Franklin Street Properties Corp. — Q3 2019 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2019. The company is a REIT focused on office properties, primarily in Sunbelt and Mountain West markets. At quarter-end it owned 32 operating properties and three redevelopment properties, totaling approximately 9.9 million rentable square feet, and managed two Sponsored REITs.
Financial performance and position
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Total revenue | $68.5 million | $68.7 million | $200.1 million | $202.3 million |
| Net income | $2.4 million | $9.6 million | $2.8 million | $11.7 million |
| Diluted net income per share | $0.02 | $0.09 | $0.03 | $0.11 |
| Funds from Operations (FFO; non-GAAP) | $24.9 million | $26.2 million | $70.8 million | $77.9 million |
| Cash from operating activities | — | $60.1 million | $62.9 million |
At September 30, cash and cash equivalents were $20.2 million, compared with $11.2 million at year-end 2018. Total assets were $1.843 billion and stockholders’ equity was $789.7 million. Debt principal totaled approximately $970 million: $150 million JPMorgan term loan, $220 million BMO term loan, $400 million Bank of America term loan and $200 million senior notes. No borrowings were outstanding on the $600 million Bank of America revolver. The balance sheet shows $964.3 million of term loans and senior notes net of financing costs. Management reported compliance with debt covenants.
Operating cash flow exceeded distributions paid of $29.0 million. Investing activities provided $3.0 million, including $51.8 million in Sponsored REIT loan repayments, partly offset by $47.9 million of property improvements, fixtures and equipment. Financing activities used $54.0 million, including distributions and net revolver repayments. Quarterly distributions were $0.09 per share; the board declared another $0.09 distribution payable November 14, 2019.
Material changes versus the comparable period
- Nine-month revenue declined $2.2 million. Rental revenue fell $1.5 million, and related-party management-fee and loan-interest revenue fell $0.7 million, mainly following repayment of approximately $51 million of Sponsored REIT loans in June 2019.
- Nine-month net income fell $8.9 million. A key comparison is the $6.8 million of equity-method income from Sponsored REIT investments in 2018, including gains associated with property liquidations; there was no such income in 2019.
- Operating expenses were broadly flat overall: lower depreciation and interest expense were largely offset by higher property operating costs, taxes and insurance, and general and administrative expenses.
- Same-store NOI (non-GAAP) increased 0.1% to $105.0 million for the first nine months, while total property NOI declined 4.2% to $104.5 million, reflecting dispositions and redevelopment properties. FFO declined approximately 9% to $70.8 million.
- Operating properties were 89.7% leased at September 30, versus 89.0% at December 31, 2018 and 90.5% a year earlier. The company leased approximately 1.139 million square feet during the first nine months; average GAAP base rent on those leases was 11.9% above rents in the respective properties, with a weighted average lease term of 8.6 years.
Outlook, commentary and risks
- No quantified earnings or FFO guidance was provided. Management said it expected positive leasing activity in operating properties through the remainder of 2019 and during 2020, citing generally steady or improving rental conditions and increased prospective leasing activity in Houston and Denver. It believed cash, operating cash generation and existing debt financing would cover working capital and anticipated capital expenditures for at least 12 months.
- Redevelopment spending remains significant. Blue Lagoon was leased to a new tenant for approximately 156,000 square feet, or 73.1% of the property, under a 16-year lease; completion was anticipated by the end of 2020, with total expected restoration, redevelopment and lease-up costs of $38.9 million. Forest Park redevelopment was expected to finish by year-end 2019, with $3.8 million of expected costs. 801 Marquette was 37% leased, with $28.8 million of expected redevelopment and lease-up costs.
- Interest-rate exposure is partly hedged. The company reported effective rates of 2.47% on the Bank of America term loan, 3.57% on the BMO term loan, and 3.69% on the hedged $100 million portion of the JPMorgan loan. A 10% increase in market rates on the specified unhedged borrowings was estimated to reduce annual earnings and cash flow by $0.2 million at September 30.
- Derivative fair-value movements reduced nine-month comprehensive income: the unrealized loss on derivatives was $21.9 million, and accumulated other comprehensive income became a $7.1 million loss. Approximately $2.5 million of accumulated derivative losses was expected to be reclassified to interest expense within 12 months.
- Risks include office-market and tenant demand, lease expirations and tenant defaults, redevelopment execution and lease-up, property expenses and taxes, interest rates and debt-market access, and counterparty or valuation risks associated with hedges. Sponsored REIT loans totaled $21.3 million drawn against $26.5 million of commitments; the company stated none were impaired. Management said there were no material changes to previously disclosed risk factors and no known legal matters expected to materially affect results.
Important facts for investors to verify
- Whether occupancy and leasing gains translate into durable rental revenue, particularly given the year-over-year occupancy comparison and the portfolio’s upcoming lease expirations.
- Actual redevelopment costs, timing and leasing progress at Blue Lagoon, Forest Park and 801 Marquette.
- Debt maturities and refinancing plans: $205 million is scheduled to mature in 2021, $400 million in 2023, and $365 million thereafter, according to the filing’s maturity table.
- Cash available after property investment and distributions, and the sustainability of the $0.09 quarterly distribution relative to operating cash flow and capital requirements.
- Potential effects of derivative fair-value changes, future interest expense and Sponsored REIT loan repayments on reported earnings and liquidity.