City Office REIT, Inc. (CIO) Q3 2022 Earnings Call Transcript

City Office REIT, Inc. (NYSE:CIO) Q3 2022 Earnings Conference Call November 7, 2022 11:00 AM ET

Company Participants

Tony Maretic - Chief Financial Officer, Treasurer and Corporate Secretary

Jamie Farrar - Chief Executive Officer

Conference Call Participants

Rob Stevenson - Janney

Barry Oxford - Colliers

Michael Carroll - RBC

Craig Kucera - B. Riley

Bill Crow - Raymond James

Operator

Good morning. And welcome to the Office REIT, Inc. Third Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference call is being recorded. [Operator Instructions]

It is now my pleasure to introduce you to Tony Maretic, the company’s Chief Financial Officer, Treasurer and Corporate Secretary. Thank you, Mr. Maretic. You may begin.

Tony Maretic

Good morning. Before we begin, I would like to direct you to our website at cioreit.com, where you can view our third quarter earnings press release and supplemental information package.

The earnings release and supplemental package both include a reconciliation of non-GAAP measures that will be discussed today to their most directly comparable GAAP financial measures.

Certain statements made today that discuss the company’s beliefs or expectations or that are not based on historical fact may constitute forward-looking statements within the meaning of the federal securities laws.

Although the company believes that these expectations reflected in such forward-looking statements are based upon reasonable assumptions, we give no assurance these expectations will be achieved.

Please see the forward-looking statements disclaimer in our third quarter earnings press release and the company’s filings with the SEC for factors that could cause material differences between forward-looking statements and actual results. The company undertakes no obligation to update any forward-looking statements that may be made in the course of this call.

I will review our financial results after Jamie Farrar, our Chief Executive Officer, discusses some of the quarter’s operational highlights.

I will now turn the call over to Jamie.

Jamie Farrar

Good morning and thanks for joining today. In our time as a public company, we faced several periods of macro uncertainty and sector specific headwinds. As in the past, we intend to operate in a conservative and patient manner, and to develop strategic opportunities to create long-term value.

That strategy is aided in our company producing leading total returns and earnings growth across the office REIT sector. Before we discuss specifics of our operational approach, I would like to summarize the office market trends as we see them.

The first trend is general pressure on leasing metrics across the industry. Year-to-date, net absorption across our nine markets is negative 3.9 million square feet, vacancy has continued to edge higher across our cities and we expect elevated levels of subleasing and downsizing we will continue to put pressure on occupancy rates in general.

While face rental rates continued to trend higher overall, net effective rents are trending lower due to more expensive tenanting costs and shorter leases that are being signed. As I will discuss shortly, the highest quality properties in the best locations, with desirable amenities are clearly outperforming across the country.

The second trend is a gradual return to the office. The highest office utilization rates continue to be in the South and West. On a national scale, the office utilization rate increased 5.3% between late August and late September according to JLL, indicating a significant movement post Labor Day.

Our internal tracking showed a similar increase. With workstation utilization now in the mid-50s at our properties, our own estimate is that our current utilization translates to being about two-thirds of the way back to where we were pre-COVID when you factor in vacation, travel and sick days.

A third trend continues to be the outperformance of Sun Belt markets. In terms of leasing volume, corporate relocation, employment growth, population growth and real estate fundamentals, our Sun Belt markets are where both people and companies want to be. We have been investing across these markets since our inception and our infrastructure, knowledge and connections give us a competitive advantage.

The last trend is one that we believe will be a driver of our industry over the next several quarters and the long-term. To accelerate a return to the office and increase employee retention in a tight labor market, employers are looking for highly amenitized office buildings that have outdoor spaces, fitness centers, lounges, food and beverage options and updated finishes. Likewise, there’s heightened demand for ready-to-lease space with desirable buildings.

Our property, The Quad in Phoenix is an excellent case study in this. The property has high end amenities, including a fitness center, outdoor tenant and common space, event and conference areas and a great on-site restaurant. The property is 100% leased today with a waiting list and we are continuing to achieve new high watermark lease rates with minimal tenant improvements.

These office trends in the state of the broader market have formed the basis of our strategy and how we are approaching opportunities to outperform and create value while managing risk. Fortunately, we have assembled a quality portfolio and a high percentage of the value of our company is invested in properties that are very well positioned for these trends.

Now we do recognize that a relatively small percentage of our overall asset value resides in less amenitized buildings, targeting tenants seeking lower cost rent. This segment of the leasing market has been much slower than in the past. We continue to evaluate the best path forward for these types of properties, which includes maintaining their current market position, elevating through capital enhancements or selective dispositions when market conditions improve.

As mentioned on prior calls, we are continuing to advance what we believe are the highest impact property enhancements and spec suites. In support of why we believe this is a prudent use of funds, we are pleased to report recent leasing activity at our 190 Office Center property in Dallas.

Earlier in the year, we completed a renovation that included the addition of outdoor common areas, a new fitness center, modernize conference facility and other upgrades. The renovation looks fantastic and has transformed the property for a modest budget of just over $2 million.

During the third quarter, we signed two leases for a total of 49,000 square feet. We recently held a leasing broker event to reintroduce the property and the leasing community and the feedback we received was extremely positive. Included in our Investor presentation is a slide that shows the before and after positioning of this property.

Moving to our spec suite program, year-to-date, we have leased 19 of our spec suites totaling 71,000 square feet. We have also leased five spaces totaling 82,000 square feet, where we have completed substantial space conditioning. We have a remaining inventory of 15,000 square feet of spec suites, with approximately 150,000 square feet planned for construction in the balance of 2022 and 2023.

Our typical spec suites have a functional design with open ceilings, high end finishes and fixtures, polished concrete floors and ample glass that conveys an incredible feel. The initial upfront cost of these spec suites is somewhat higher than a traditional office building. However, the benefits far outweigh the incremental cost, and we found that the cost to release these spaces in the future are modest, driving a better long-term return.

Further, we are pursuing long-term opportunities to create additional value. This includes exploring potential redevelopment at select properties, where there’s a higher and better use for additional uses such as multifamily site on the property. These types of creative projects have a longer lead time, but we believe that over time, significant incremental value can be generated.

From a financial perspective, we continue to operate prudently with ample liquidity. The sale of our life science portfolio in 2021 significantly reduced our overall leverage levels and we continue to operate conservatively.

The last topic I will touch on is the completion of our $50 million share repurchase program. The average repurchase price was equivalent to us buying our own portfolio at approximately an 8% cap rate and $218 per square foot.

We believe this offers great long-term value and a substantial discount to our internal net asset value estimation even in this challenging climate. We are, however, mindful of reducing our equity market cap further and do not currently have any additional repurchases planned.

In summary, we believe this is a time for both caution and strategic position. We will remain highly mindful of general market conditions, while also actively deploying our team and select capital investments into impactful projects.

I look forward to providing further updates on these initiatives and we will hand the call over to Tony Maretic to discuss our financial results.

Tony Maretic

Thanks, Jaime. Our net operating income in the third quarter was $28.1 million, which is $600,000 lower than the amount reported in the second quarter. This decrease is primarily a result of the sale of Lake Vista Pointe during the second quarter. While operating expenses have increased as a result of inflation in various categories, the impact on net operating income has been muted as recoveries mostly offset this impact.

We reported core FFO of $16.5 million or $0.39 per share, which was $1.1 million lower than the second quarter. The drivers of that decrease were primarily lower net operating income from the sale of Lake Vista Pointe along with higher interest rates on our floating rate credit facility.

Our third quarter AFFO was $7.7 million or $0.18 per share. The largest single item to impact AFFO was $900,000 of tenant improvement expenses related to a 21,000 square foot new tenant at our Florida Research Park property whose lease will commence in Q4.

On a per share basis, our share repurchase program was accretive to our results. Including the second quarter and third quarter, we repurchased $50 million of common shares at an average price of $12.48 per share.

As Jaime mentioned, we also continue to invest in building out ready-to-lease spec suites and implementing vacancy conditioning, which is a key part of our 2022 business plan. The total investment in spec suites and vacancy conditioning in the third quarter was $1.2 million.

Moving on to some of our operational metrics, our third quarter same-store cash NOI change was in line with our expectations at negative 4.3% or $800,000 lower as compared to the third quarter of 2021. Third quarter same-store cash NOI was impacted by lower occupancy year-over-year and free rent periods associated with new leases.

Contributing $500,000 to that decrease, BB&T vacated their space at Park Tower during the third quarter of 2021 to accommodate the new 73,000 square foot tenant. The new tenant’s lease commenced on May 1, 2022, but will not begin paying cash rent until February 2023. That new tenant’s eight-year lease increase the value of the property, but the downtime and free rent period is a significant contributor to our negative Q3 same-store results.

Our total debt at September 30th was $676 million. Our net debt, including restricted cash to EBITDA was 6.3 times. We have no debt maturities in 2022 and two small maturities in the fall of 2023. Our debt is primarily fixed rate.

As far as liquidity, as of September 30th, we had $115 million of undrawn availability on our credit facility. We also had cash and restricted cash of $42 million as of quarter end, along with financeable unencumbered properties as an additional source of liquidity.

Last, based on our results to-date and our expectations for the fourth quarter, we have reiterated our prior 2022 guidance.

That concludes our prepared remarks and we will open up the line for questions. Operator?

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] Our first question for today comes from Rob Stevenson of Janney. Rob, your line is now open.

Rob Stevenson

Good morning, guys. When you are looking at the page 15 of the supplemental, the lease expirations over the next four quarters and matching those expirations and the known move-outs there versus the stuff that you have signed, what does that look like in terms of sort of net flow of space in terms of space you are getting back without a tenant versus stuff that’s currently unleased that’s going to wind up starting to pay rent. How should we be thinking sort of the netting out of expirations versus lease signings and commencements?

Tony Maretic

Sure. Good morning, Rob. It’s Tony here. Fair question. Best way to answer it is maybe talk about in two components. First 1 is to talk about signed deals that we have that will be moving in over that period of time. That adds up to about 188,000 square feet of new leases that I will start taking occupancy beginning in Q4 through that period of time. So that’s positive.

Offsetting those are the known move-outs and so I am happy to go through those. I think we have talked about most of these already, but just to go through them, we have a 49,000 square foot tenant at our 5090 property that is vacating at December 31, 2022. That’s really the only big one in that period.

Moving to the next quarter in Q1, we have a 30,000 square foot tenant in Denver and a 44,000 square foot tenant at 190 Center that will be vacating in that quarter. And then further along in Q2 of next year, we have a healthcare company at 190. That’s the largest one, 130,000 square foot downsizing. And then lastly, we have a 34,000 square foot tenant in Q3 of next year that will be vacating our Papago property. So a number of move-outs, net-net it’s a slight decrease in occupancy.

Rob Stevenson

Okay. And then can you talk about what the cash needs are over the next few quarters? You talked about spending a little over $1 million in the third quarter getting vacant space ready and the spec suite development. How much else of that sort of $40 some million of cash has an earmark for it versus paying down the, I believe it’s $185 million out on the line. How are you guys thinking about that?

Tony Maretic

Fair question. So, I mean, just looking forward into the next kind of year, we haven’t given guidance yet, but I will say that we are committed to the spec suite program. We really think we have got a lot of success from doing this program. We currently only have 15,000 square feet left inventory that hasn’t been leased.

We have about 55,000 square foot that is currently under construction and potentially up to another 100,000 square foot plan for 2023. So we will be committing to that and have a similar kind of TI and CapEx costs associated with that.

But just as a reminder, if we are successful in leasing up that full 170,000 square foot of spec suites that I just talked about, I mean, that’s potentially another $4 million of NOI. So you will see a continuation of that trend to invest in these spec suites.

Rob Stevenson

And what are you running currently in terms of the price per square foot on a rough number in terms of building out the spec suites, what is that costing you?

Tony Maretic

Good question. So it really varies by property. Typically, they are in this $50 per square foot to $60 per square foot range, but for certain properties where we are adding furniture, it could go as high as $80.

Rob Stevenson

Okay. That’s helpful. And then last one for me. Jamie, I know that you said you need to be cautious about buying back more common here. How are you guys thinking about the preferred, is it just too helpful in terms of the credit metrics that you want to keep that outstanding, is it expensive debt or do you start looking to buy back some of that given the discount in the marketplace and the fact that it wouldn’t impact any type of liquidity issues for you?

Jamie Farrar

Yeah. It’s a good question, Rob. So we kind of look at it both as a hybrid, it’s a fixed commitment. It’s also equity because it’s perpetual preferred. So when we look at use of capital and whatnot, it’s not something we are focused on today. And where it trades, it’s pretty illiquid, so small movements really do move the price. So that’s not something we are focused on.

Rob Stevenson

Okay. Thanks, guys. Appreciate the time.

Tony Maretic

Thanks, Rob.

Jamie Farrar

My pleasure.

Operator

Thank you. Our next question comes from Barry Oxford of Colliers. Barry, your line is now open.

Barry Oxford

Great. Hi, guys. Jamie or Tony, when we are thinking you mentioned that you are going to have a few more move-outs than move-ins. As we look at occupancy, it moved down in the second quarter to the third quarter, we also saw a loss in margins. As we look out into 2023, are we going to kind of continue to see slow deterioration in those two numbers or not necessarily?

Tony Maretic

Hey, Barry. Good morning. It’s Tony here.

Barry Oxford

Yeah. Yeah.

Tony Maretic

Yeah. In terms of occupancy, the -- as I mentioned here, over the next three quarters, there is a net-net negative. So we are expecting occupancy to tick downwards. You mentioned margins. I am not sure if you are referencing the leasing spread which was negative.

Barry Oxford

No. I was looking at just revenues and expenses to NOI?

Tony Maretic

Yeah. Yeah. So I mean we are expecting occupancy to tick downward through the middle of next year and I mean that’s partly why we are committed to the spec suites program, which I talked about just because we have got so much success in leasing up space in that manner, that we are hopeful that, that’s a catalyst for increase in occupancy in the back half of next year.

Barry Oxford

Okay. Okay. Great. And then last question, when you look at the dividend and the dividend safety, how are you guys feeling about that at this particular juncture?

Jamie Farrar

So we will take a long-term view, Barry, both on balancing our dividend policy and also our portfolio reinvestment and so…

Barry Oxford

Okay.

Jamie Farrar

… we have been fairly close to covering it, kind of going through this year and so we are comfortable there. We are cognizant that if interest rates really move heavily next year and there’s a real impact on our cash flow, that’s something we have to be mindful of and so we are going to continue to watch the dividend and make sure that we are comfortable. But as we are standing here today and looking forward we are feeling fine with where we are at.

Barry Oxford

Okay. Perfect. Thanks for the commentary guys.

Tony Maretic

Thanks, Barry.

Operator

Thank you. Our next question comes from Michael Carroll of RBC. Michael, your line is now open.

Michael Carroll

Thanks. Just going back to the spec suite program, I mean, where do you typically build those sites out, I think, there are specific buildings, markets or is it just across the portfolio where you see opportunities?

Jamie Farrar

Yeah. We prioritize, Michael, as far as what we see as kind of the best opportunity, the lowest risk, and so what does that generally mean, it’s our most amenitized properties would be near the top of the list.

And those are the ones -- if we look back over the last 12 months, often we will start construction and when tenants are touring, they like the plans, they love seeing it under construction and those are often leased before we are even finished.

And so really we are looking at our most leasable assets and focusing there. Now it is spread across many of our markets and many different buildings. So we are trying to be thoughtful in having a variety of options.

Michael Carroll

And then did I hear this correctly that you had 15,000 square feet of spec suites already built out and you could build out was it 100,000 square feet next year? Is that what the numbers were?

Jamie Farrar

Yeah. 15,000 of current inventory, 15,000 square feet, we have 55,000 square feet under construction as we speak, that should be delivering shortly and plans for about another 100,000 plus in 2023.

Michael Carroll

And what’s the level of activity on the 15 and the stuff that’s under construction right now in terms of leasing interest?

Jamie Farrar

So, as I said earlier, while we are building this out, these are the most desirable spaces and the most activity we have had. So it kind of varies across the Board. There is discussions on a number of those 15,000 square feet of inventory that we have and in some of the stuff that’s under construction, we are having dialogue on as well.

Michael Carroll

Okay. And then, Jamie, you said earlier in your prepared remarks that there’s a percentage of your portfolio that didn’t qualify as the highly amenitized and quality buildings that you think, I don’t know if I am putting words in your mouth that, is well suited in this macro environment. Can you kind of provide some color on how many buildings that you would kind of put into that bucket?

Jamie Farrar

Yeah. That’s a fair question. So what we are seeing today as far as the most tenant interest is in buildings that are well located with walkable amenities and feel new and modern. The buildings that are very suburban that have nothing you can really walk to that feel a little bit dated when you walk in across the industry, those are the toughest, right?

And so the leasing activity really is concentrated in ones that are vibrant and so when we look at our own portfolio, we have got a number of assets that are in great locations that have good bones that maybe need a little bit of capital to elevate them and they are going to move up as far as the quantum of activity that we are going to be able to fully lease and so we are evaluating those.

If you were to step back and say ones that are a little bit more suburban. Typically, they may have lower occupancy today as well. There’s a number of properties and without getting into real specifics, if you were to say, as a percentage of our portfolio, it would be probably in the 15% of our assets.

Now a number of those properties have property specific debt, and so when we look at it, there’s not a lot of the company’s equity is invested in those particular assets. It would be sub-5% when we kind of look at what we think it’s worth versus the property level debt.

So the vast majority of our equity value and our assets are in buildings that we think are really well positioned. We do have some that are challenges that we are trying to get our arms around the best way to enhance value.

Michael Carroll

And then what’s the time line of resolving or deciding on what you want to do? Is that something that’s going to take multiple years, is that something near term in nature or how should we think about that? And what could those transactions look like?

Jamie Farrar

So that’s fair. And I think I would say it’s more medium-term in many cases. Now some of them are well leased long-term, but they might not be the assets that are best positioned today. And so when capital markets -- the investment sales market start to improve, those are the ones we look at potentially selling and recycling and that’s not near-term, but medium-term, I think, that’s fair.

In some cases, we think it may make sense to put a bit of capital into these, elevate them a bit, and then, potentially position them for either leasing if we do that or potentially monetizing down the road.

Michael Carroll

And then you said that there are some of those buildings have like secured debt or mortgage debt. I mean, is it something that you would hand back to the debtor?

Jamie Farrar

I mean, in a worst case scenario, that’s always on the table and that’s part of the benefit we have had of structuring where when you buy an asset, you compartmentalize the risk in a property specific loan. So that’s always an option. You can hand the keys back and eliminate the debt. It’s obviously not something that we want to do. But that is always an option.

Michael Carroll

Okay. Great. Thanks, Jamie.

Jamie Farrar

You are welcome.

Operator

Thank you. Our next question comes from Craig Kucera of B. Riley. Craig, your line is now open.

Craig Kucera

Yeah. Thanks. Good morning, guys. Tony, can you walk me through your lease termination recognition expectations here in the fourth quarter and maybe as far as what you know in 2023?

Tony Maretic

Sure. So in terms of the lease role for Q4, if your question is for the balance this year, we really only have one large tenant. We have a 49,000 square foot tenant at our 5090 property. They are vacating at December 31, 2022. So it will be paying rent until the end of the month. That’s the only large tenant in Q4.

I described a few others. I can go through those again. We have a 30,000 square foot tenant at Denver Tech in February of 2023, 190 Center, we have a 44,000 square foot tenant that’s vacating at the end of March and those are the two for Q1.

And then beyond that, we have a healthcare company at 190 Center that will be downsizing by 130,000 square feet at the end of June and we have a 34,000 square foot tenant at our Papago Tech property in Phoenix that was expected to depart at the end of July 2023 and so that’s all of the large known vacates over the next four quarters.

Craig Kucera

Got it. I apologize if I wasn’t clear. I guess what I was looking for is, I think here in the third quarter, Toyota, which you had -- were amortizing…

Tony Maretic

Oh!

Craig Kucera

… some lease termination income and I just was trying to figure out what to look forward for the next several quarters, because I think you had a few that you were going to be amortizing for the next several quarters?

Tony Maretic

Apologies. Thanks for clarifying, Craig. So, yes, so the other termination fee income that we recorded in the quarter, half of it was from Toyota. This is obviously the last quarter that we will be recording that income as they departed at the end of August. The second largest item that we had during the quarter was approximately $250,000 from a 44,000 square foot tenant at 190. That’s a tenant that we are vacating at the end of March. So you will see that number for termination fee income decrease by roughly half and effectively burn off through the early part of next year.

Craig Kucera

Okay. Great. And Jamie, I’d like to talk about your lease retention rates. I think historically, there have been more in the maybe 60% to 70% range, but they really dropped off here in the third quarter I think to about 20%. Do you view this quarter as an outlier or more of an industry-wide trend, perhaps, heightened concerns about recession?

Jamie Farrar

So I do think you are going to see retention rates decrease from where they have been historically. I don’t think this quarter is really representative. So we had two really large tenants that we knew a year plus ago that were moving out and that drove the bulk of it lowering into 2022.

So if you back those out, it was closer to -- it was just under 70%. But there is going to be periods where you have some larger tenants that are going to downsize, et cetera. And I think the historical 70% plus renewal is going to be a little lower than that.

Craig Kucera

Okay. Thanks. Appreciated guys.

Tony Maretic

Thanks, Craig.

Jamie Farrar

My pleasure, Craig. Thanks.

Operator

[Operator Instructions] Our next question comes from Bill Crow of Raymond James. Bill, your line is now open.

Bill Crow

Yeah. Thank you. Good morning, guys. Do you think broadly speaking, tenants are finally coming to grips with what their longer term space requirements will be or is there still this discovery process going on?

Jamie Farrar

Yeah. I personally think, Bill, we are still in the discovery process. We have seen utilization improve. But the strategies that we are hearing companies are using are all over the map and it’s inconsistent as far as number of days back, how people are staggering, whether they are all in on the same days and so I think there’s a lot of discovery going on right now.

Bill Crow

Yeah. You mentioned the possibility of converting an office tower to multifamily. Is that something that you would do on balance sheet or is that an opportunity to sell an asset to a converter?

Jamie Farrar

So it’s a little different. I don’t know how much of our portfolio really is conducive to converting the existing buildings into multifamily. I think where there’s more opportunity is areas where we have some excess land or if you had multiple buildings and you consider demolishing perhaps one, freeing up a bunch of land and then using that as a multifamily site. So that’s more what I was looking at.

In some of our other properties, there is the potential -- there’s very high value in condos as an example and great location of real estate is there a potential to create a condo tower within our site.

There’s some challenges with that. We have to backfill with respect to parking and whatnot. But there’s substantial value in the land and some of the excess land and that’s more where we are focusing on.

And again, there’s nothing that’s going to happen imminently there, but medium term, longer term, there’s potential. That’s probably something that we would end up trying to monetize and let somebody else do the actual project, there could be a JV, to be determined.

Bill Crow

No. It’s interested-- interesting. I apologize I have two more that I’d like to ask. If we look at your portfolio in two buckets, then we take one bucket is everything you have acquired post Sorrento Mesa sale and those that were in the portfolio beforehand. How do you think -- I won’t pin you down on cap rates today, you can offer up what you think they are, but how do you think those cap rates have changed since the beginning of the year those two buckets?

Jamie Farrar

Well, it’s a good question. So if you look at the best located assets, the highest quality, the cap rates are certainly higher than where they were previously. If you take more core plus value add, those CapEx -- those cap rates are substantially higher, right? And so back to the kind of first bucket you had there, Bill, it’s probably 100 basis points, 150 basis points higher on the cap rate and higher than that on the balance of the portfolio.

Bill Crow

Yeah. That’s helpful actually. One final question. I didn’t hear a firm commitment on the dividend and I understand that given the trends going on. But could you give us a timeframe when your model says that AFFO should be sustainably covering the dividend, is that in the next year or is this a 2024 sort of event?

Tony Maretic

A fair question, Bill. Obviously, there’s variables that we are considering interest rate being a pretty significant one. It -- based on 2023 and our assumption that interest rates will continue to rise here with the next Fed meeting and potentially beyond and the decrease in occupancy that we have discussed earlier on this call, it’s really 2024 and beyond where we are going to see ourselves kind of back to dividend coverage and it will be this period of time here, similar to the last three quarters where it will be a shortfall.

Bill Crow

Perfect. Thank you all for your time today.

Tony Maretic

Thanks, Bill.

Jamie Farrar

Thanks, Bill.

Operator

Thank you. We have no further questions for today. So I will hand back to Jamie Farrar for any further remarks.

Jamie Farrar

Thanks for joining us today. We look forward to updating you on our progress next quarter. Good-bye.

Operator

Thank you for joining today’s call. You may now disconnect.