Parkway Properties' (PKY) CEO Jim Heistand on Q2 2016 Results - Earnings Call Transcript

| About: Parkway Properties (PKY)

Parkway Properties, Inc. (NYSE:PKY)

Q2 2016 Earnings Conference Call

August 9, 2016 9:00 AM ET

Executives

Jeremy Dorsett – Executive Vice President and General Counsel

Jim Heistand – President and Chief Executive Officer

Jayson Lipsey – Chief Operating Officer, Executive Vice President

Jason Bates – Executive Vice President, Chief Investment Officer

David O'Reilly – Chief Financial Officer, Executive Vice President

Analysts

Manny Korchman – Citi

Jamie Feldman – Bank of America

Tom Lesnick – Capital One Security

Alexander Goldfarb – Sandler O'Neill

Operator

Greetings, and welcome to the Parkway Properties Second Quarter 2016 Earnings Conference Call. At this time, all participants are in a listen-only mode. The 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 your host, Mr. Jeremy Dorsett, Executive Vice President and General Counsel. Thank you, you may begin.

Jeremy Dorsett

Good morning and welcome to Parkway's second quarter 2016 earnings call. With me today are Jim Heistand, Parkway’s President and Chief Executive Officer; David O'Reilly, Parkway's Chief Financial Officer; Jayson Lipsey, Chief Operating Officer; and Jason Bates, Chief Investment Officer.

Before we begin, I would like to direct you to our website at pky.com, where you can download our second quarter earnings press release and supplemental information package. The earnings release and supplemental package include reconciliations of non-GAAP financial measures that will be discussed today to their most directly comparable GAAP financial measures.

Certain statements made today that are not in the present tense or that discuss the company's expectations are forward-looking within the meaning of the Federal Securities Laws. Although we believe that the expectations reflected in such forward-looking statements are based upon reasonable assumptions, we can give no assurance that these expectations will be achieved. Please see the forward-looking statements disclaimer in our second quarter earning press release for factors that could cause material differences between forward-looking statements and actual results.

As you are aware, on April 29, we announced a merger transaction with Cousins Properties. We recognize that you may have many questions regarding the pending merger, so we refer you to the press release that was issued to announce the merger in the investor presentation and related conference call transcript regarding the proposed transaction that has been posted in both company’s website.

In addition, our definitive joint proxy statement, we filed with SEC on July 25, and it has been posted in both company’s website. Certain of our Directors and Executive Officers maybe deemed to be participants in the solicitation of proxies with respect to the proposed transaction. Information about the participants and proxy solicitation is contained in the joint proxy statement.

The purpose of today’s call is to discuss our earnings results for the second quarter and with the session of fewer remarks by Jim on the proposed transactions. We will not be speaking today about the pending merger transaction either in our prepared remarks or in response to any questions.

With that, I will now turn the call over to Jim.

Jim Heistand

Good morning and thank you for joining us today. Before discussing our results this quarter, I’d like to provide an update on the pending merger results. As Jeremy mentioned, the joint proxy statement was filed with SEC on July 25, and proxies have been mailed to Parkway and Cousins shareholders of record as of July 15.

On August 23, Parkway and Cousins will hold separate special shareholder meeting, where the shareholders of each company will vote on the merger. In addition to the approval of both Parkway and Cousins shareholders, the closing of the merger is subject to among other things, the SEC declaring effective Form 10 of Parkway, Inc. the newly formed company that will own and operate the combined Houston portfolio. Both companies are working diligently toward an anticipated fourth quarter close of the transaction.

I would now like to briefly discuss our second quarter results. We saw a strong core operating results this quarter and we continue to see steady improvement performance across our market. Our second quarter results are highlighted by recurring FFO of $0.34 per diluted share, which excludes non-recurring items such as merger-related expenses and positive same-store recurring cash NOI growth of 6.5% at Parkway’s share.

Our occupancy and lease percentages remain strong at 89.1% and 90.5% respectively. On the investment front, subject to quarter end, we closed on the sale of the Stein Mart Building in the Jacksonville, Florida, for a gross sale price of $23.6 million; and as resulted of the sale, we have fully exited at Jacksonville CPD. Until the closing of the pending merger transaction, it will continue to be business as usual here at Parkway. We will continue to focus on unlocking our portfolios embedded growth and addressing remaining vacancies particularly in Houston and in Tampa.

I will now turn the call over to David O'Reilly to give you an update on financial results.

David O'Reilly

Thank you, Jim. We reported a net loss this quarter of $0.02 per basic and diluted share, and FFO per diluted share of $0.29. And Jim mentioned, recurring FFO for the quarter was $0.34 per diluted share, which excludes merger expenses and other non-recurring items. We’re providing a reconciliation of net income to FFO and recurring FFO on page 9 of the supplemental report.

Our net debt-to-adjusted EBITDA multiple, which is adjusted for annualized investment activities, remaining within our target range at 6.3 times, which is down from 6.7 times at June 30, 2015. We also saw quarter-over-quarter increases of our interest coverage ratio to 4.2 times and fixed charge ratio to 3.6 times, both of which are among the highest coverage ratios in Parkway’s history.

In April, we use available cash in our balance sheet to payoff two gross mortgages at par, selling $162 million, which were secured by Lincoln Place in Miami and CityWestPlace One and Two in Houston. These two loans had a blended cash interest rate of 6.1%. We recorded a gain of $462,000 on extinguishment of debt in the second quarter of 2016 related to the write-off of the remaining GAAP mark-to-market adjustments associated with these bonds.

As mentioned in our first quarter call, given the pending merger, we will not be updating or affirming our previously issued guidance range for the full year 2016 for earnings per diluted share or FFO per diluted share.

I will now turn the call over to Jayson Lipsey to give an update on operations.

Jayson Lipsey

Thank you, David. While our leasing velocity has decreased from 2015 levels, impart due to decreased inventory in our portfolio, we are pleased with the quality of leases that were executed this quarter and the impressive average rental rates achieved.

Total leasing for the quarter equals 180,000 square feet at an average rate of $38.58 per square foot. While we did see an increase in leasing costs this quarter, this increase was largely due to a higher allocation of new and expansion leases, which are also led to much higher average rental rates for this activity.

We executed 77,000 square feet of renewal leases at an average rate of $38.69 per square foot, representing a positive renewal spread of 1.3%. I am particularly pleased to report a 37,000 square foot renewal and 5,800 square foot expansion lease [indiscernible] Houston signed with the gross rental rate $40.69 per square foot.

So we executed fewer renewal leases this quarter, our rental rates for those lease where $5.71 per square foot above the average of renewal leases last quarter and $8.85 above our average renewal rates over the past year. We also signed 70,000 square feet of new leases at an average rate of $39.32 per square foot this quarter, representing an increase of 7.2% quarter-over-quarter; and 33,000 square foot of the expansion lease at an average rate of $36.70 per square foot, representing an 8.3% increase as compared to last quarter.

As Jim mentioned, our portfolio is 90.5% leased and our occupancy is 89.1%, up 10 basis points from last quarter. Excluding Houston, our occupancy for the quarter was 91.6% and our lease percentage was 92.8%. Our customer retention for the quarter was 54.2%, primarily due to the expected return of segment swing space at, Two Liberty Place in Philadelphia and our recurring same-store GAAP NOI decreased by 5.6% at share as compared to the same quarter last year, due impart the BMC software’s contraction at CityWestPlace in the first quarter of this year. Despite this, we saw positive same-store recurring cash NOI growth this quarter of 6.5% compared to the same quarter last year.

Leasing pipeline in most of our markets remains very strong. In subsequent to quarter end, we’ve executed 262,000 square foot leases. Two of which were sizable renewals in Jacksonville and Tampa, that I would like to highlight.

The Jacksonville renewal lease was executed a deal with South [ph] in total approximately 113,000 square feet with an average rental rate of $20.90 in a five-year lease term. The Tampa renewal lease totaled 89,000 square feet at Corporate Center III at International Plaza and has an average rental rate of $35 with 12-year lease term. If these two renewal lease had been executed in the second quarter, our customer retention for the quarter would have been 74.4%.

This concludes our prepared remarks. We’ll now open the call up for questions. Before we do, we ask that you limit your questions those related to our second quarter earnings results. Thank you.

Question-and-Answer Session

Operator

Thank you. At this time, we will be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of Manny Korchman with Citi. Please state your question.

Manny Korchman

Hey, good morning everyone.

Jim Heistand

Good morning, Manny.

David O'Reilly

Hi, Manny.

Manny Korchman

Just wanted to talk about Houston for a second. Just wondering how showings have been impacted by the recent volatility in oil prices if at all?

David O'Reilly

Well, I think that there is a confluence of a bunch of things going on in Houston right now. You’ve had oil return back to kind of the low-40%s. You had significant production cuts which will likely help the long-term, but in the short-term, it has reduced capital spending. I think our customers, while their credit seems to be hanging in well, our focus on their core businesses and not on leasing office space. And so I think the best way to characterize things in Houston right now are swell. We've seen an increase in the amount of subway space availability in Houston is kind of a 20-year high right now. And so I think that what we're seeing is a very slow market.

Now in the context to that slow market, fundamentals from a rental rate standpoint seem to be holding up fine. We’ve not seen precipitous drop at rates, but there's also not demand that setting the market price right now. And so the deals that we announced were done a great rate from my perspective. But what we’re really waiting for and what we really need to drive significant net absorption in the market and in our portfolio is an increase of the global offering.

Jim Heistand

And Manny, this is Jim. And I think our view and one of the reason we did the merger and spin, we're talking about is, not withstanding oil prices may be this year and next year, I mean the fundamentals there with the new supply, the steadily space that has we taken up, we just think it's going to be a few years before things get back and balanced, kind of almost irrespective of what oil is, obviously higher oil price will accelerate that and lower price will probably prolong there. But watching that day-to-day, it’s not going to – oil price in one day is not going to change the fundamentals of the real estate for office in Houston in the near term.

Manny Korchman

Great. And then, quick and just any update on the Two Liberty sale.

David O'Reilly

Sure. Obviously, we expect that to close in the second quarter as previously announced. That has not yet happened, but they were still actively working on it.

Manny Korchman

Thanks guys.

Jim Heistand

Thank, Manny.

Operator

Our next question comes from the line of Tom Lesnick from Capital One Securities. Please state your question.

Tom Lesnick

Hey, good morning, guys. Thanks for my questions. I guess, first, I was just wondering if maybe you could breakdown your same-store revenue or NOI stats for us in a couple different ways. I guess, first, what would they be like without the CityWestPlace? In fact, they could be there. And then what was the difference between the Houston portfolio and rest of the portfolio.

Jim Heistand

So I think that the best way to answer that Tom is that our same-store debts are driven especially on a GAAP basis, meaningful down by the BMC infraction and extension. When they left Building One and consolidated their space, and we signed a lease agreement, there was an acceleration of some mark-to-market GAAP adjustments in there lease that increased our GAAP NOI a year ago. So as compared today, it’s creates a slightly negative same-store number. The great news is that the rest of the portfolio and even a bit in some of the assets in Houston are creating some positive cash same-store growth. If not for the BMC lease, that same-store number would be about 800 basis points to 900 basis points higher.

Tom Lesnick

Yes, I appreciate that. And then going back to the BMC space for a second, what kind of GI package is expected on your space [ph] this quarter or, maybe instead of giving may be specific numbers, how has that number trended over the last two quarters and do you expect it to continue on trend?

David O'Reilly

Well, the only, I think the bit of the answer I can give is that we actually signed a couple of leases at CityWestPlace last quarter, which we talked about that on the call. And I think those leases were done certainly on the high-end but within the range of what we’ve always talked about as the standard G.I. package for our portfolio, which is probably $4 to $5 per square foot per-year of the lease term. I think that the rate was also great. I think we did those deals in the high-20s in that range, which is good. I think that we'll certainly be willing to be aggressive leasing up the CityWest one space. And we continue to work on the variety of deals in the pipeline.

And I would expect that for a large deal in the Westchase submarket today, we would probably trend above that $5 per square foot per-year of lease term by – at least $1 maybe $1.50 per square foot per-year of lease term.

Jim Heistand

And Tom all of that concession package whatever you may provide there will be a direct function of what kind of credit, what kind of term is going into that space, especially given the environment today.

Tom Lesnick

It makes lot of sense. And I guess just last one for me. Did you bring any – did you bring forward any overhead reduction into G&A for the second quarter? I just noticed that it was a bit lower than trend, so just curious if there's any that you could map.

Jim Heistand

I would say that consistent with our comment last quarter – at the end of last year, we made a strong push to rationalize our G&A given that we were no longer growing in actually net dollars in the portfolio over the past year, year and a half. That is starting to materialize in the first quarter. We didn't see as much of that materialize last quarter, but we’re starting to see it now and we do expect on a run rate basis that that number would continue by a recurring basis that the both seen are supplemental.

Tom Lesnick

That's very helpful. All right, guys. Thank you, very much.

Operator

Our next question comes from Jamie Feldman with Bank of America. Please state your question.

Jamie Feldman

Okay, thanks good morning. Can you guys talk…

Jim Heistand

Good morning.

Jamie Feldman

Can you talk about the investment sales market in Houston, right now? Any changes, any appetite from buyers?

Jason Bates

Hey, Jamie, this is Jason Bates. I would tell you it’s still very, very slow. I think the last thing I heard was volume for the year was around $200 million and this is a market that easily should be doing $2 billion of gross volume per year. So, I think it’s just slow. There’s a couple of assets that’s started trickle into the market, but you know buyer and seller expectation is still continuingly meeting each other. And so from the information I’ve got seen on the ground is not a big pipeline of seller that are interested and trying to test the market at this point and the buyer pool today is certainly thinner than it had been in the past.

Jamie Feldman

Okay. And have you seen any change given some of the moves off the bottom in oil?

Jim Heistand

Yes. I mean I would you that there’s certainly interest, right. I would say from the folks that we spent time with and just being what we’re seeing in the market, more people are doing work around the market. They’re starting to dig in. They’re interested. They’re curious. And so, I would say, the level of interest from potential buyers, who haven’t been as active in Houston over the past five years has certainly pickup, but it hasn’t translated yet into conversions of buyer buying a property from a seller to market covering price. So I think people are interested. They’re doing work. The fact that will seemingly to stabilize somewhere in the $40 to $50 range. It gives people confidence that it’s okay to start looking at moving in, but it’s still going to flow to actually convert into transaction.

David O'Reilly

Yes, I think, Jamie, when we were going to process of Phoenix Tower prior to the announcement of the merger, I mean we were surprised as how much interest there was in terms of that. So I mean people are obviously looking for dislocation to come in, but at a price point, there is an awful lot of interest to come in there to make [indiscernible] from what we see.

Jamie Feldman

Okay. And then how would you characterize the types of interested – I know there’s not many, but are these large sovereign wealth foreign or these more local players that would be more one-off stuff?

Jim Heistand

Yes, it depends on the assets, right, but I would tell you its wide ranging. So whether it’s less sold sovereign capital or foreign capital, everyone described that, but sort of larger capital sources, some of is high net worth domestic, some of is high net worth foreign, some of is syndication, aggregators whether that’s foreign syndication or domestic syndication. I would tell you the buyer group that’s probably been least active at the moment is in your more traditional pension funds or domestic advisors at this point are seemingly not active, but I would tell you the rest of the groups, there are some representatives from those groups that I have seen or heard being in the market, doing work.

Jamie Feldman

And what do you guys think it takes its return? It’s actually a good transaction.

Jim Heistand

Probably, I think Jamie, this is going to take some time. I mean, you got – we obviously think long-term, the economic there will continue to grow over the longer term, but you got to work through some of the new supply that was taking on place on the market. Lot of users didn’t need all the space that they had originally intended to plan on. So that’s got to come in balance. And so it’s just going to take some time. I think you will see this – if you the demand supply begin to kind come together at some point, and our view is we’re not predicting internally here till 2018 and be positive for better growth in that market.

Jason Bates

I would add, Jamie. I think the great news is that energy companies are figuring out how to be profitable at lower energy prices, which I think is overall very good for the industry. But I think that it’s going take the chain reaction of events which will start with a sustained recover and energy prices, which will cause energy companies to start taking up more space and then playing offense again, and that will lead to certainly the perception of fundamental recovery within the office market. And I think that will drive us the change in sentiment.

Jamie Feldman

Okay. That’s helpful. And then you guys had some good progress in Tampa. I know you mentioned the One Corporate Center deal. But just generally there and then Atlanta also, I know Atlanta has a slower overall leasing market – leasing quarter, but it sounds like fundamentals are still okay. Can you just provide some color and your thoughts on those two markets?

Jim Heistand

Well, I will start with Atlanta. Our bucket portfolio continues to form very well. Our portfolio there is 94% leased. We continue to drive rates upwards on just about every deal we do. And so the fundamentals in bucket really are the best I’ve ever seen them. In Tampa, I think the fundamentals remain fine. And while – admittedly the progress has been slower than I’d have like to seen, we’re making progress, we still got a whole pipeline of deals. And we have been executing some here and there. And just not equipped alike but I’m very optimistic that the portfolio which is 86% has the potential to getting into the 90%s in the near future.

David O'Reilly

I think, Jamie, in Tampa, the renewal rates that we did the large renewal on $35 per foot, relative to the Westshore historical rate that’s a very strong rate in the Westshore and substantially higher ultimately than what we underwrote in that whole portfolio.

Jamie Feldman

Okay. All right. Thanks, guys.

Operator

Our next question comes from Alexander Goldfarb with Sandler O'Neill. Please state your question.

Alexander Goldfarb

Sure. Good morning. Just a clarification, you said in Houston the leasing requirement has been pretty slow. I’m just curious, [indiscernible] just given the qualities in that portfolio, you have the CapEx setting for the BMC space. Are you seeing tenants who that resonates with or most tenants in the markets is purely price driven. And therefore it doesn’t matter about the amenities that are just looking for the cheap option?

Jim Heistand

Well, I think the tenants that we’re working with are still looking for value. And that’s sort of the combination of price and quality. And so I think everyone certainly appreciates the value proposition at CityWestPlace. And I think that’s why we have been seeing at least in terms activity well more than our fair share of this pipeline activity. Converting in Houston today is very difficult, but I think that the quality is absolutely resonating with prospects in the market. And I expect that eventually we’re going to have success to CityWestPlace One, I think just given the market condition is going to take longer than we originally predicted.

David O'Reilly

And I think Alex, the way you look at it in terms of competitive sets, you obviously have new construction, it has sublease in a new construction. But so, the price range difference to what the new construction will that being are still continues to ask is that a higher number than what we need at CityWest with less amenities. So as we look at it, it still gives them a good value in terms of a high quality of project, but that has a great deal of more amenities than your typical single standalone building there in Houston. So, we’ll have a lot of interest in that because of the combination of price and quality.

Alexander Goldfarb

Okay, so, Jim, basically, what you’re saying is with all the new construction that we’ve heard about getting put on the market for sublease. You’re saying that you’re still more competitive at CityWestPlace then where that new construction is being priced on this sublease market is that correct?

Jim Heistand

That’s correct. With a broader amenity based than a lot of those single building assets.

Alexander Goldfarb

Okay, okay. Second question is [indiscernible] on Huston earlier this year, you guys were talking about – in the market, there were some DC or oil guys who are putting funds together and trying to ask distressed oil projects, et cetera. Are you still seeing those trajectories form together? Or was that sort of something that occurred earlier this year as well as come down again, you’re not seeing as much of that activity from those start up efforts?

Jim Heistand

Those startups are definitely still sort of very busy right now. And so I think that the trajectory is not difficult. We’re definitely seeing a continuation of that trend, which is I think a very positive trend. The only downside is they’re not big users. And so, those users are typically in the sort of 10,000 square feet or less kind of range. And so they’re not huge needle movers than we’ve historically seen in Houston, but I think it’s a very positive sign in the market.

David O'Reilly

What we have also seen I think – while thus far it hasn’t resonated in great – additional occupancy in the portfolio, but we got a lot of corporate or headquarter users in our asset. And as a result, there has been consolidation in other locations in back in our buildings, so to the extent they still needed less people they were bring in people from other locations, hence the renewal and expansion in the One and Tampa buildings because that’s where their headquarters are. So we receive some benefit of that just by function of the location and quality of the assets that we own.

Alexander Goldfarb

Okay. That’s helpful. Thank you very much.

Jim Heistand

Thank you.

Operator

And at this time, I’m showing no further question. So I will turn it back to management for closing remarks.

Jim Heistand

All right, as always we appreciate everybody and I guess this is the last earnings call for the old Parkway. And hopefully, and at some point, we look forward to talking to all again going forward once the merger is complete as the new Parkway Houston, specific Parkway going forward. So I look forward to see you in the near future. Thank you.

Operator

This does conclude today’s conference. Thank you for your participation. You may now disconnect your lines at this time.

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