respect to the preferred dividend, we have not paid the dividend, as you point out for seven quarters and we have no current intention of renewing the payment on that given that overall cash position, which I outlined earlier in the call.

But that's something that the – again, the question of what do we do about the other maturities we have and the bid for cash, we're very focused on. The other – obviously the major use of cash in our business is the leasing commissions and tenant improvements required to keep an office portfolio leased and increase the leasing and that's another important use for cash.

Wilkes Graham – Compass Point

Okay. Thanks.

Operator

Your next question comes from the line of Jordan Sadler with KeyBanc Capital.

Jordan Sadler – KeyBanc Capital

Thank you. Good morning.

Shant Koumriqian

Good morning.

Jordan Sadler – KeyBanc Capital

Wanted to – Shant, maybe, if you could, walk us through where we stand from a cash flow – free cash flow from operations perspective in terms of the burn rate that we’ve talked about historically. I think, you framed it previously in terms of where you would expect to be unrestricted cash at year end, if that's how you'd like to get there, that would be helpful, but what I'm trying to get to is sort of the quarterly burn rate or contribution, if we're there yet, inclusive of the Disney deal, the southern California gas company deal gas company deal and the Pacific enterprises expiration, so pro forma those few larger…

Shant Koumriqian

Sure. So in terms of the current quarter, what we said previously was as we get into the latter half of the year, we're going to start to have a decrease in rental revenue, primarily this year as a result of the Pacific Enterprises expiration. That lease itself was approximately $3 million a quarter of revenue. That lease expired on June 30th. So as far as the current quarter is concerned, we had a similar trend where operations funded G&A, capital expenditures and leasing costs. We had an equivalent surplus from the core assets, so by core we're backing out the default properties and excluding anything of discontinued operations.

So you have approximately a $3 to $4 million positive cash flow after funding all operating costs, including G&A, leasing costs and capital expenditures. Fairly consistent with last quarter, we did have a fairly light quarter when you look at our AFFO schedule and leasing costs. On a same store basis looking towards the latter half of the year, we'll lose about $3 million of revenue from Pacific Enterprises. We did renew about half of the sub tenants at various rental rates that are significantly below where Pacific Enterprises was paying rent. There will be some free rent period as well, so we'll have some offset of $3 million loss and we continue to talk to tenants that are interested in some of those spaces today.

Gas company and Disney do not impact the results from an operating perspective. Those rental rate decreases do not occur until the mid to latter half of 2011. One thing that we will do between now and the end of the year is fund some of those losing costs and I'll touch on that as we project that cash through the end of the year. Previously, we said we expected cash to be somewhere in the low $30 million range to mid $40 million range last quarter we brought it up a little bit. At this point I think we would leave that range in place, mid $35 million to mid $45 million range.

The major uses of cash between now and the end of the year are the PLF refinancing. Previously, we said somewhere between $7 to $15 million pay down and we're not adjusting that yet at this point. We probably have about $5 million of working capital type payables that we'll be funding between now and the end of the year. A few million dollars of disposition costs related to the properties in default and other and then the rest of the decrease will be related to leasing, both funding of costs associated with the gas company lease that we just signed, as well as the Disney lease, primarily lease commissions at this point and then funding up reserves to pay for some of the tenant improvements on the gas company lease and then the rest of the decrease between now and the end of the year would be funneled into leasing, primarily renewals for 2011 and to the extent that we do any new leasing, any lease costs associated with that.

So again, we're somewhere in the $71 million of cash today. We would expect to be between $35 and $45 million of cash at the end the year. The major uses would be the PLF pay down and leasing costs. And again, that excludes any proceeds from any asset sales; we're reflecting no asset sales between now and the end of the year that would generate positive cash.

Jordan Sadler – KeyBanc Capital

But the pro forma operating cash flow on a quarterly basis, excluding the default properties and pro forma Pacific Enterprises did you say is $3 million?

Shant Koumriqian

For the current quarter it's about 4.

Jordan Sadler – KeyBanc Capital

Okay.

Shant Koumriqian

If you back out the impact of Pacific Enterprises you're getting back down to breakeven.

Jordan Sadler – KeyBanc Capital

Okay.

Shant Koumriqian

So consistent with what we previously said, if you get to the latter half of the year, the positive cash flow becomes breakeven to slightly negative and the main driver of that will depend on how much leasing we do.

Jordan Sadler – KeyBanc Capital

And the – let's fast forward a year to the back half of 2011. What will be the rental revenue impact associated with the roll downs and the give backs on Disney and southern California gas?

Shant Koumriqian

Well, you'll probably see that coming through the next couple of quarters. The gas company lease was in the $37 gross range and again, as we said we're doing leases in downtown between $20 to $24 so estimate somewhere in that range. Keep in mind it's a 350,000 square foot tenant for Disney (inaudible).

Jordan Sadler – KeyBanc Capital

It will account from 550 originally?

Shant Koumriqian

It was 576,000 originally.

Jordan Sadler – KeyBanc Capital

… to 350.

Shant Koumriqian

They're renewing 350.

Jordan Sadler – KeyBanc Capital

Okay.

Shant Koumriqian

225,000 will stay in place between now and November of 2010 – '11, excuse me and that will come when most vacant [ph].

Jordan Sadler – KeyBanc Capital

And Disney?

Shant Koumriqian

And Disney will renew all 160,000 square feet starting in June of 2011. So effective July 1, their rental rate will roll down. They're currently paying somewhere under $22 to $23 net range and again, what we've said, our in place rents in the Glendale markets are also significantly above market, you'll have a fairly sizable roll down on that lease as well, minimal tenant improvements.

Jordan Sadler – KeyBanc Capital

Thank you. And finally, if I may, just, Nelson can you touch on Christopher's departure and, sort of, what that reflects or is a signal of, perhaps and then how the termination or severance payment was determined?

Nelson Rising

Well, it reflects, basically, that Chris is – we were encouraged by opportunities he has elsewhere, if you recall. He and I were in partnership together Rising Holdings Partners when joined the firm in mid May of 2008 and he elected to move on. With respect to…

Peggy Moretti

I would just add that on Friday, July 30, the company filed a separation agreement, which is a public document. Chris return to Rising holdings, Inc and the public document speaks for itself.

Jordan Sadler – KeyBanc Capital

With the – but who determined the amount of the payment?

Peggy Moretti

It was a contractual on…

Jordan Sadler – KeyBanc Capital

What was that based on?

Peggy Moretti

It was an employment agreement that Chris had with the company and the board of directors, management – board of directors filed the public document that I just mentioned.

Jordan Sadler – KeyBanc Capital

Okay. Thank you.

Peggy Moretti

Thanks, Jordan.

Operator

Your next question comes from the line of Brian Chindurly with BAM.

Brian Chindurly – BAM

Yeah. Hi, guys. Congratulations on all the progress and all the leasing activities. Question for you, what other than the obvious maturities, the main one being the KPMG in 2012, what other major leases do you have to deal within the short term now that you've got the gas company and Disney out of the way?

Nelson Rising

Shant.

Shant Koumriqian

If you look at our supplemental package in the LACBD schedule, the expiration schedule for LACBD, we tracked through the numbers. There's about 2.1 million square feet of leases expiring between now and the end of 2012. In the downtown LA sub-market, there's about a million square feet expiring and 2011, 576,000 square feet of that is the gas company. 3350 we're renewing, 225,000 will come back, of the remaining 400,000 plus square feet, the majority of that expires in August through the end of 2011, so August 11 through the end of 2011. We're currently in conversations with each and every one of those tenants both for renewals and we also have outside tenants interested in some of their space.

The other expirations in LA County would be in our Glendale portfolio we've got about 325,000 square feet expiring in 2011 in the Glendale portfolio, 160 of that was Disney that we just renewed. The other 160 is spread among many assets and those leases are expiring in the latter half of 2011. With that market, it's probably a little bit too soon to tell what's going to happen with those tenants, but we're obviously out in front of them as well. 2012 we got a more reasonable lease expiration schedule, both as well in downtown LA and in the tri-cities. So as far as the expiration remaining once that are concerned and in the latent it's mostly in the back half and we're talking to all of those tenants today and feel pretty good about our prospects of either renewing or back filling the space.

Brian Chindurly – BAM

Got it. Given the liquidity situation and some of the things you've got coming at you in the next year or two, you mentioned that you've got various avenues that you’re exploring, specific to KPMG and other capital rising. Have you – at this point have you engaged any advisers to help you sort through those opportunities or where does that stand?

Nelson Rising

Well, we are in the process of putting together a plan for this. At this point we have nothing, we're prepared to announce, but we are very focused on it and I would suspect you'll hear something from us in the next several months.

Shant Koumriqian

And then just to add other than leasing, as far as debt maturities, we only have a $15 million pay down on the term loan in May of 2011, which we're prepared to make with cash on hand. Beyond that, it's the 2012 debt maturity of KPMG tower is our main use of cash which is in the fourth quarter of 2012, between now and then, the major use will be leasing, which is what we're focused on.

Brian Chindurly – BAM

Right. Now, you've been very successful in doing deals with very minimal tenant improvement dollars that you've had to come out of pocket on, I guess from what you just told me on your lease expiration schedule, really the major activity that you would have to be concerned about would be toward year end 2011 because of the August 2011 through year end 2011 lease renewals, is that the right way to look at it?

Shant Koumriqian

Funding, yes, funding of the costs, but we're out talking to those tenants today.

Brian Chindurly – BAM

Okay. So to the extent that you do something earlier, you might have to expend some of those dollars a little earlier; is that right?

Shant Koumriqian

To the extent, yes, we would, which we're prepared to do as well as part of our use of cash between now and the end of the year, some dollars are earmarked for 2011 renewals, as well as any potential new leasing that we would do.

Brian Chindurly – BAM

Okay. Now of the 113 million of restricted cash for various purposes, some of those relate to contingent obligations and you've been very good at navigating around some of those and freeing up some of the potential contingent obligations. Are there situations where some of that $113 million could be released back into the unrestricted cash column? And if so, can you talk a little bit about what you're working on there?

Shant Koumriqian

There are two sources of cash in the $113 million. We have about $21 million of leasing reserves, which are available to us to pay for existing leases, as well as new leasing from a timing perspective, because not all TI dollars are requested by tenants early, early on in the leasing process. The other main source of cash in the $113 million is swap collateral there's about $38.5 million of collateral for a $425 million swap that is held by our counter party. That money will be released to us between now and August of 2012 when that swap expires.

Nelson Rising

That's really a function of whether it's going happen this year or next year or the following, is where the LIBOR yield curve is and that's the term limit which the swap was negotiated, but as Shant says, it's a certainty it will come back to us over that period of time.

Brian Chindurly – BAM

So the $38.5 million of swap collateral does that come back to you, sort of, quarter-on-quarter per some adjustment provision or how is that being handled?

Shant Koumriqian

It gets mark-to-market on a daily basis. We have a $5 million corporate credit. On a monthly basis as we make payments, the future obligation is reduced, so at this point it's much more certain how much will come back. The main variable is what happens with the forward LIBOR expectations, to the extent expectations to decrease, we're going to have to post a little bit more collateral but at this point we're posting all the $5 million breakage amount which is the present value of the future payments we're expected to make.

Brian Chindurly – BAM

Okay. So of the $113 million of restricted cash, roughly $59 million of it at some point becomes more available to you, it's just an issue of timing and how that plays out?

Shant Koumriqian

That’s correct. And then the rest of it is prepaid rents, tax and insurance reserves, so from our perspective, static working capital can ebb and flow, but is there as a function of the non-recourse financing that we put in place.

Nelson Rising

And to the extent that the restricted cash is for tenant improvements and leasing commissions that's the financing for a major part of our capital costs.

Brian Chindurly – BAM

Right. Got it. Thank you very much. If I have anything else, I'll call you guys after the call.

Nelson Rising

Thank you.

Operator

Your next question comes from the line of Michael Knott with Green Street Advisors.

Enrique Torres – Green Street Advisors

Good morning. This is Enrique Torres on behalf of Michael Knott.

Nelson Rising

Good morning.

Enrique Torres – Green Street Advisors

I have a question regarding the parking centers in downtown LA. Are you finding that tenants are requiring for you guys to chip in more free parking and if so, what would you expect the change in parking revenues to be perhaps like one year from now?

Nelson Rising

Well, one of the things that downtown has is constrained parking situation and as a result of that, demand obviously will be less when there's more vacancy, but the demand for parking is fairly inelastic and so Shant, be more specific with that.

Shant Koumriqian

Yeah. For the most part, most of our buildings have enough parking on a one per thousand basis, a number of our competitors have even less than that. So like Nelson said, parking is constrained downtown. We view parking, as well as all aspects of a lease as a potential concession. What we've found so far is parking has held up, clearly with any decreased occupancy, we have less utilization of our parking garages, but for the most part parking has held up. Our parking rates have held up as well.

Enrique Torres – Green Street Advisors

Hey. My other questions have been answered. Thank you.

Nelson Rising

Thank you.

Operator

Your next question comes from the line of John Guinee with Stifel.

John Guinee – Stifel

There's a couple of things that are sort of hard for people to get their arms around and maybe you could expand a little bit on that. One is the last time, I checked maybe about $800 million in NOLs buried in the 10-K and then the other is the potential former CEO tax liability or tax protection contingent liability. Can you walk through those two rather significant issues?

Nelson Rising

Sure. Let's deal first of all with the tax protection that was negotiated by Rob Maguire when the company went public. And the agreement covers five assets, plus last one day – office not for hotel, KPMG tower, Wells Fargo tower, gas company tower and U.S. Bank tower. The other buildings are not encumbered by the tax protection. The tax protection agreement with respect to Wells Fargo tower expires in 2015. KPMG tower expires in 2013. Gas company tower expires in 2015 and the exposure on – plus last one day, expires in 2013. And so that is the extent of that obviously to the extent that we were to attempt to sell an asset we would need to deal with the tax protection and to the extent that we are not selling an asset, it does not have any material impact on us.

Shant Koumriqian

And to add, the tax protection prevents an outright taxable transaction, so a sale. There are various structural alternatives to an outright sale of an asset, including financing, including age joint venture, where funds come in to the asset level to both finance either tenant improvement requirements for upcoming leases or to finance a debt maturity. So again, an outright sale is an issue, but there are other alternatives and once the tax protection period is expired, there will be no remaining constraints.

In terms of the net operating losses, we'll make sure to bring those amounts forward in the Current Q that we'll file here in the next day or so. We do have, I believe, north of $600 million of net operating losses at our operating partnership and then there's a sizable net operating loss in one of our taxable REIT subsidiaries as well, based on both of those net operating losses, we would not have to pay a dividend for – to meet REIT requirements for the foreseeable future. So anyways, we do have some very sizable net operating losses, we'll make sure to bring those forward in the Q that aren't disclosed in the 10-K for anybody who wants to go back and check.

John Guinee – Stifel

Okay. Just as a follow-up. Gas company tower cash flow will change significantly in late 2011 and KPMG, $400 million debt situation will mature in 2012 and I guess the question is, is there a tax protection situation that we should understand more fully if debt service can't be covered and the asset goes into default or if there is a debt maturity, which then requires some sort of paydown which can't be met and do either of those scenarios effectively trigger tax protection?

Nelson Rising

Well, if you take, for example, a debt maturity and the debt maturity that would – and the asset in which there's a debt maturity, which is before the expiration of the tax protection, that's an issue. We would have to be very – we're very focused on and the earlier question dealt with what we were going to be doing about the maturity on KPMG Tower and I can say right now we're very focused on that and you're correct. If for some reason we were unable to extend that maturity that could – if we defaulted, that could trigger that tax protection on that asset.

Shant Koumriqian

John, the ultimate issue would be a foreclosure. So a foreclosure would be a taxable event to the extent that you have an asset that's covered with tax protection. You would have to consider the cost of carrying that asset to the extent that it's generating negative cash flow; compare that to the cost of funding any tax protection obligation, which would mature upon a foreclosure event. So that's the main risk that you should be concerned about. But again, for KPMG Tower, we have a 12 debt maturity. I think what we said last time is we have one of the best debt rules in the city, Brand Blvd.. From a financing perspective, we think that's an asset that is financeable. The real question is how much. And again there are other alternatives for dealing with tax protection, additional financing to the extent that it's available, a potential joint venture, so there's an asset level solution there.

And then on an asset like the gas company tower, we did just sign a 350,000 square foot renewal. That asset also has a very good rent roll. We will need to do some additional leasing, but the existing debt maturity does not expire until August of 2016, which is beyond the tax protection period. We have a very good rent roll with minimal near-term roll and we've got a 5.1% interest only rate in the interim. We would need to do a little bit more leasing and therefore we would feel comfortable with that asset once we achieved that leasing and then go to the two you were focused on.

Nelson Rising

And just two bad debt on Wells Fargo Tower, that maturity is 2017 and the tax protection expires 13, 13.

Operator

Your next question comes from the line of Suzanne Kim with Credit Suisse.

Suzanne Kim – Credit Suisse

Hi. I have a couple of questions. I just want more color on what's going on with LA. I heard from another call that you are sort of pricing the leases aggressively and also the concessions and TIs and the free rent and I was wondering if you could just sort of describe that and discuss how if we've hit the bottom in terms of – if we've like plateaued in terms of the level of concessions at this point? And also if you can give us an update on the preferred issue, if when and if they've decided when they're going to vote on the preferreds?

Nelson Rising

Well, let's go to that preferred question first. We have been contacted by certain preferred holders, expressing an interest in the process and we have not received the valid meeting request at this point. Once we did, the process is very clearly spelled out in the issuing document for the preferreds. But at this point, no meeting has been set because we don't have the valid meeting notice on file. We've had many conversations with people who are preferred holders and I would suspect that they will move ahead with the request for a meeting. And at that point, we will cooperate as we have in every way to fulfill our obligations under the documents. The next – going back to the leasing…

Shant Koumriqian

I think when we look at leasing – we said this in prior calls as well. We look at leasing on a building-by-building, space-by-space and floor-by-floor basis. So for example at U.S. Bank Tower, we did a number of leases with existing subtenants at, what we felt were attractive rates to us with minimal concessions. We've also done market based deals with market TI allowance. So I think to address your comment, I think we're looking at concessions in a prudent manner, all types of concessions and we're focused on what's the right decision for the space and for the building, taking into consideration a whole host of factors.

Nelson Rising

Right. And you're referring to a prior call and we were particularly focused on leasing efforts in Orange County in that particular call, if I'm referring to the correct call. And the idea there was we were not going to buy rate. We were going to go at a market rate and not buy rate by concessions such as tenant improvements and the like. And so we were able for that period of time to get our average leasing costs down from about 550 per square foot per year of term down to $3, $3.50, so that's what I think you were referring to.

Now, that is something we still aspire to, but on the other hand, as we're trying to do major leases, we don't have the same flexibility as we did, but we still have the same basic philosophy. We're not in the process of trying to buy rate, but rather to get a market break transaction and so we're still on the same page on that.

Suzanne Kim – Credit Suisse

In general, do you feel that it's softening, it's still – do you still feel the softening continuing or do you feel that it's sort of kind of mitigated a bit?

Nelson Rising

Earlier in my comments I mentioned that we see some bright spots. One of the bright spots is the number of national law firms that are looking at downtown – Los Angeles as a place, ten of them have located in downtown Los Angeles in the last three years, so that's encouraging. I did mention in my earlier comments that we do see the downsizing that we saw so vividly in 2008 and in 2009 is slowed, if not stopped.

We're seeing tenants now looking to be taking space for five to ten years rather than looking at an extension for one to three years. So those are all signs, it's not scientific, but it certainly feels better than it did and I think that all the other things that are happening in downtown, Los Angeles, really give us a sense that the market will come back. I can't tell you it's going to be back by the end of this year or the end of next year, but certainly it's very encouraging compared to where we were two years or a year ago.

Suzanne Kim – Credit Suisse

Great. Thank you.

Nelson Rising

You’re welcome.

Operator

Your next question comes from the line of Jordan Sadler with KeyBanc Capital.

Jordan Sadler – KeyBanc Capital

I wanted to just clarify on the operating cash flow. The break even, roughly – roughly breakeven expectation excludes the preferred dividend?

Shant Koumriqian

That's correct.

Jordan Sadler – KeyBanc Capital

Okay.

Shant Koumriqian

Excluding the preferred dividend.

Jordan Sadler – KeyBanc Capital

So in order to reinstate that, it would essentially be negative $5 million or something like that?

Shant Koumriqian

Yes, for the current quarter – current quarter, like I said, we had about a $4 million positive, so that's reflecting the preferred, you would have a negative $1 million this quarter and then growing next quarter because of the Pacific Enterprises expiration.

Jordan Sadler – KeyBanc Capital

Right. Okay. That's helpful. And then you might have touched on this, but I missed it. The restricted cash was up actually $8 million sequentially. What was the cause of that?

Shant Koumriqian

When we file our Q, we'll have that breakout of our restricted cash. It was primarily the properties in default. The servicers are not applying rental payments against interest. They're letting interest accrue, so that's the main reason for the increase.

Jordan Sadler – KeyBanc Capital

Okay. I got you.

Shant Koumriqian

When you look at the detail, you'll see once you exclude properties in default, for sure the capital sales will be flat.

Nelson Rising

And the Q will be when that draft filed this afternoon.

Jordan Sadler – KeyBanc Capital

Okay. And then there were some discussions, I think, on the last call regarding some land parcel sales. I know you kind of said there's nothing going on, but there was at least one or two in Orange County that you were selling or trying to sell.

Nelson Rising

Yes.

Jordan Sadler – KeyBanc Capital

And I was just curious on the status there.

Nelson Rising

There is a site in Orange County and that is currently being marketed.

Jordan Sadler – KeyBanc Capital

Okay.

Peggy Moretti

It's actually under contract, but the question Jordan was are there any additional land parcels – being marketed. So the answer to that is no, but one is under contract.

Jordan Sadler – KeyBanc Capital

Okay. So there's only one under contract. And what is the value – expected value?

Peggy Moretti

We can’t disclose that.

Jordan Sadler – KeyBanc Capital

Okay. Could you give us a range? Just a – or an idea?

Shant Koumriqian

No. And we won't until it's done, but the year-end cash number excludes any proceeds from that sale, the cash number that I gave excludes sales proceeds, including that one.

Jordan Sadler – KeyBanc Capital

Okay. That's helpful. And then were you also trying to remarket Glendale and getting this Disney lease done help that process, the Glendale process?

Nelson Rising

We have not been – well, we – there's one asset in Glendale which we are marketing which is 207 Goode. As far as the other Glendale assets, we are not marketing and we do not have any current plans to market the Glendale portfolio.

Jordan Sadler – KeyBanc Capital

Okay. And then lastly, just the leasing costs, I mean as you look forward and let's say you have a million square feet or so of lease-up that you would like to do or expect to do over the next number of quarters, what are the expected leasing costs in downtown right now in terms of TIs and leasing commissions on new leases versus renewals?

Shant Koumriqian

Basically, it's a fairly competitive market.

Jordan Sadler – KeyBanc Capital

I guess I'm looking at your history and there's quite a bit of variability. The 2009 costs obviously came down quite a bit, but I'm just curious, is it going to look more like 2009, 2008, 2007?

Shant Koumriqian

Again, depending on the mix, I think what you're going to see going forward is our leasing costs will be increasing. A number – the amount of leasing that we do in Orange County is a much smaller component and was reflected in some of those prior numbers. What you're seeing in downtown LA on new lease deals are anywhere between $4 to $5 to $6 a foot a year. Clearly on renewals, I think we've got a little bit more of an advantage. As we focus on our leasing here towards the latter half of the year and into 2011, part of our focus will be securing new tenants.

So I think what you should expect is our leasing costs per foot per year to increase as we start to shift our focus on signing leases on currently vacant space or spaces that are coming back to us. And again, on a major – on our larger tenant and our portfolio as well, your lease costs will be higher than what you're seeing here over the last several quarters because those tenants are highly sought after by other landlords in the marketplace. I think the general trend of our cost per square foot per year decreasing will start to reverse itself as we start to focus more on new leasing to absorb space.

Jordan Sadler – KeyBanc Capital

Thank you. That's helpful. I appreciate it. One last one, if I could. On the preferred, this thing is ticking along at $5 million or so a quarter of accrued, unpaid interest. I mean – and you guys now are obviously – you spend quite a bit of time and focus getting rid of some of the properties that were dragging on you from a cash flow perspective and probably now more focused on leasing than ever before, but this one aspect of the story continues to drag. So what are you guys thinking, what has been most recent analysis and discussion surrounding that instrument?

Nelson Rising

Well the first thing, we should focus on an earlier question and that is the preferred holders, because we had gone six consecutive quarters without paying a dividend, have their – the right to two members of the Board. And at this point, while we've had conversations with preferred holders, if they have not perfected that right in the form of having a meeting request, a valid meeting request filed. We intend to be as cooperative as we can possibly be with those who are interested and to move forward with that. From the standpoint of renewing the dividend, at this point there's no current plan to do that because of the impact it would have on our liquidity and our cash going forward. There was a question that was raised earlier about what would we be doing with respect to attracting equity, either the asset or the entity level and we are considering a range of alternatives there, but nothing to announce at this point.

Jordan Sadler – KeyBanc Capital

Great. So you probably want to address the preferred before going ahead with the capital raise, it would be fair to say?

Nelson Rising

Well, let's say – it would be fair to say that consideration of the – of how we do it and the timing of that is very much on our minds when we haven't reached a conclusion on that.

Jordan Sadler – KeyBanc Capital

Okay. Thank you.

Nelson Rising

Thank you.

Operator

Your next question comes from the line of Patricia Fox [ph], shareholder.

Patricia Fox

Good morning. In light of the current discussion regarding the failure to pay the preferred dividend, what is the specific deficiency regarding the lack of a valid notice on file?

Peggy Moretti

This is Peggy Moretti. Patricia, can you repeat that question, please?

Patricia Fox

Yes. In light of the ongoing failure to pay the preferred dividend shares, what is the specific deficiency in the fact that the company has no valid notice of this meeting on file? I believe Mr. Rising said that there was no – the company had not received a meeting request yet and then just recently reiterated that. So I'd like to know what the specific deficiency is. Is it the number of shares or the format or the qualifications of the people?

Peggy Moretti

There are a number of representations that are required to be made, specifically the number of holdings that a representative has and to date we have not received a valid request with those representations.

Patricia Fox

And is there –

Nelson Rising

We've had very open and direct conversations and so we're just waiting for that to happen and at that point we will move as required.

Patricia Fox

Okay. And my question is, is it the number of shares that's the deficiency or is it something else, say a person owns 100 shares and that person requests a meeting or an election, is that sufficient or not?

Peggy Moretti

It is 10% of the holder, you need to provide representation and prove where their holdings are. So it's a technical issue, if you will. So the deficiency is in the form of the representation.

Patricia Fox

So do you –

Peggy Moretti

As Nelson said, once a valid meeting request is received, the company will act accordingly.

Patricia Fox

Okay. Thank you.

Peggy Moretti

Certainly.

Operator

Your next question comes from the line of John Guinee with Stifel.

John Guinee – Stifel

One last question, we'll let you go.

Nelson Rising

Okay. John.

John Guinee – Stifel

City Tower and 3800 Chapman, debt on City Tower is about $3.40 a square foot, 3800 Chapman, the debt is about $2.80 a square foot. It seems as if something will happen with the lenders sooner than later on those assets. Can you walk through the status of both assets?

Nelson Rising

Well, the 3800 Chapman is a situation where we have a debt service guarantee until such time as we have consecutive quarters, I think it's five consecutive quarters of needing debt service coverage. And so on that asset, our flexibility is dependent on having five successive quarters of debt service coverage meeting the standard provided in the agreement. With respect to City Tower, obviously your assessment is correct, that the debt service – the debt amount is quite high on that. Currently it is covering. And Shant?

Shant Koumriqian

Yes, John, on both of those, on 3800 Chapman, we have a debt service guarantee, we have what we believe is a good rent roll and in place leasing reserves, our focus has been to try to lease up the asset. It is a challenging market. The debt service guarantee covers all debt service interest. You get a credit for NOI, so that's what our focus has been there.

As Nelson said, we have a constraint that we need to deal with on that asset. On City Tower, the offset has been covering, it's marginal, it's got a significant amount of debt and I believe it's about 80% leased. What we have highlighted in our prior Qs is up until this point we've been using interest reserves and leasing reserves, both of those are effectively fully utilized at this point and it's an asset that we're mindful of. It's significantly over-levered.

John Guinee – Stifel

Thank you.

Operator

Thank you. That concludes our question-and-answer session today. I'll now turn the call over to MPG Office Trust management team for any closing comments they may have. Gentlemen?

Nelson Rising

Well, thank you all for your participation today and we look forward to our next call.

Peggy Moretti

Thank you.

Operator

Ladies and gentlemen, that concludes our conference call for today. You may all disconnect and thank you for participating.

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Source: MPG Office Trust, Inc. Q2 2010 Earnings Call Transcript
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