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Edited Transcript of FPO earnings conference call or presentation 24-Feb-17 2:00pm GMT

Thomson Reuters StreetEvents

Q4 2016 First Potomac Realty Trust Earnings Call

Bethesda Oct 5, 2017 (Thomson StreetEvents) -- Edited Transcript of First Potomac Realty Trust earnings conference call or presentation Friday, February 24, 2017 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Randy Haugh

First Potomac Realty Trust - VP of Finance

* Bob Milkovich

First Potomac Realty Trust - CEO

* Andy Blocher

First Potomac Realty Trust - CFO

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Conference Call Participants

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* Craig Mailman

KeyBanc Capital Markets - Analyst

* Blaine Heck

Wells Fargo Securities - Analyst

* Sheila McGrath

Evercore ISI - Analyst

* Michael Lewis

SunTrust Robinson Humphrey - Analyst

* John Guinee

Stifel Nicolaus - Analyst

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Presentation

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Operator [1]

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Good morning and welcome to the First Potomac Realty Trust fourth quarter and year end 2016 earnings conference call. As a reminder today's call is being recorded. At this time like to turn the call over to Randy Haugh, Vice President of Finance.

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Randy Haugh, First Potomac Realty Trust - VP of Finance [2]

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Good morning and welcome to First Potomac Realty Trust fourth quarter 2016 conference call. On the call today are Bob Milkovich, Chief Executive Officer, Andy Blocher, Chief Financial Officer, Samantha Gallagher, General Counsel, Mike Comer, Chief Accounting Officer, Tircia Moore, SVP Investments and Portfolio Management and other members of our management team.

After the market closed yesterday evening our Company issued a fourth quarter 2016 earnings press release and posted supplemental information relating to the fourth-quarter operating results and portfolio performance on our website. Shortly thereafter we filed our 10-K. Many of you have signed up to receive this information automatically by email.

This information was also included in the 8K furnished last evening to the SEC. The press release can also be found under the investor relations section of our website, first-potomac.com.

During this call we will discuss our anticipated operating results and future events, including anticipating earnings and related assumptions, certain non-GAAP financial measures such as FFO, FFO available to common shareholders and unit holders, core FFO and Safe Property NOI, anticipated debt repayments and other potential financing transactions, expected dispositions and our ability to complete such dispositions, as well as our ability to identify and complete additional acquisitions.

All non-GAAP financial measures are reconciled to the most directly comparable GAAP measures in a press release and supplemental information included in the last evening's 8K. These and other statements relating to future results and events are for forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are based on our current assumptions, however, the Company's actual results or events might differ materially from those projected in the forward-looking statements.

Additional information concerning factors that could cause actual results or events to differ is contained in our Company's annual report on form 10K and described from time to time in the Company's other filings with the SEC. Many of these factors are beyond our ability to control or predict. We assume no obligation to update our forward-looking statements.

With that I would like to turn the call over to our Chief Executive Officer, Bob Milkovich.

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Bob Milkovich, First Potomac Realty Trust - CEO [3]

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Thank you Randy and good morning everyone and thank you for joining us. We began 2016 with the announcement of our strategic business plan. The major tenets of the plan are to derisk the portfolio de-lever the balance sheet and maximize shareholder value.

We had a productive year and the progress we are making against the plan has been substantial. Let me quickly highlight our accomplishments.

We successfully sold $295 million against our goal of $350 million of asset sales.

This included, the monetization of Story Park land-site in July 2016 as well as a 2017 sales of Plaza 500 and One Fair Oaks, a building that was vacated upon lease expiration on December 31 of last year. Using the proceeds from these dispositions, we redeemed all $160 million of our series a preferred shares and repaid additional corporate debt. We signed a lease with Avendra to take the lower two floors of 540 Gaither Road at Redland which is being vacated by the Health and Human Services in March of this year.

As discussed previously, we think this is a big step improving the value of our redevelopment at the property. We extended the Bureau of Prisons lease at 500 First Street for one year to July 2017. And we believe there likely to extend again although nothing has been finalized.

This provides us with continued cash flow at the property as we refine our redevelopment plans. The 167,000 square feet Northern Virginia build-to-suit was delivered on budget and ahead of schedule. We made two significant additions with Tricia Moore to our management team and Kati Penney to our Board of Trustees.

We reduced our corporate overhead by $3.7 million, $2 million of which was recognized in G&A. I'm extremely proud of our teams accomplishments on every front in 2016. And I would like to acknowledge all of my colleagues and associates for their continued hard work and dedication.

With these achievements in mind, I would like to walk through the fourth-quarter and full-year results as well as provide an update on some of our key initiatives in 2017. Core FFO for the fourth quarter was $0.27 per share bringing our core FFO for 2016 to a $1.06 per share and that was at the high end of the range of our guidance that we provided. We delivered positive 2.4% same property NOI growth for the full-year despite the impact of a $1.8 million of NOI write-offs associated with a single tenant in DC.

At year-end, our lease percentage was 93.8% and our occupancy percentage was 92.6%. Year-over-year our lease percentage increased by 170 basis points and our occupancy increased by 230 basis points. On a sequential basis our leased and occupied percentages declined by 30 basis points and 20 basis points respectively, largely as a result of a 37,000 foot move out at Crossways Commerce Center.

In the fourth quarter we signed 96,000 square feet of leases bringing the total leasing for the year to 834,000 square feet. We signed 10 new leases for 54,000 square feet. Of the six comparable leases which represents 30,000 square feet, we experienced a roll up of 19.4% on a GAAP basis and 9.6% on a cash basis.

We signed three renewal leases during the quarter totaling 42,000 square feet and representing a tenant retention rate of 36%, which was lower than normal due to expected move outs of Harris Connected Crossway Commerce Center and Antenna Research Associates at Ammendale Business Park. However for the full-year the retention rate was a strong 74%. On the renewal leases we expensed a roll up of 7.1% on a GAAP basis and roll down of 0.4% on a cash basis.

Moving on to the major projects in our portfolio. At the end of the third quarter we completed renovations at [141] K Street to the lobby, restrooms, bike room, fitness center and the mezzanine level which includes a new conference center and lounge.

We are proceeding with base building work and have successfully leased the ground floor to three retail tenants including Taylor Gourmet for 2100 square feet, Honeyfish Poke for 950 square feet and subsequently yearend we leased to LPQ for 9500 square feet. These tenants are very visible at the quarter location fronting Franklin Square and will provide a great amenity to both the building and the neighborhood which aligns with our desire to provide exceptional amenities at our properties.

We continue to complete an internal market study and evaluation of the Ranger redevelopments scenarios for 11 DuPont Circle, and 500 First Street. Both properties are corner locations with glass on all four sides so we have plenty of optionality on the level of renovation. Once completed, we would anticipate a construction period of approximately 12 months for each project. We continue to be bullish about the redevelopment opportunities in our portfolio and the ability to create value.

On January 9 of this year we sold One Fair Oaks for gross proceeds of $13.7 million. Followed by the sale of Plaza 500 on February 2017 for gross proceeds of $75 million. These sales bring total dispositions identified as part of our strategic plan to $295 million and moves us closer to our stated goal of $350 million.

Additionally, we have two of our joint venture properties; Aviation Business Park and Rivers Park l and ll under contract for sale. We have a 50% and a 25% ownership interest in each of those assets respectively and we expect these sales to close in March 2017. Given our current progress, we plan for the remainder of our $350 million goal to be achieved during 2017 with the sale of additional non-core assets.

Turning to the Washington DC region, the areas economy performed very well in 2016, adding 65,500 new job during the year including 22,000 jobs in the professional and business services sector and 6,600 new federal jobs. Despite this underlying employment growth, the overall Washington DC office vacancy rate dropped only 10 basis points to 14.1% in 2016. This was due to continued right sizing by both the government and public sector tenants as well as a continued new supply delivered to the market.

And overall positive theme for 2016 is that the space demand was less reliant on the federal government, reflecting a continued diversification of the economy. Beyond that, the new administration has created some uncertainty in the Washington DC real estate market as we wait to see how the campaign promises and policy proposals are implemented.

Also, despite the hiring freeze, the administration's position on tax reform and government spending is generally believed to translate to stronger near-term growth for our region. DC has been making strides toward diversification of the economy which is demonstrated with the announcement of the move of the Nestle headquarters to Northern Virginia. Additionally, the administration's promise to decrease the federal workforce could lead to an increased opportunity in the federal contractor business which ultimately could generate job growth in the Northern Virginia. Uncertainty aside, continued growth is projected in Washington DC for 2017.

Lastly, we are seeing an uptick in office construction activity across Washington DC. However, the product coming online has significant pre-leasing in place that is above the historical average. Additionally, leasing demand remains focused on product quality, access to transportation, and amenity rich locations.

Not all buildings are the same. However each one performs specifically to its quality and position within the sub-market and the factors I just mentioned are the key ingredients.

In summary, 2016 was a great year for first Potomac and we are extremely pleased with our execution so far against our strategic initiatives. Our market remains healthy, and we are creating a company and a portfolio position to produce strong growth and value creation in the future with a balance sheet that provides adequate strength and flexibility to support long-term performance. We are committed to being good stewards of the business focused on execution and making decisions that we believe create value for our shareholders over the long run.

With that I would like to turn the call over to Andy to review our financial results.

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Andy Blocher, First Potomac Realty Trust - CFO [4]

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Thank you Bob and good morning everyone. Net loss attributable to common shareholders approved from $41.2 million in the fourth quarter of 2015 to $1.6 million in the fourth quarter of 2016, or from $0.72 per diluted share to $0.03 per diluted share.

Core FFO decreased from $17.1 million in the fourth quarter of 2015 to $16 million in the fourth quarter of 2016 or from $ 0.28 per diluted share to $0.27 per diluted share. The decrease in core FFO was driven by $1.4 million write-off unamortized lease incentives and rent abatement during the fourth quarter associated with the default tenant in our Washington DC portfolio.

The sales of Nuneaton Business Park Center, Cedar Hill l and ll and the Nova Non-core portfolio resulted in the $3.5 million decrease in NOI and the repayment of the $34 million mezzanine loan on 950 F Street in the second quarter of 2016 led to a $900,000 decrease in interest income.

The decrease in core FFO was partially offset by $900,000 increase in NOI from the Northern Virginia build to suit which is excluded from the same property NOI pool and a $300,000 decrease in core G&A as a result of lower compensation related expenses. The decrease in core G&A does not include $6.1 million of severance costs incurred in the fourth quarter of 2015. We utilized the majority of the proceeds from asset sales and the repayment of the mezzanine level to redeem our outstanding series A preferred shares which resulted in a $3.1 million reduction in preferred dividends on a year-over-year basis.

FFO available to common shareholders and unit holders increased from $9.2 million or $0.15 per diluted share in the fourth quarter of 2015, to $16 million or $0.27 per diluted share in the fourth quarter of 2016. There was no difference between FFO available to common shareholders and unit holders and core FFO in the fourth quarter of 2016. For the full-year 2016 core FFO increased from $62 million in 2015 to $63.9 million or from $1.02 per diluted share to $1.06 per diluted share.

The increase was primarily driven by $2.3 million increase in same property NOI, a $2 million decrease in core G&A which excludes $6.5 million of severance costs in 2015. $2.1 million increase in NOI from the Northern Virginia build-to-suit coming online and $400,000 decrease in interest expense. These improvements were offset by a $12.8 million net decrease in NOI from the sales completed since the beginning of 2015 and a $2.1 million decrease in interest income as a result of the mezzanine loan repayments in America's square in the first quarter of 2015, and 950 F Street in the second quarter of 2016.

The loss of NOI from the dispositions and mezzanine loan repayments was partially offset by using the significant portion of the proceeds to redeem all of our outstanding preferred shares which reduced preferred dividend by $9.3 million year-over-year. The difference between core FFO and FFO available to common shareholders and unit holders for 2016 was mainly due to the write-off of $5.5 million of original issuance costs associated with the redemption of all of our outstanding preferred shares in 2016.

The property NOI decreased 5.2% during the fourth quarter, bringing total same property growth to positive 2.4% for 2016. The fourth quarter decrease was due to a $1.4 million write-off of unamortized lease incentives and rent abatement related to a defaulted tenant at 840 First Street. Excluding the write off same property NOI would have been positive 0.5% for the quarter and positive 3.9% for the year.

Some of the largest contributors to our strong occupancy gain same property NOI growth during the year were 440 First Street, Clover Leaf Center, Atlanta Corporate Park and Greenbrier Business Park. Those increases were partially offset by a decrease in occupancy at 1401 K Street in Washington DC, and Sterling Park Business Center in northern Virginia as well as the write-off at 840 First Street I just mentioned.

On the financing side in October we prepaid without penalty the $12 million loan encumbering Hillside l and ll, withdrawals on our unsecured revolving credit facility and available cash.

We had approximately $94 million of consolidated debt maturing in 2017 which is comprised of a $62 million mortgage loan on Redland and a $32 million construction loan at 440 First Street.

Before moving to 2017 guidance I would like to briefly discuss our reporting treatment of three single tenant properties with expirations in 2017. First, CACI vacated One Fair Oaks on December 31, 2016. We subsequently sold the property in January so it's included in occupancy for the yearend 2016 but obviously will no longer be included in future reporting.

The lease with Health and Human Services at 540 Gaither Road, one of the three buildings in Redland expires in March 2017. At termination we will place a single building into redevelopment. It will be excluded from our square footage and the same property NOI calculation until it comes back online. The reported for 500 First Street will be handled in the same manner as 540 Gaither Road once the lease with the Bureau of Prison expires.

Turning to our guidance. In our press release we introduced our 2017 core FFO guidance range of $0.78 to $0.84. We expect between $82 million and $88 million of portfolio NOI in 2017 which reflects the following: the sale of One Fair Oaks at Plaza 500 which were completed earlier this year; the sale of Rivers Park l and ll and Aviation Business Park, which are owned in unconsolidated joint ventures and are currently under binding the contract; the move out at lease expiration of the Health and Human Services at 540 Gaither Road; and the Bureau of Prisons 500 First Street.

It is important to note that this range excludes additional disposition and acquisition activity above and beyond the items just discussed. We will provide updates as we gain more clarity on the specifics of the assets we plan to sell or buy to achieve our strategic business plan and goal of $350 million of dispositions. We expect between $17.5 million $18.5 million of G&A fro the year.

Please note that the majority of the anticipated increase in G&A can be attributed to the Company's transition in 2016 to new long-term incentive compensation structure based on forward-looking performance. While the total dollar amount of from performance awards remain relatively unchanged from prior years, the new performance awards are based on future shareholder total returns on both a relative and absolute basis based on the forward three year performance period.

The performance periods for the 2016 award commence with the announcement of the strategic plan in February 2016 and the 2017 award began on January 1, 2017. None of the performance metrics were achieved under the prior awards resulting in no expense recognition from the performance portion of our awards for each of the previous four years.

Excluding these changes, the top end of the G&A range would represent a 4% increase in G&A relative to full-year 2016. Our year-end occupancy range is 91% to 93%, our same property NOI guidance is negative 1% to positive 1% reflecting tougher comps in a portfolio that's reaching stabilized occupancy level.

As previously discussed, by 540 Gaither Road and 500 First Street are excluded from year end occupancy and same property NOI. As they are projected to be in redevelopment once the current tenants vacate.

As we move through 2017 please note the following significant known reductions with respect our future NOI. We recognize over $2 million of NOI in 2016 from the nova non-core portfolio which we sold last year. Compared to 2016, we expect a reduction of approximately $11 million in NOI associated with lease expirations of CACI international, Health and Human Services at 540 Gaither Road in March 2017 and the Bureau of Prisons at 500 First Street at the end of their lease extension. Plaza 500 will provide approximately $4 million less NOI in 2017 that in 2016.

While the guidance provided does not assume additional dispositions or acquisitions, proceeds from additional sales will largely be utilized to repay outstanding balances on our unsecured revolving credit facility and as a result, could have a material impact on where actual results fall within the guidance range we provided.

In closing, we are very pleased with the progress we've made against the strategic plan over the last 12 months and we remain firmly focused on continuing to execute to action items we have outlined. With that, I would like to open the line for your questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions)

Our first question comes from the line of Craig Mailman with KeyBanc Capital Markets. Please proceed with your question.

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Craig Mailman, KeyBanc Capital Markets - Analyst [2]

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Hello guys. Can we just follow-up on the potential Bureau of Prisons extension -- what do you think is realistic in terms of the NOI stream there before they ultimately leave?

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Bob Milkovich, First Potomac Realty Trust - CEO [3]

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Good morning, Craig, it's Bob. How are you?

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Craig Mailman, KeyBanc Capital Markets - Analyst [4]

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Good.

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Bob Milkovich, First Potomac Realty Trust - CEO [5]

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As far as the Bureau of Prisons goes, we competed hard for renewal and we did not win. Having said that, they needed additional time and they extended for a one-year period through July 2017. Based on what we know through market intelligence, the recipient building does not have the space built out or constructed just yet.

We're kind of gauging that the amount of time it takes to build out space could require them to extend, and they've signaled as much, although the we don't have anything in writing or formalized. We just feel like it's going to be hard for them to get out by the end of July, so how much more they would extend is just undetermined until we get into deeper discussion with them.

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Craig Mailman, KeyBanc Capital Markets - Analyst [6]

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And then just a follow-up on earnings. Andy, with the co-working an tenant 840, versus the $1.4 million, how much net should come out of the run rate as we think about heading into 1Q?

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Andy Blocher, First Potomac Realty Trust - CFO [7]

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The entire $1.4 million was written off, so from that perspective, when you're looking at what it is that we recognize net of that for 2016 relative to 2017, it's probably about $1 million.

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Craig Mailman, KeyBanc Capital Markets - Analyst [8]

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And the stock is clearly rebounded here from the lows back in November, at least on our numbers trading at discount here, but as you guys look to kind of grow the portfolio potentially, can you talk about how your cost of capital kind of fits with what you are seeing on the acquisition front?

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Andy Blocher, First Potomac Realty Trust - CFO [9]

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I will talk about the capital side, I mean from our perspective we still have some work to do with respect to the plan. We continue to finish off the dispositions, work on the redevelopments. And certainly from a capital perspective, our goal is to really achieve and maintain a balance sheet that provides multiple sources of capital at advantageous pricing that we can access whenever it is that we want.

So that will allow us to be opportunistic. When you look at the sources, we do have potential additional potential dispositions that we can trigger as well to fund acquisitions if you so choose.

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Craig Mailman, KeyBanc Capital Markets - Analyst [10]

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What are you guys seeing on the acquisition front, is there anything out there that could make sense given your cost of capital and what you guys have been trying to do with the portfolio?

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Bob Milkovich, First Potomac Realty Trust - CEO [11]

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This is Bob. Just from a macro level, we saw over $6.5 billion of office trade in 2015, and that came in closer to $6 billion, $6.1 billion in 2016. There was definitely less product coming to market, but we continue to underwrite opportunities that we think makes sense. And in part, that's just to know exactly where the market is trading and it also helps us through our disposition program and having that type of information.

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Craig Mailman, KeyBanc Capital Markets - Analyst [12]

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Thanks, guys.

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Operator [13]

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Our next question comes from the line of Blaine Heck with Wells Fargo. Please proceed with your question.

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Blaine Heck, Wells Fargo Securities - Analyst [14]

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Good morning. You guys seem pretty close to the finish line on getting the dispositions done.

You've redeemed the preferreds and brought down G&A and you delivered the GSA build to suit, I guess at this point what are the major kind of mile posts we should be looking for in the next year? Is it just kind of continuing with the repositioning, blocking and tackling on leasing, and waiting for the lease up of the redevelopments, or are there any other kind of major initiatives that I'm missing there?

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Bob Milkovich, First Potomac Realty Trust - CEO [15]

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This is Bob. I think the first thing is we set forth a plan just over a year ago, and I think we really accelerated through it and had some great accomplishments in 2016. I don't want to overlook that. And we measure ourselves as we get into 2017, we still have to finish out the plan and part of that plan is capital allocation in some of the redevelopment.

I think continue to be a best-in-class owner operator in DC, where we can get more space leased and try to push lease economics and really being a good operator. And then finishing out the plan is probably the main focus at this point as we go into 2017.

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Blaine Heck, Wells Fargo Securities - Analyst [16]

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That's helpful. Can you give just a little bit more color on the tenant at 840 First? How long were you guys aware that they were having problems? And it seems like it was a relatively new tenant if you're writing off lease incentives and rent abatements. Do you guys have any other tenants in the portfolio that you're concerned about at this point?

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Randy Haugh, First Potomac Realty Trust - VP of Finance [17]

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Let me start off and I will turn it over to Bob and Tricia. If you recall, last quarter we rode off some bad debt in the quarter.

It was a tenant that was signed up in late 2013, built out their space, so on and so forth. We did take some bad debt. We informed the Street that this could have been an issue, and unfortunately it became an issue. Bob, I don't know if you want to talk about the nature of the lease of the tenant.

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Bob Milkovich, First Potomac Realty Trust - CEO [18]

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I would just say we look at the downtown property certainly very bullishly. This was a situation that had a very front-loaded concession package and the tenant was having trouble meeting its obligation and we just wanted to move swiftly with conviction to get the space and see if we can re-lease it.

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Andy Blocher, First Potomac Realty Trust - CFO [19]

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And Blaine, on a look-forward basis, I think the improvements we've made to the quality of the portfolio have really reflected improvements in the tenancy as well. And as a result, as we sit here today, there are no glaring issues that would have the potential to present significant risk for us on the bad debt side or something in the very near term. Obviously bad debt is part of our business, but there's no other situations like this that we are monitoring.

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Blaine Heck, Wells Fargo Securities - Analyst [20]

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Good to hear. Last question, you had a couple of move outs at Crossways and Ammendale. How are the prospects for backfilling that space and how much downtime you guys expect at this one?

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Randy Haugh, First Potomac Realty Trust - VP of Finance [21]

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We think they are very normal situations in terms of both situations we have the space on the market. We don't have anything in writing to backfill those spaces, so we are currently in marketing mode.

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Blaine Heck, Wells Fargo Securities - Analyst [22]

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Okay. Thanks, guys.

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Bob Milkovich, First Potomac Realty Trust - CEO [23]

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Thank you.

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Operator [24]

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Our next question comes from Sheila McGrath with Evercore ISI. Please proceed with your question.

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Sheila McGrath, Evercore ISI - Analyst [25]

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Can you identify which other assets you are considering for sale and does your guidance reflects these sales? And just for modeling purposes, what should we think about in terms of timing?

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Bob Milkovich, First Potomac Realty Trust - CEO [26]

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Sheila, we have, I think it was stated in our prepared remarks, we talked about Aviation and Rivers Park that are both in the queue right now. Those are held in joint venture. We anticipate those will close in March of this year.

And once we work our way through that we will be doing pretty thorough evaluation of what other properties to put in non-core properties to put in the queue for the remainder of 2017. Bear in mind that Aviation and Rivers Park gets us over the $300 million mark certainly, and much closer to our goal, so we can be a little bit more calculated.

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Andy Blocher, First Potomac Realty Trust - CFO [27]

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Following up on what Bob said, with the sales of Aviation and Rivers Park, we'd properly be in the 310 to 315 towards our goal of 350. And as that relates to guidance, obviously we have included One Fair Oaks, Plaza 500, and the two JV assets in our guidance, but our guidance doesn't contemplate any additional dispositions.

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Sheila McGrath, Evercore ISI - Analyst [28]

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Then you guys made meaningful progress with deleveraging. Just wondering, given the maturity schedule and the asset sales with what your whole plan is, how that metric of debt plus preferred to undepreciated book will look roughly by year end? Do you expect it to be lower than the 57%?

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Andy Blocher, First Potomac Realty Trust - CFO [29]

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From our perspective, we think it will probably -- on a book basis it will probably come down slightly. On a debt plus preferred EBITDA basis, which is the measure we have been focused on, obviously as we are paying down our debt with the sales of the assets that we have. But with the loss of Health and Human Services over at 540 and when the Bureau of Prisons leaves 500, that will probably put us in about a trough position with respect to debt plus preferred EBITDA.

Candidly, with the execution of the plan, just based on our initial forecast, we're doing a little bit better than we thought. We had thought that we were going to be right at about 9 when we troughed out, we're probably now going to be in the high 8s. We feel really good about what it is that we're doing with the rest of the portfolio.

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Sheila McGrath, Evercore ISI - Analyst [30]

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And last quick question. Just on the Bureau of Prisons extension. In your guidance, do you assume a holdover period or do you assume expiration?

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Bob Milkovich, First Potomac Realty Trust - CEO [31]

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Obviously when we provide guidance it's a range of outcomes. So you know to the extent that the Bureau of Prisons extended, it would put us a little bit higher in the range; to the extent that they didn't, we're certainly covered by the range.

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Sheila McGrath, Evercore ISI - Analyst [32]

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Thank you.

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Operator [33]

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Our next question is from Michael Lewis with SunTrust Robinson Humphrey. Please proceed with your question.

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Michael Lewis, SunTrust Robinson Humphrey - Analyst [34]

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Thank you. My first question I guess relates to an earlier question you had about cost of capital. I'm just wondering sort of a hypothetical now, but would you consider issuing equity and material discount to NAV, whether for an acquisition or opportunistically, or you kind of have a line in the sand, we won't issue below our internal NAV or 5% below or 10% below?

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Andy Blocher, First Potomac Realty Trust - CFO [35]

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Michael, we don't want to be speculative with respect to those questions. I think you've heard over certainly over the course of the last year, we don't publicly discuss our cost of capital. Obviously we measure every situation that's out there on a facts and circumstances basis, and we are eyes wide open with respect to how important the capital allocation decisions are, so I don't think that it benefits us in any way to speculate one way or the other.

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Michael Lewis, SunTrust Robinson Humphrey - Analyst [36]

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Fair enough. You mentioned 11 DuPont and 500 First among the redevelopment properties. Is it too early to give kind of a sense of what the magnitude of the spend might be at those, and then also what the potential rent lift could be?

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Bob Milkovich, First Potomac Realty Trust - CEO [37]

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Michael, it's Bob. We're still working through those right now, and I think that's the healthy tether that we want to make sure we're gauging, that being the rent versus the amount of spend that we have. Because you never want to under-improve an asset or over-improve an asset.

But what we feel very good about in both situations is for an urban product, they have windows on all four sides, which leads to better floor to glass ratio, you have corner locations, and of course, 11 DuPont fronts a park. It's right at the DuPont Metro, so you really want to be measured in what you do because both of these, we believe, are real good opportunities.

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Michael Lewis, SunTrust Robinson Humphrey - Analyst [38]

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And then, lastly, you have a NAV sheet supplemental, what's not in there of course is the cap rate. I can see where the Street is and where we are and kind of estimate. I'm curious more kind of around some of the product that's not DC office, some of the business park stuff, the things you have listed as non-core. Not exactly what the cap rate is, but how confident you are that you could pinpoint that, in other words, is there a wide range of values there, or do you think you have a pretty good sense of what the value of this non-core portfolio is?

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Andy Blocher, First Potomac Realty Trust - CFO [39]

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Let me start off, Michael, with I think our disclosure gives you a pretty good road map for the assumptions that you need to make with respect to the income statement and balance sheet line items in order to come to our NAV. Similar to cost to capital, we don't think that it benefits us in any way to go and speculate with respect to valuations. Bob, I don't know if you -- liquidity in the sub markets or --

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Bob Milkovich, First Potomac Realty Trust - CEO [40]

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I think everything depends on how the product is positioned. It depends on is there some leasing the needs to be done and things of that nature. If I use Aviation, River Park by example, it's a much different asset offering in the capital markets today than it was a year ago because our team performed very well in procuring a fair amount of leasing in both those assets.

It really depends on if you have near-term roll, if you have certain things, it's kind of very asset specific, but we do monitor it. We get very granular on our internal analysis of all of our properties and we price them frequently, so we are on top of that.

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Andy Blocher, First Potomac Realty Trust - CFO [41]

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Michael, it's Andy again. We have executed a variety of different property types in submarkets through the $295 million and soon-to-be more than that with the joint ventures that are out there. So to the extent that they are assets to sell, we don't believe we've really sacrificed pricing in order to achieve our result, which is to sell the assets and work on the balance sheet.

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Michael Lewis, SunTrust Robinson Humphrey - Analyst [42]

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Thanks a lot.

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Operator [43]

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Our final question comes from the line of John Guinee with Stifel. Please proceed with your question.

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John Guinee, Stifel Nicolaus - Analyst [44]

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Thank you. Nice job, guys. Couple of detail questions and some big-picture questions.

First, and I'm looking at page 38, you are nice enough to provide net rents, and most of them seem to be at market with the exception of Redland II and III, net rent is almost $28, and Prosperity Metro Center, the net rent is about $27. How much are those above market, and if I look at page 33, do I tie in some big rents with highly visible tenants to those two or three buildings?

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Bob Milkovich, First Potomac Realty Trust - CEO [45]

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I think the general way to think about it, and we have seen this across the portfolio and I think most property owners for the last several years have seen this across their own portfolios is that contractual rent -- annualized contractual rent obligations have outpaced market increases, so as certain tendencies roll, you do experience a slight decline. However, if you are in a renewal position, your hope is that even if you end up with a lower face rate, you end up with a lower amount of concessions. Some of that can be tied out.

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Andy Blocher, First Potomac Realty Trust - CFO [46]

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I'm sorry, this is Andy. It's obviously a facts and circumstances based scenario. It's not all the properties aren't signed at the same time. There are leases that were signed earlier, bigger TI packages, or smaller TI packages, whatever it may be, it's not a straight line. There's variability obviously.

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John Guinee, Stifel Nicolaus - Analyst [47]

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Second, Bob, can you just give us some big-picture thoughts on how defense contractor leasing actually works in this day and age? In the old days they were able to pass through all of their occupancy cost to the federal government. They seem to stay forever.

And in this day and age, it seems to me that they're not able to pass through those costs, they're much more price sensitive. The contracts are tied to -- or the leases are tied to contracts. Can you help people understand that? And also where the defense contractors tend to want to be in this day and age?

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Bob Milkovich, First Potomac Realty Trust - CEO [48]

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I would concur with your thesis in terms of the way that contracts were passed through, there's a lot of scrutiny on that today. From a very big picture, if you look at most of your big government/defense contractor organizations within the DC area, they tend to warehouse millions of square feet, some of it are for very contract-specific purposes. If you take a Booz Allen or General Dynamics or some of these big names, they tend to set up different positions in the region, some of them become regional hubs and some of them become contract-based offices.

There was always the theory in the old days as well that you had to be within close proximity to the contracting officer. I think we will continue to see the defense contractor locations be Northern Virginia, again, near the Pentagon, near NRO, near National Geospatial. And on the Maryland side, you tend to see those congregating around Fort Meade, NSA, Cybersecurity. So they really are located approximate to where the contracts are being let.

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John Guinee, Stifel Nicolaus - Analyst [49]

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Great. Thank you.

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Operator [50]

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Thank you. There are no further questions at this time. I would like to turn the call back over to Mr. Bob Milkovich for closing remarks.

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Bob Milkovich, First Potomac Realty Trust - CEO [51]

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Thank you very much. I would like to thank everyone for joining us today. We really had a good year, and we are glad to be on the phone with you.

I'm sure a lot of us will be crossing paths as we move through 2017, and we look forward to seeing you all of you. This concludes our call for today. So thank you very much.

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Operator [52]

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This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation and have a great day.