Duck Creek Technologies, Inc.
Q2 2015 Earnings Call Transcript

Published: 31 Jul 2015

[Operator:]

Good morning. And welcome to the DCT Industrial Second Quarter 2015 Earnings Call and Webcast. All participants will be in listen-only mode. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Melissa Sachs, Vice President, Corporate Communications and Investor Relations. Please go ahead.

[Melissa Sachs:]

Thanks Gary. Hello, everyone and thank you for joining DCT Industrial Trust second quarter 2015 earnings call. Today's call will be led by Phil Hawkins, our Chief Executive Officer; and Matt Murphy, our Chief Financial Officer, who will provide details on the quarter's results and our updated guidance. Additionally, Bud Pharris, our Managing Director of the West Coast region will be available to answer questions about our market, development and other real estate activities. Before I turn the call over to Phil, I would like to remind everyone that management's remarks on today's call will include forward-looking statements within the meaning of federal securities laws. This includes, without limitations, statements regarding projections, plans or future expectations. Actual results may differ materially from those described in the forward-looking statements and will be affected by a variety of risks, including those set forth in our earnings release and in our Form 10-K filed with the SEC, as updated by our quarterly reports on Form 10-Q. Additionally, on this conference call, we may refer to certain non-GAAP financial measures. Reconciliations of these non-GAAP financial measures are available in our supplemental, which can be found in the Investor Relations section of our website at www.dctindustrial.com. And now, I will turn the call over to Phil.

[Phil Hawkins:]

Thanks, Melissa, and good morning, everyone. We had another excellent quarter highlighted by strong leasing in both our operating and development portfolios. Market fundamentals remain very healthy with broad and deep tenant demand combined with supply that remains well and check in all of our market. Our strong operating portfolio performance continued in the second quarter with same store NOI growth of 13.3% on a cash basis and 9.3% on GAAP basis, ahead of our internal expectations due to better than expected occupancy and rent growth. Matt will provide more detail and color on our operating results as well as guidance shortly. While the lease up of our development pipeline has recently been a focus for some investors and analysts. We've always had a high level of confidence given the asset in the markets as well as the proposal on lease negotiation activity we were seeing. As you saw in last week development meeting update and last night's earnings release, our confidence was warranted. Since the end of the first quarter we've leased 2.9 million square feet in 15 different transactions, bringing our current development pipeline up to 53% leased and the total pipeline including committed projects not yet started to 59% leased. And jus as important, leasing activity on each of our development project is strong. So we expect this leasing momentum to continue in the third quarter and beyond. Our returns are higher than initial expectations as well given higher rents and quicker leaseup. As a result of a leasing on our existing development projects, as well as pre-leasing on a few planned projects, we are raising the mid point of our development start guidance for the year by $50 million which Matt will discuss in more detail shortly. As expected our acquisition volume was pretty light in the quarter buying three assets for a total of $18.6 million. While we don't anticipate a lot of investment activity given where asset pricing is, our market teams relationships and persistent will likely generate a few additional acquisitions this year with attractive value creation and return potential. The recent Houston Port acquisition is a good example of both our local teams' capabilities as well as the strength of a leasing market. The seller which occupy the entire building initially plan to downsize and relocate their operations to another to be identified building in the same port submarket. Shortly after identifying the value adds acquisition opportunity, we began talking with the prospect for 50% of the building. Due to end of our due diligence period the seller then concluded our building was the most suitable for them due to limited availability in the submarket. So we entered into a lease pact for the portion of the building not yet spoken for by our other prospect. We've since then secured a lease with a new tenant, so a building which is the beginning of our acquisition process had not lease commitments, is now fully leased with a new tenant expected to take occupancy in the third quarter. And the stabilized yield of 6.6% is at least 100 basis points if not a 150 basis points higher and what a buyer would now pay for the fully leased asset. Lastly, let me give you an update on the Friday incident which we disclosed on May 7. This incident resulted in a second quarter loss of $3.4 million including expenses. We do hope to recover approximately $1 million from insurance although discussion with our carrier has not yet been finalized, so the second quarter results do not reflect any reimbursement. Since the incident, we have investigated and confirmed there was no breach of our system. We've also reviewed and enhanced our internal control. As we head into the second half of the year, I feel great about our business. Thanks to talented team of people, high quality portfolio, strong tenant demand and disciplined new supply, my expectation is that this is a very positive confluence of factors that will lead to continued success and performance. Let me now turn the call over to Matt who can provide more detail on our quarterly results and updated guidance for the year.

[Matt Murphy:]

Thanks, Phil, and good morning. From an operational perspective, I don't think it would be an exaggeration to call second quarter of 2015 one of the strongest in DCT's history. We achieved record setting same store NOI growth, continued outperformance in rental rate growth and the development leasing that we've been describing as being on a door step has begun to turn into significant numbers of executed leases. In short, the combination of exceptional market fundamentals, our ever improving portfolio focused on into a location and dynamic market, and our market team's skill in maximizing leasing economics has produced results that have exceeded our already high expectations. I'll go through some of the details of our second quarter numbers and discuss how these results impact our expectations and guidance for the remainder of the year. Our operating metrics were very strong this quarter. Operation occupancy ended at 95.1%, about 30 basis points ahead of plan, as leasing activity was brisk and tenants continue to make decisions quickly and are frequently pushing to occupy space as soon as possible. Leasing staffs were outstanding as we sign 4.8 million square feet of leases including 1.2 million square feet of new leases and 2.1 million square feet of development leases, both of which bode well for future NOI growth. Rent growth was outstanding as well with GAAP coming in at 14.1%. While cash rent growth was only 1% during the quarter that number was skewed by 233,000 square foot lease we signed in Memphis to complete the lease up about 500,000 square foot building there. In a lease structure that both accommodate the short term needs of our tenant and positions the building well for its anticipated sale next year, the lease begins with a very low introductory rate and then jumps 42% up to its normal base rent. As a result, cash rent growth on this lease was a negative 32% and at single lease decreased cash rent growth in the portfolio by 410 basis points. Same store NOI growth was another significant bright spot for the quarter. Cash same store NOI growth was 13.3% for the second quarter, ahead of plan and the highest quarterly number in DCT's history. GAAP same store NOI growth was also very good at 9.3% for the quarter. These results were driven by average occupancy of 95.2%, an increase of 230 basis points over Q2, 2014, as well as over $1.1 million of embedded rent pumps along with the excellent growth in rental rate I have already described. Sequential same store NOI growth was also strong in quarter, increasing by 4.5% on a cash basis and 4.9% on a GAAP basis over the first quarter of 2015. These results were also enhanced by approximately $800,000 of un-forecasted one time items primarily damages and restoration fees paid by tenants upon move out. Turning to guidance. Our strong second quarter operating results and leasing activity were both ahead of plan, and we feel optimistic about the fundamentals for the rest of the year. Consequently, we are raising our expectations for growth in 2015 same store NOI to between 4.5% and 6% on GAAP basis, an increase of 25 basis points. And to between 6.25% and 7.75% on cash basis, an increase of 50 basis points. On capital deployment and capital funding front, planned activity for the remainder of the year remain robust. We are increasing our guidance for development starts for the year by $50 million to be between $250 million and $350 million. This reflects the excellent leasing we've achieved thus far, as well as the leases we expect to execute in the near future. This should allow us to start several buildings that we had previously forecasted to start in 2016. Pricing and competition for high quality assets continues to make acquisition challenging. And as a result, we are further decreasing our expectations for acquisitions for the year to be between $125 million and $175 million. Any future acquisitions this year are likely to have a value add component like the Houston transaction that Phil described earlier. Our plan is to fund this investment with proceeds from asset sales as well as leverage neutral incremental debt. While our guidance for dispositions in 2015 remains unchanged to $250 million to $350 million, the remaining disposition this year are likely to be a little more backend weighted as we believe the majority of the disposition we are currently working will not close until the fourth quarter. On a capital markets front, we did not issue any stock under our ATM during the quarter. In fact, we haven't used it since October of 2014. We are focusing on funding our activities to dispositions; we are planning to reload the ATM program during the third quarter to maintain optionality. Also as I've mentioned previously is our intent to access the public bar market in the second half of 2015 with the proceeds used to pay down align as well as some of our 2015 debt maturities. The combination of operating results and expectations described above as well as our updated deployment and funding plan would have resulted in an increase to FFO guidance of little over $0.03 per share at the mid point. However, the financial impact of the front net of the expected receipt of a $1 million of insurance proceeds is anticipated to result in a net charge for the year of little $0.025 per share. In addition, the second quarter sale of the remaining 8th Vineyard build-to-suit and the unwinding of that venture resulted in development profit, net of the $3.7 million GAAP impacted non controlling interests which were approximately $0.02 below forecast. Consequently as a result of netting this one time items against positive operating results and expectations, we are narrowing our 2015 FFO guidance and lowering the mid point by a penny per share to $1.90 to $1.98. With that I'll turn it back over to Gary for questions. Thank you.

[Operator:]

[Operator Instructions] The first question comes from Gabriel Hilmoe with Evercore ISI. Please go ahead

[Gabriel Hilmoe:]

Thanks. Phil just on the development we've seen, a lot of activity in last few months even in this past week I guess. But can you maybe frame out just what the current pipeline is looking like? I know you don't want to get into the ton of detail but just trying to get a sense, it sounds like activity is likely going to continue kind of what-- relatively what you've seen over the last months and weeks.

[Phil Hawkins:]

We have I'd say number of leases in very different markets that are out for negotiation including even a couple that are out for signature. I just didn't get sign by yesterday or -- when they are guessing we will cut it off. So that feel good, we also have pretty significant proposal activity. I'd say it is pretty much every asset we have in a development pipeline right now. Without going to more detail I'd say it is cross project, cross sizes, cross market, I wouldn't flag any one market is being or even anyone project is being falling out of that positive trend. We necessarily even waiting, it feels like a good, broad pipeline right now.

[Gabriel Hilmoe:]

Okay. And then maybe for Matt just on the expense reimbursements in the quarter. It sounds like even if you backup that benefit the same store NOI growth was still probably in the mid to upper 11% range. And I just wanted to clarify are you adjusting for that expense benefits in the back half as well with the change in the NOI range? Just trying to get a sense, the drivers behind the uplift in cash stream NOI.

[Matt Murphy:]

Right. I do think there was a little bit of benefit from an expense perspective in the second quarter. And the guidance does allow for the reversal of that in the second half. I haven't done the math exactly the way you described in terms of eliminating them, but I would say it is definitely still in double digit; we are not for the sort of one time items and sort of timing differences. So I don't know the 11% right, I don't know what's wrong; you got to be in the neighborhood.

[Gabriel Hilmoe:]

Okay. Thanks. And maybe just one more quick one. Phil, there was another large portfolio that traded last couple of days and I think in the past DCT may have taken a look at that portfolio as well but just any comments you can make just in terms of the comparability between IIT and DCT's portfolio?

[Phil Hawkins:]

I think speaks overall to the continued demand from investors for industrial product. There is another large portfolio that -- is also pending at economics that will be pretty compelling relative to public market valuation with different investors involved than what you've seen so far with KTR and IIT, which will I think also demonstrate I think the public -- to public REIT investors the breadth of investor demand out there, admittedly bias, so we do know that portfolio quite well. We also know the KTR portfolio quite well for a lot of different reasons we compete against a lot of that, to try to buy those assets. We looked at that portfolio. And in my opinion our overall asset quality is higher than either of two portfolios that have traded so far.

[Operator:]

The next question comes from Brendan Maiorana with Wells Fargo. Please go ahead.

[Brendan Maiorana:]

Thanks. Matt, just follow up on the same store. So the guidance for the back half of the year implies a pretty meaningful slowdown, and just based on sort of where rents are feels like occupancy is going to be flat. You got nice kind of rent gain baked in, even with the expenses going against -- is there anything that would drive the numbers down significantly to sort of be in the low single digits in the back half the year like move out or anything like that we should be aware of.

[Matt Murphy:]

Well, I don't think so. From an occupancy perspective, baseline projecting the numbers to be flat, frankly little bit down from where we ended up. Obviously it is range so we could go to either side of that. So obviously the deceleration and is a result of the back half of 2014 occupancy increasing. In fact we averaged for that pool over 95% in the fourth quarter of 2014. So I don't think there is -- there is no -- I mean we have a couple -- the largest move outs, we have a 215,000 in Southern California. Actually I talked about last call, they signed a short term holdover, there was some optimism they would stay, they have in fact already moved out. That's the single biggest one. But I don't -- it is normal churn. So I think ultimately I hope we can do better than 95% occupancy in the second half. But that's what the basis of the forecast.

[Brendan Maiorana:]

Okay. That's helpful. And then maybe just as a follow up. So I think the build-to-suit that you guys announced in Atlanta the million square foot there, I think that customer is an existing DCT customer. Can you guys confirm whether or not that the case and how you feel about the prospects and the building that they are in and back sell prospects?

[Phil Hawkins:]

They are an existing customer. There is an extended period after they occupied the new building. They were overlap in the current building which will give us fair amount of time in addition to between now and their occupancy of the new building. So give an additional period of time. I don't want to go into specific but a fair amount of time where they will essentially be paying double rent. And we will have the ability to lease it. If we do lease it, however, that will relieve them of that rental obligation. The rent in place in our view in their existing building is below market. So we do expect a roll up on rent and hopefully and I would think at reasonable expectation wise we would not expect any downtime on the building that they are leaving.

[Operator:]

The next question comes from Eric Frankel with Green Street Advisors. Please go ahead.

[Eric Frankel:]

Thank you. Obviously you guys are looking to really increase your development starts over the next couple of years. I was hoping you give comment on your return expectations for development going forward?

[Phil Hawkins:]

Eric, well first we've increases this year by another $50 million and half we did last quarter. I don't know if I am looking out couple of years with that trend. Hopefully but again no -- we are not putting something in concrete out there in terms of annualizing start. We will take one project at a time, one market at a time and evaluate the overall economy, tenant demand and supply. Generally as well as on a micro market basis as we make those decisions. We continue to look at return that are plus or minus on a spot basis to 150 basis points higher than what we believe is a somewhat conservative expectations of a stabilized cap rate if we would have sold the asset or what investors and analysts would describe as NAV once stabilized. So we are looking to create meaningful value, so I am going to refer that to margin, a meaningful margin where we take speculative risk on build-to-suit basis same thought process applies including it needs to be a building that we believe is a market building not a specially use building. And in these weird economics that create value although given the less risk of leasing, we will take less of a margin. Yes I think that's -- I can address a follow up if didn't quite hit the question, the answer you are looking for.

[Eric Frankel:]

That's acceptable, thank you. I was hoping similar to Brendan's question about the Atlanta build-to-suit you can comment on the meet mechanics of the Carol Stream business outside of Chicago.

[Phil Hawkins:]

Yes, they are an existing tenant as well much -- they are I would say to size about third of the total and there is no similar mechanism in that. We will have the lead time of construction and move in to prepare. They are currently leasing that space now but they will be leaving that building upon occupancy of the new building.

[Edward Caso:]

And what's the current size roughly of the tenant's space now?

[Matt Murphy:]

I think it is 105, Eric. It is right around 100

[Eric Frankel:]

Okay. Much meaningfully smaller. Okay, sounds great.

[Phil Hawkins:]

Not nearly as meaningful as the one at Atlanta. They are coming out of some other buildings as well. Not ours and so it is a consolidation of some of facilities unlike Atlanta which is just pure growth.

[Operator:]

The next question comes from Wan Sunabrio [ph] with Bank of America. Please go ahead.

[Wan Sunabrio:]

Hi. I was just hoping you could extend a little bit more on supply to start you sort of said you view all markets in an equal balance, but is there anything in particular any markets that are concerning in a near term or as you look out maybe 12 to 18 months. Any thoughts maybe on Houston in particular given the recent decline in oil prices we've seen.

[Phil Hawkins:]

I hope I'll get all those sub questions. First, no, not a market that I identify a concern. Last couple of quarter we would have picked on Dallas, maybe Houston and maybe the Inland Empire, I would say Dallas construction has come down, demand has gone up. And you are seeing therefore different dynamic. Houston, I am pleased, impressed, maybe little surprised to how well that market has developed from demand perspective. Construction I think is responding, come down if demand comes down, similar construction going on port market where actually demand is shifted toward as we -- as evidenced by the acquisition and we leaseup, the building I talked about in my earlier remarks. Inland Empire and I'm going to let Bud actually comment on that, is probably the market with most construction. Inland Empire West is much more imbalance, that's where we are, both our current asset as well as our development. Inland Empire East, construction has picked up. I guess they are picking in one area is something to watch would be Inland Empire; the demand is really healthy there as well. Before I turn it over to Bud, I'll look at over next 12 to 18 months, all I can tell you is the same dynamic, the same factors that have been talking about now for probably two years that increase discipline this time versus last time, I believe are still in a fact and still apply and will likely lead to continue discipline, I can't assure you of that for the next 18 months. I am not fortune teller or future teller but I continue to believe that will be the case. There are no doubt the anomalies as some supply kicks up, multiple developers all chase the same goal or demand kicks down in particular market, I am sure will not be perfect or flawless but I still feel pretty optimistic. My view is what to worry about an industry is not demand not as much. It is the worry about -- I mean that's worry about supply. Supply is easy to turn on as we've proven; it is also easy to churn off. It is demand, we see and what I see in terms of the economy I believe demand is going to remain about where it is now, healthy, broad amongst size of the tenants, industry types. We even saw pick up in some housing related transactions in the second quarter as well as now in the first month of the third quarter. So even that is a positive. So I feel good but I also recognize that this is an uncertain world and uncertain business. And that's why they call risk but I am pretty confident pretty optimistic. Bud, do you want to comment on the Inland Empire?

[Bud Pharris:]

Sure. Thanks, Phil. I think what's interesting to point is when looking at supply and something we think about a we watch carefully but you also have to talk about demand is still stated. And demand has been very strong and remain so throughout Southern California and the Inland Empire particular, we've seen really strong positive net absorption numbers year-to-date on track to be by far the strongest year ever dating back 2000. So that feels good and generally speaking looking at the numbers it was about 14 million square feet of construction underway in the East. That's about 20% leased and conversely in West which is little bit of tier two city there is 10 million square feet, that's 45% pre-leased and so that absorption that strength is something we are seeing on continuing. We also track very actively users in the market, we watch this list quarter by quarter, year-over-year and right now we got a list that has about 34 active users looking for 23 to 26 million square feet in a range and these are people that will transact in the next 0 to 12 months. A lot of M&A deals as well going on so we feel really good about the demand, feel good about the fundamentals and very strong in the Inland Empire.

[Operator:]

The next question comes from Manny Korchman with Citi. Please go ahead.

[Manny Korchman:]

Good morning, guys. Matt, on the planned bond issuance, could you share sort of sort your idea on potential size where pricing might be-- and how you think about timing given that you are thinking about paying off debt next year with it.

[Matt Murphy:]

Yes. So I think clearly it make sense for us as a relatively new issuer in the market. It's got to be next out door; it is maybe it is going to be $250 million deal or more. I think $250 million is -- I know the way I am thinking about it today. I also think given liquidity in the market as well as our own maturity schedule, it is extremely likely to be a 10 year deal. And I think based on preliminary bank or conversation that we are having with bankers and when you are still fit more than 30-60 days out, it is obviously all comes with caveat, but I would say pricing somewhere the $200 million over treasury between $175 million and $250 million over, is a reasonable starting point. Obviously, those numbers get more -- Hawkins s giving me dirty look at them, putting such a wide range out there but I think that's reasonable given what the market was if we are going to do it today. Probably $200 million if we are going to do it today.

[Operator:]

The next question comes from Craig Mailman with KeyBanc. Please go ahead.

[Craig Mailman:]

Hey, guys. So your comments on supply were helpful here just I guess as a follow on to that. How is that affecting what you guys are thinking about rent growth? Because supply has been disciplined but it has been steady in most markets. And just the trajectory of asking rent on most markets.

[Phil Hawkins:]

I think two phase of rent growth. The first is the market we covers, you are obviously seeing significant imbalance between supply and demand and rent growth that in many markets it has been high single digit, low double digit. In most markets now we passed that phase and there maybe one or two left in Atlanta, one of the more recent examples where late to recover but boys it recovered very well. Now we are wishing rent growth because we have vacancy rates remain in most markets mid single digit. Demand is really healthy and they have got multiple choices as an owner or a developer. And you got rent, cost inflation coming in the form of land prices that are going up as well as construction cost they are going up, 3% to 5% which gives you I think an environment where you can achieve mid single digit rent growth in many if not most of all market. Just because your supply at current level does not meet, it alludes rent growth. In fact, I think it helps maintain market that somewhat balance, in fact, the more supply can remain at current levels, you don't create huge imbalances of supply demand, you are not going to get a big reaction, over reaction of new supply coming in, trying to chase a incredibly tight opportunity. So I think we are in a pretty good situation right now from a rent growth perspective as well as supply demand and current vacancy.

[Craig Mailman:]

That's helpful. I guess I was just thinking about to as people are just accepting lower returns so even those costs are going up. The low return thresholds, I don't know if that would have kept the cap on rent growth. Net -net they would could have offset each other.

[Phil Hawkins:]

You are correct. Returns have come down but also proceeds risk has come down and land cost gone up. Land cost, they have gone up much faster than single digit rent growth would have imply. And so lower returns have offset that somewhat. I think we are now in an environment given where interest rates are and given that similar competition is looking development with a levered basis. It was a guarantee but they are looking at leverage and/or and take out. But as interest rate have flatten and come back, I think cap rates are flattening. And with cap rate flattening will also have an impact I believe on further compression in development yield. At least that's my hope. Who knows how the world actually unfolds but --

[Craig Mailman:]

Then just bigger picture. Relatively to the private market trade out there in the market, we know that KT or IT and you alluded to another portfolio you and the broader industrial group continue to wide spread relative, just as I am thinking about kind of ways to narrow that gap or exploit the gap is asset which you guys have done but is there any thoughts about really being more opportunistic about selling assets that potentially you could sell for in excess of what the street is kind of modeling in for any repurposes and kind of your thoughts on doing that and your view on potentially special dividend.

[Phil Hawkins:]

Who knows where valuation for a large portfolio may ever come in? I think from an individual asset basis I think the street isn't too far off with respect to individual asset pricing. It is pretty transparent world out there and many investors and all analysts have a relationship with at least if not multiple investor sales brokers, you certainly hear from our, you see trade that we make. I think the real question is there a portfolio premium and what is that for any particular portfolio, whether you are public or private. I don't think individual assets sales address that. In my mind we sell assets when we believe pricing and current returns NOI growth and long term return in the form of IRR feel less compelling to alternatives to deploy that capital. Certainly where we are deploying that capital right now is in development. I can also tell you that we look at with a board level as well as amongst the management team at stock buyback and evaluate that as an alternative. We've not decided to execute on that. But we certainly consider and think about that as a use of capital as we look at other alternative to deploy that capital as well as the cost of source and capital through asset sales. None of that is a science but we are mindful of all that and trying to be the best do it we possibly can be with the existing capital we've been entrusted with as well as the opportunities to recycle and redeploy that capital in a way we think is best should to maximize value over the intermediate longer term.

[Operator:]

The next question comes from Erin aslakson with Stifel Please go ahead.

[Erin aslakson:]

Hey, good morning out there. Just one question how sustainable do you think the mark-to-market on rent rollover are as you kind of pull forward and the vantage going to next year.

[Matt Murphy:]

Yes. It's Matt. Honestly I think if you look at -- if you evaluate the leases that are rolling over the next say 18 months, I am sure you heard one of our competitors addressed it that way kind of looking at the comparison of what has the vintage of what leases we have signed versus the future. And actually bodes pretty well. If you look at the leasing that we've done on the first half of the year, 26% or little more than 26% of that was done during the trough and I'll agree with their characterization of trough are sort of 2009 through the end of 2011. Whereas for the next 18 months little over 40% of our leases were signed during that same trough. Now it is not -- that doesn't guarantee anything. There is a lot more going on than just when was the prior lease signed. But to me that sort of indicate that favorable environment from that particular statistic is not yet done by any means. So as I will continue to never predict any particular quarter because of the nature of that calculation and the volatility of the mix. I still think there are some legs on that. And I think if you look at it from a vintage which is one way of looking at it I think those stats certainly bear that out.

[Operator:]

The next question comes from Mich Mueller with JMP Securities. Please go ahead.

[Mich Mueller:]

Nice quarter guys. Matt, I missed your commentary on the changes of guidance. So just do me a favor I really appreciate it.

[Matt Murphy:]

Yes. I mean ultimately what it comes down as but for the one time charges guidance would have gone up by $0.03 to the mid point.

[Mich Mueller:]

And the charges -- the charges were --

[Matt Murphy:]

Oh I am sorry, yes, so the charges are really the net GAAP impact of the sale of 8th Vineyard which ultimately ended up being as a $1 million debit and the fraud which was $3.4 million in the second quarter and we are anticipating a $1 million insurance proceed to ultimately it is $2.4 million for the year which translates in our current share account into $0.026 a share, so it is really $0.035 one time items, we are lowering guidance by one point or $0.01 at the middle.

[Mich Mueller:]

Got it. So an effective raise and then it seems like most of the proceeds that you are raising from the debt offering are just going to be utilized to term out some maturing debt. I am just trying to think about the capital plan as you move into 2016.

[Matt Murphy:]

Yes. So first of all yes the bond yield will effectively be a refinancing of a number of things, ultimately it ends up paying down the line. So that will not be incremental debt certainly not any meaningful way probably not at all. And the capital plan, not get into 2016 in debt but ultimately right now I think the best cost of new capital for us is selling assets. We will continue as I said before to capitalize our deployment plan in a way that it is leveraged neutral, we were to get to a place where we feel like our balance sheet is in pretty good shape. I think of leverage today not so much as liability divided by current value of assets but more on a debt to EBITDA basis. And so what we will do assuming all of the various pieces of the capital stock market, stay where they are today is fund deployment which we now believe will be development predominantly with disposition in an amount and at a rate that allow us to maintain leverage.

[Operator:]

The next question comes from Ki Bin Kim with SunTrust Robinson Humphrey. Please go ahead.

[Ki Bin Kim:]

Thanks. Just a couple maintenance questions here. So going back to your comments about lease price, if you just kind of wrapped up for us, it sounds like you think the 40% lease spread that you signed in the first half on GAAP basis as we are going to next year and so could get better based on the vintages. Is that correct conclusion?

[Matt Murphy:]

Yes. That's what -- the way I would put it, that's one way to interpret. The way I would put it I see nothing systematic that would put a damper in the near future on where rent growth -- nothing that is a result of a change in a comparison that should change the out flow for the next 18 months. The lease -- the rent growth status so volatile a it relates to mix. That I don't want to predict a number what I have been describing it is environment where I don't think the party is over. What I think they are going to go up, down or side ways depends on your view of what you think market rates are going to do et cetera. So I can understand that conclusion, I don't know that I am willing to say that yet but I don't know what's going to change in the short term.

[Ki Bin Kim:]

Okay, that's helpful. And I know we were talking about that same sort of line to build up and how the expense number could be little bit in slugs or vague but do you have what that was look like or that the -- that would be in the third quarter or so. Obviously you had little bit favor comp in the second quarter, how much that doesn't make an impact in the third quarter going to other way.

[Matt Murphy:]

Contrary to what it may seem like when you run an model it is hard to predict expenses. I think what you can see is that you can do math on where we are at the first half of the year versus the second half. I don't think the giving back the positive expense variance that we experience in the second quarter is going to have meaningful impact. I was asked if we will get some of that back and in my forecast predicts that we will. But we are talking about hundreds or thousands of dollars not millions. And one thing you always have to keep in mind, again it is not as simple and clean as it appear theoretical basis. Most of expense variances to get compensated for our tenant pay 85% to 90% of our expenses. So ultimately savings and expenses are muted by reductions in recoveries and the reversal of any savings will be similarly muted.

[Ki Bin Kim:]

Okay. And just last one. You guys have really transformed your portfolio since I guess since your ITO days. Any sense of where you think reasonable peak occupancy would be for your portfolio take or not today going forward.

[Phil Hawkins:]

Well, I think you can -- I think it is up to about 95%. Not to speak ill or try to be positive. I think we got enough turnover downtime rebuilding of tenant improvement for new tenants, 95% is not a bad number. Now I think it is quite possible that we will hit 96% to 97%, some of our peers have already done that. I also think that if we continue to find a couple of side opportunities that we will sell -- we will again sell for and buy empty although it looks like it will be less meaningful in terms of at least the buying empty part over the next six months given where pricing is for everything. But to me -- I don't want to promise sustainable occupancy above 95%, I hope for the better. We certainly will push for better. And as we get better we can probably affect -- assets to but we will -- I don't want to promise -- I don't over promise above 95%.

[Operator:]

The next question comes from Paul, Rountree with JPMorgan. Please go ahead.

[Paul Rountree:]

Hey, guys. Just a quick question on the development pipeline. Your disposing is up about 100 million plus of pre-lease development that haven't started yet. I just wondering are you guys ramping up on the build-to-suit compare this way.

[Phil Hawkins:]

Ramping up, Paul it is kind of strategic something we changed in our outlook. The answer is no. We try to be optimistic in each of our market. And we would love to pre-lease great buildings if we can. And certainly I love the land we had -- we have is terrific. But I think it is a result of market opportunities that come our way as opposed to any shift in tactics now like we can control that.

[Matt Murphy:]

The only other thing I would add Paul is that don't confuse build-to-suit and pre-lease. So build-to-suit is building that built because of the lease as opposed to the pre-lease that is a spec building that gets leased before it start. So what you are seeing, a lot of work what we are doing they are leased buildings in pre development but they are not build-to-suit. The 240,000 square foot in Seattle is a perfect example. We are going to build that building anyway. We are thrilled to have an tenant already signed up before we start. So it is not like we are in the build-to-suit business. We will do that as opportunities warrant as Phil said. But most of what you see that's pre-leasing is in fact that it is pre-leasing spec development.

[Operator:]

The next question comes from Tom Lesnick with Capital One Securities. Please go ahead

[Tom Lesnick:]

Hey, good morning, guys. Just looking at your lease expiration schedule by market for 2016 and 2017, on a percentage basis it looks like in the Memphis and Orlando are little higher than the other markets. Just wondering how you guys are thinking about retention in those markets over the next couple of years. And how that shifted all your thinking about market allocation.

[Matt Murphy:]

Well clearly as I look at and I haven't done a whole lot of study in beyond 2016 to be honest with you in terms of what spaces are rolling. I think the markets that where we have explosion particular in some cases like in Southern California the size ranges that we have -- Southern California is our biggest exposure, I call it exposure, biggest roll next year. Unlike where this specific, the building, the spaces they are leasing. We got some big spaces rolling in Southern California which is someway little bit scary but in someway that's exactly where the market is today. It is hard for me to predict retention that significantly different than kind of the historical norm which is going to be kind of mid 60s. In some ways retention is then harmed by the current environment because companies are growing and we have our portfolios and buildings are so full, if you need another 30,000 square feet in a building, it is full, you are not going to keep that tenant. The flip side is tenants that are staying the same size; don't really have a lot of attractive options. They are really unlikely to find a better deal somewhere else. Quite honestly for most of our tenants moving is the pain in butt, it is pain for us too, it is an expensive and logistically challenging measure. So you got two sort of things that are working against one another. But at the end of the day it is an individual decision on an individual tenant basis. And so I don't see any reason why kind of historical trends should be any different. Or you are going to see sort of maybe low 60s to mid 70s kind of retention. And I don't see any reasons to divert from that.

[Tom Lesnick:]

Great. And then shifting to construction cost for a second. Obviously there is multiple components but just looking at the labor market, are you guys seeing any trends higher in certain markets than others right now?

[Phil Hawkins:]

Bud you want to take that?

[Bud Pharris:]

Sure. Our construction cost as Phil has mentioned earlier 3% to 5% is pretty spot on. California in particular and the West Coast as it relates to some of the products that are used would in particular is wood and restructure or something that we are seeing as material price increases. The kind of the good news to that to is that the wood restructure are also, wood is also used on the residential side. We see some other price volatility that's more volatile in concrete steel and those kind of back off but at the end of the day I think that the real driver on some of these things is being in a state of California with our energy code and water quality requirements, they cause issue for us as it relates to increased requirements for development things along that line. But generally speaking we are seeing that 3% or 5% is pretty spot on. Some of the general contractors are staying within their typical profit margins but at the subcontractors and the material suppliers that are sticking to their numbers little bit higher because they can and they have a lot of other opportunities. So that's kind of what we are seeing some of those increase as well.

[Tom Lesnick:]

Got it. And then just kind of bigger picture question. What are your thoughts on doing another development JVs similar to 8th Vineyard going forward?

[Phil Hawkins:]

Usually done development in JVs, we have one in Broward County in Florida is another example we are in the process of actually developing the land before started going vertical is to acquire land. And if we are going to acquire land on our own we prefer that, if the seller that land wants to stay into the asset, we will consider that as long as we have complete control. And these are the JVs we've done over the last couple of years and having many but there have been several have involved DCT having complete control over the spec to start in leasing and other decisions. It is not sheer typical JVs have sheer control and we just don't feel that we wanted to be in a situation where we are depended on somebody else to make good decisions on our behalf.

[Operator:]

[Operator Instructions] The next question is a follow up from Eric Frankel with Green Street Advisors. Please go ahead.

[Eric Frankel:]

Thank you. Just a few quick follow up questions. One, could you maybe gone into little bit more detail on the leasing process for DCT white river?

[Phil Hawkins:]

Policing process or lease --

[Eric Frankel:]

Sorry I -- progress I should say not process sorry.

[Phil Hawkins:]

Hey, Bud, it is your -- you go ahead.

[Bud Pharris:]

Yes. So we've got Eric as you may have seen in our release, we've got 215,000 square feet leased and we have very active, very active progress on the balance of the building. We've got a couple of tenants that we are speaking with right now. One in lease negotiations and another two tenants looking at the last remaining space. So the activity has been really strong. We talked about that for the last 60 days internally, and in the last couple of weeks as you have seen, we've done -- we've had some great progress. So feel really good about our position there in and hope to transact here very shortly.

[Phil Hawkins:]

The only thing I would add generally, Eric, it is part of the same thing. While demand is up across all markets, Seattle really seems to have caught fire. Not there was necessarily ice cold, three months, six months ago but I have talked to my peers that are developing or own buildings there, and they got a similar experience or observation. For whatever reason Seattle tenants are on the prowl. And we are happy to help them find home.

[Eric Frankel:]

I appreciate the additional color. Bud, actually I had to ask couple of follow up questions for you. I think you referenced perhaps with water restrictions In California, the entitlement process and obviously you build yourself a couple of building in terms of -- can you comment on entitlement process or how it is changed during the cycle relative to the past several years.

[Bud Pharris:]

Yes. I think most importantly to point out, Eric, as you probably know is the entitlement process in California is not an easy one. We have had certainly as they are referenced the energy code and some of water quality requirements. Greenhouse gases and clean air initiatives are important. Age of equipment as it relates to getting under construction is also something that is creating more pressure on the construction process but from the entitlement standpoint it really hasn't changed a whole lot in most instances, actually in all instances we are following, standard related to getting a project approved in the jurisdictions. I have been doing it for a long time, we have many of our team members here have been doing this for long time and understand the process but it is not like other parts of the country where you can be under construction in a short period of time. Some of these entitlement can take anywhere from 12 to 18 months but it is process we know well and continue to work with our jurisdictional approvals here in -- it is not necessarily direct science, it is a little bit of art too so but we feel really comfortable in that process.

[Eric Frankel:]

Okay. And finally you referenced the really high numbers of construction starts in Inland Empire. Could you maybe go-- or more detail on SBLA and if there is any progress that could be made and taking advantage of the options you have in place to do build-to-suit or spec development if it calls for it.

[Bud Pharris:]

Yes. That is something we are looking at a lot of opportunity that comes from the Inland Empire West and East often times and most of the times we are seeing the same proposals in a high desert, so the willingness to look at that market is something we see in the tenants, we are talking to him about our opportunity is not just for basic space but also the manufacturing infrastructure and things on that line. So we are talking to some tenants. We had a fair amount of activity but I think for just the straight bulk distribution user that's a tougher proposition in the high desert but there is still like I said quite a bit of interest in the site as it relates to manufacturing, assembling and things on that line.

[Operator:]

This concludes the question-and-answer session. I'd now like to turn the conference back over to Phil Hawkins for any closing remarks.

[Phil Hawkins:]

Well, thank you everyone for joining our call today. We had an excellent second quarter and expect a favorable tenant demand and discipline new supply. We will maintain an environment in which DCT can continue to deliver strong results for the year and beyond. With that enjoy the rest of your summer and will talk soon.

[Operator:]

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.