Brandywine Realty Trust

Ladies and gentlemen, thank you for standing by, and welcome to the Brandywine Realty Trust Second Quarter 2020 Earnings Conference Call. At this time, all participants' lines are in a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. To ask a question during the session, you will need to press star and then 1 on your telephone. Please be advised that today's conference is being recorded. If you require any further assistance, please press star and then 0. I would now like to hand the conference over to your speaker today. Mr. Jerry Sweeney, President and CEO.

Sir, you may begin. Good morning, everyone, and thank you for participating in our second quarter 2020 earnings call. On today's call with me are George Johnstone, our Executive Vice President of Operations, Dan Palazzo, our Vice President and Chief Accounting Officer, and Tom Wirth, our Executive Vice President and Chief Financial Officer. Prior to beginning, certain information discussed during this call may constitute forward-looking statements within the meaning of the Federal Securities Law. Although we believe estimates reflected in these statements are based on reasonable assumptions, we cannot give assurances that the anticipated results will be achieved. For further information on factors that could impact our anticipated results, please reference our press release as well as our most recent annual and quarterly reports that we file with the SEC. So, as we begin our prepared comments, first and foremost, all of us at Brandywine sincerely hope that you and yours continue to be safe, healthy, and as engaged as possible during this challenging time. This pandemic continues to disrupt all of our lives and has resulted in a new landscape for everyone, including every business. The duration of this crisis is increasingly unclear. On our April 23rd earnings call, we did expect a return to the workplace environment by midsummer. Given the events of recent weeks, however, that timeline has been extended. We are continually assessing COVID-19's impact on every element of our business, and based on this detailed review, we remain confident in our ability to execute all components of our 2020 business plan. Additional details on our approach to this crisis are outlined in our COVID-19 insert that is found on pages one to five of our supplemental package. So during our prepared comments, as we always do, we'll review second quarter results and an update to our 2020 business plan. We'll also review the announced joint venture on our one and two Commerce Square properties in the Central Business District of Philadelphia. Tom will then summarize our financial outlook and update you on our strong liquidity position. After that, Dan, Tom, George, and I are certainly available to answer any of your questions. So, in looking at the second quarter, we continue to execute on every component of our 2020 business plan. For spec revenue, we are 99 percent complete with only 69,000 square feet and $300,000 remaining to achieve our spec revenue target for the year. We had good second quarter leasing activity, about 400,000 square feet of both new and renewal activity, with strong rental rate mark-to-market of 19.4 percent on a GAAP basis and 10.3 percent on a cash basis. Same-store numbers had been tracking in line with our business plan, but the delayed opening of Philadelphia resulted in about a $2 million NOI decline from our parking operations for the balance of the year. Our parking operations are included in our same store pool, and as such, this NOI decline has reduced our cash and gap ranges by about 100 basis points each. Office operations are progressing in accordance with our business plan. Cash collection rates continue to be extremely good, and we have collected over 99 percent of our second quarter billings, and our July collection rate tracks very well also with about 98% collected as of yesterday. Capital costs were at the low end of our targeted range, and we have lowered our estimated full-year 2020 capital ratio by 100 basis points down to 11% to 12%, really reflecting the experience we're having with generating short-term extensions that require minimal capital outlays, and I'll touch on that in a moment. Retention was only 37 percent, which was mainly driven by the known move out of SHI in our Austin portfolio as they began occupying their newly owned building that we built for them at our Garza Ranch project. As noted previously, we have backfilled 80 percent of their space, which will commence later this year at a 19 percent cash mark to market. And look, while SHI was the primary driver in our occupancy decline, we had several other tenants' expirations. All of those move-outs were known and part of our plan. And of the known move-outs, 183,000, or 51%, has already been re-let and will recommence in 2020. I should also note that about 70 basis points of our occupancy decline were were due to removing Commerce Square from our same-store pool. Most importantly, though, we do expect occupancy returning to our targeted range of 92 to 93 percent by the end of this year. We did post FFO of 34 cents, which is in line with consensus, and Tom will amplify that during his comments. And in looking at our 2020 business plan, as we talked about on our last call, this crisis really embodies both danger and opportunity for our company. Our clear priority has been to assess all elements of risk and institute plans to effectively mitigate and anticipate any adverse impact. We do remain focused forward on opportunities to enhance our business plan execution, whether that be by early lease renewals, margin improving rebidding programs, or working with institutional partners to seek investments where we can create growth opportunities. And just a quick recap of our COVID-19 key components. We have maintained, in accordance with all local, state, and CDC guidelines, a doors-open and lights-on approach to our building operations. While it's a little bit difficult to quantify in some of our buildings, we estimate the current occupancy range of our buildings is around 5% to 10% in CBD Philadelphia, up to about 20% in our DC assets. Austin is around 10%, with some pullback in that given the situation down there. And the Pennsylvania suburban operations seem to be around 15%. Secondly, the stability of our operating platform remains a top priority, with particular attention on rent collections and rent deferrals. all of which are amplified on page one of our supplemental package. One of our real top priorities has been a strategic outreach to all of our tenants. So we are in extremely close touch with all of our tenants, understanding their concerns, listening to their transition plans, and providing help wherever we can so we fully understand their objectives. As such, as part of that program, While we've reached out to our entire tenant base, our particular focus has been on those tenants whose spaces roll in the next two years. The results of those efforts are framed out on page three of our supplemental and have resulted in 73 active tenant discussions totaling about 950,000 square feet that to date have resulted in 28 tenants totaling about 216,000 square feet executing leases since March 15th. These leases have an average term of 24 months with a 4.2% cash mark to market and a 5% capital ratio. On the construction front, all of our markets are allowing construction activities, and we've not programmed any additional pullback in construction activity delays this year. On a positive front, we are beginning to see downward pressure in select circumstances on construction costs, hard construction costs, as well as some soft costs as the overall forward construction pipeline continues to shrink. Our leasing pipeline stands at 1.5 million square feet, and we've actually had better than expected progression in that pipeline during the quarter. Once again, our team's been in extensive touch with every prospect And the breakdown of the 1.5 million square feet is as follows. Deals progressing but execution uncertain. The timing of that uncertain, and we're targeting the next 90 days, about 24% or 354,000 square feet. Deals progressing but too early to tell when they would actually get executed, about 900,000 square feet or over 60% of the pipeline. And that's really the noticeable change. Since April's call, many more deals have advanced from the on-hold due to COVID, which right now comprises about 14 percent of that current pipeline, into the deal progressing but too early to call. So, tenants are slowly beginning to refocus their attention on their office space requirements. On the capital front, we're really delighted to announce a joint venture on our one and two Commerce Square buildings in Philadelphia. The joint venture is with an extremely high-quality global institutional investor who's making their first office investment in Philadelphia, which from our perspective further demonstrates the attractiveness of our Philadelphia market to institutional investors and really validates investors' perception on Brandywine's ability to create value. Our investor has requested that we do not disclose their name and certain terms of the agreement at this point in time But the general framework of the venture meets many, many of our key objectives. It's a $115 million preferred equity investment, which represents 30 percent of the venture's capitalization at a total value of $600 million, or $316 per square foot, which we believe is an exceptionally strong pricing. The going-in cap rate is 5.1 percent. That cap rate improves based upon the rollover, but we really view that as simply a data point due to the pending level of vacancy and the value creation opportunity. So, right now, we're 97 percent. That does drop to 70 percent over the next 18 months. After providing for payments for transitional leases and closing costs, Brandywine received over $100 million of net proceeds, which, as Tom will amplify, added to our excellent liquidity position. The transaction is a 70-30 joint venture. We share control on decisions. And while we can't close some of the specific terms, we can share that our partner's targeted rate of return is on an all-in basis is in the very low double digits, so we view it as very effectively priced capital. It provides for the same level of returns on preferred equity with a liquidation preference upon a capital event to our partner, and in return for that preference, Brandywine receives a significant promote structure upon a capital event. Both Brandywine and our partner have each committed $20 million of incremental capital to reposition the properties and re-tenant known vacancies. We will continue to manage and lease the property. Frankly, due to the leasing status and the price, the transaction will have minimal dilution, less than a penny a share on 20 earnings per month. and we'll improve our net debt-to-EBITDA ratio by approximately between three and four turns between now and the end of the year. The transaction does reduce our forward rollover exposure by 1.8 million square feet in our wholly owned portfolio, and Grady Wine will also recognize a gain of about $270 million on this transaction. Very important point to note in the structure. Given the state of the debt markets, and the near-term rollover profile of this property, we closed the venture with the existing $221 million mortgage in place. That's only a 37% loan to value. As leasing progresses and the debt markets continue their recovery, we plan to refinance at a higher LTV, thereby affording both Brandywine and our partner another opportunity to generate liquidity. And speaking of liquidity, the company is in excellent shape, as outlined on page four of our supplemental package. We are projecting to have a $500 million line of credit availability year-end 2020. And if we refinance rather than pay off an $80 million mortgage later this year, that liquidity increases to $580 million. We have only one $10 million mortgage that matures in 2021. We have no unsecured bond maturities until 2023. We anticipate generating $55 million of free cash flow after debt service and dividend payments for the second half of 20. And our dividend remains extraordinarily well covered with a 56% FFO and 75% CAD payout ratio. So with those items addressed, let me just spend a few moments on our development set First of all, all of our production assets, that's Garza and Four Points in Austin, 650 Park Avenue in King of Prussia, and 155 in Radnor, are all fully approved, fully documented, fully ready to go, subject to identifying pre-leasing. And as we've noted previously, these are near-term completions that we can complete within four to six quarters. and their individual costs range between $40 and $70 million. As you might expect, we didn't really make any significant advancement in our deal pipeline of almost 600,000 square feet during the quarter, and frankly, don't really anticipate any significant advancement of some of these major discussions until the crisis begins to abate and there's more focus on return to the workplace. In looking at our existing development projects on 405 Colorado, look, this exciting addition to Austin's skyline remains on track for completion in the first quarter of 21 at a very attractive 8.5% cash-on-cash yield. We have a pipeline of 125,000 square feet, but frankly, as I noted on the production assets, We don't expect any significant decision-making to occur until after the crisis begins to abate. On the Bulletin Building, delighted to report that it's now been placed in service at 94% occupancy and 98% leased. The property will stabilize on schedule in the fourth quarter of 2020. 3000 Market Street is a 64,000-square-foot life science renovation that we undertook a within Schuylkill Yards. As noted last quarter, we did sign a lease with one of our existing life science tenants, Spark Therapeutics, who has taken the entire building on a 12-year lease. We expect that lease will commence in the third quarter of next year and deliver a development yield slightly north of 9%. Quickly looking at Broadmoor and Schuylkill Yards. At Broadmoor, We continue fully advancing our development plans on Block A, which is 360,000 square feet of office and 340 apartment units. And we've gotten through final design and pricing, and we'll be in a position to have all of that ready to go by the end of Q3 this year, subject to financing and pre-leasing. Schuylkill Yards, within Schuylkill Yards, we really continue a very, very strong life science push. The overall master plan for Schuylkill Yards provides that at least 2.8 million square feet can be life science space. So we really do view that we have a tremendous opportunity to establish a full ecosystem. You know, 3,000 market in the bulletin building conversions I just mentioned, to life science really evidences the first part of that pivot to create a life science hub. We're also well into the design development and marketing process for a 400,000 square foot life science building with the goal of being able to start that by Q221, assuming market conditions permit. Finally, we are converting several floors within our CIRA center project to accommodate life science use. The aggregate square footage for that converted space is 56,000 square feet, and we have a current pipeline of 137,000 square feet for that space. Schuylkill Yards West, our residential office tower, is fully approved to go and ready subject to finalizing our debt and equity structure. We have also modified the design of the office component to accommodate some level of life science use. As I mentioned last quarter and will mention again this quarter, the COVID-19 crisis has clearly had a big impact upon the timing of moving forward this project and getting the financing in place. We continue to work with our preferred equity partner, but the crisis clearly slowed the pace of procuring and finalizing both that equity piece as well as the debt piece. We do remain optimistic that we'll get this across the finish line as soon as the situation returns to some level of normalcy. In general, we do continue to maintain a very active dialogue with a broad cross-section of institutional investors and private equity firms. In addition to our Commerce Square announcement, we continue to explore other asset-level joint ventures that will both improve our return on invested capital continue to enhance our liquidity, and provide growth capital for our development pipeline. These discussions are active and ongoing, and they certainly encompass both our Broadmoor and Schuylkill Yards projects. One final note that we noted in our press release is we would normally have provided 2021 earnings forecast during our third quarter earnings cycle. Based on the current uncertain business climate, we will not provide that 2020 guidance as part of our third quarter call, but we do plan on issuing guidance no later than our fourth quarter earnings cycle. Now turning the mic over to Tom, who will provide an overview of our financial results. Thank you, Jerry.

Our second quarter net income totaled $3.9 million, or two cents per diluted share, And FFO totaled $57.7 million, or $0.34 per diluted share. Some general observations regarding the second quarter results. Operating results were generally in line with our first quarter guidance with a couple of items to highlight. On our portfolio operating income, we estimated $80 million in portfolio NEI, and we were $1.1 million higher than that. While we did have parking being about a million below our anticipated reduced parking level, primarily due to the transit and monthly parking, we did have lower physical occupancy, and therefore sequential operating expenses were lower, and we experienced higher operating margins in Q20, offsetting the lower parking income. Interest expense improved by $0.8 million, primarily due to lower interest rates than forecast. Our second quarter fixed charge and interest coverage ratios were 3.4 and 3.7 times, respectively. Both metrics were similar to the second quarter of 2019. As expected, our second quarter annualized net debt EBITDA increased. The increase to 7.0 times was primarily due to the lower anticipated sequential EBITDA outlined in the prior quarter. Adjusting for the commerce swear transaction on a pro forma basis for the second quarter, that 7.0 would decrease to 6.7. Two reporting items to highlight for the second quarter, cash collections. As reported, our overall collection rate for the second quarter was a very strong 99.6% based on actual quarterly billings. However, if we did include the second quarter deferred billings, our core portfolio collections rate would still have been a very strong 97 percent. In addition, cash same-store, as outlined on page one of our supplemental, we have included 2.3 million of rent deferrals in our second quarter results. While not billed during the quarter, we feel this presentation is more accurately representing our current same-store metrics, with normalized ongoing forward results not inflated by the subsequent deferred cash receipts. Looking then to third quarter guidance, looking forward, we have portfolio operating income will total approximately $74 million and will be sequentially lower by $7.1 million. This decrease is primarily due to Commerce Square JV. The joint venture will result in deconsolidation of the property, and that will lower the NOI by $7.5 million. One good pickup on the other side is there's $1.2 million of incremental income for the Bulletin Building, which has been placed into service in June, and the building is now 94 percent occupied. FFO contribution from our unconsolidated joint ventures will total $6.5 million for the third quarter, which is up $4.1 million from the second quarter. And that's primarily due to Commerce Square Joint Venture, which is being deconsolidated effective with our earnings yesterday. For the full year 2020, the FFO contribution is estimated to be $19 million. G&A for the third quarter will total 7.3 and will be sequentially $1 million lower than the second quarter. This is primarily due to lower compensation award amortization, and it's pretty consistent with prior years. Four-year G&A expense will approximate $31 million. Interest expense will be $1.5 million sequentially compared to the second quarter and will total $18 million for the third quarter, with 94.5 percent of our balance sheet debt being fixed rate at the end of the second quarter. The reduction in interest expense is primarily due to the $100 million of net proceeds received from the Commerce Square Joint Venture, paying off our line of credit at Commerce Square Mortgage Debt, and then also the Commerce Square Mortgage Debt will now be deconsolidated. Capitalized interest will approximate $1 million for the third quarter, and full-year interest expense will approximate $76 million. We plan to extend our 2 Logan mortgage beyond the August 1st maturity date. and we're looking to either pay that off or have it extended, and we'll be working on that during this quarter. Termination and other fee income. We anticipate terminations and other income totaling $2.2 million for the third quarter and $10.5 million for the year. Net management, leasing, and development fees will be $4 million and we'll approximate $10 million for the year. We have no planned land sales and tax provisions of any significance, no anticipated ATM or additional share buyback activity. In our guidance for investments, we have only the one property in Radnor, Pennsylvania that we will acquire for $20 million, and that is scheduled for redevelopment so that we know generating of earnings of any kind in 2020. Looking at our capital plan, as we outlined, we have two development projects in our 2020 capital plan with no additional developments planned for the balance of the year. Based on that, our CAD range will remain at 71 to 78 percent. And uses for this year will total $285 million, $67 million of development, $65 million of common dividends, retained revenue creating will be $25 million, revenue Maintain will be $27 million. Mortgage amortization of $1 million. We are including the $80 million payoff for the mortgage at 2 Logan and the acquisition of 250 King of Prussia Road. Sources for all those uses are cash flow from after-interest payments, 115, $100 million of net proceeds from Commerce, Square, Joe, and Venture. We're going to use the line of credit for $39 million, cash on hand of 21, and land sales of 10. Based on the capital plan outlined, we're in excellent position on our line of credit and liquidity. We also project that our net debt will range between 6.3 and 6.5. It will likely be at the low end of that range as a result of the Commerce Square joint venture, which has reduced our leverage in the second quarter. In addition, our debt to GAV will approximate 38%, which is down from 43%, primarily, again, due to the joint venture situation. improvement in that metric. In addition, we anticipate our fixed charge ratio will continue to approximate 3.7 on an interest coverage basis and 4.1, no, 3.7 on a debt service coverage and interest coverage would be 4.1. I now turn the call back over to Jerry.