FRANKLIN STREET PROPERTIES CORP quarterly report, Q2 FY2017

Franklin Street Properties Corp. — Q2 2017 Form 10-Q

Reporting period: Three and six months ended June 30, 2017. Amounts are in U.S. dollars; financial statement amounts are shown in millions unless stated otherwise. The company is a REIT focused on office properties, with 35 operating properties totaling approximately 10.1 million rentable square feet, plus one redeveloped property in lease-up and interests in Sponsored REITs.

Financial results and position

Metric	Q2 2017	Q2 2016	Six months 2017	Six months 2016
Total revenue	$68.4m	$60.8m	$137.1m	$120.6m
Net income (loss)	$(17.4)m	$1.6m	$(12.9)m	$4.2m
Diluted earnings (loss) per share	$(0.16)	$0.02	$(0.12)	$0.04
Funds from operations (FFO), non-GAAP	$28.6m	$26.7m	$57.1m	$52.8m
Operating cash flow	Not presented by quarter	$40.0m	$32.4m

Revenue increased 12.4% in Q2 and 13.7% for the first half, mainly from properties acquired in 2016. The company’s GAAP loss was driven by a $20.5m after-tax provision for loss on its Baltimore property held for sale.
Before equity-method losses, other items and property-sale/held-for-sale gains or losses, income was $3.2m in Q2 versus $3.5m a year earlier, and $5.9m for the half versus $6.4m.
First-half property NOI, a company-defined non-GAAP measure, rose 9.4% to $73.7m, with acquisitions contributing substantially. Same-store NOI declined 4.2% to $62.4m; comparative same-store NOI after identified nonrecurring items declined 4.7%.
Portfolio leasing was reported at 88.1% at June 30, down from 89.3% at December 31, 2016; vacant space increased to approximately 1.201m square feet from 1.086m. A separate property table reports 87.7% weighted occupied space, reflecting a different measure.
Cash and cash equivalents were $11.5m, up from $9.3m at year-end. First-half investing cash use was $12.1m and financing cash use was $25.7m; distributions to stockholders totaled $40.7m.
Total assets were $2.043bn and total liabilities $1.135bn at June 30. Balance-sheet debt, net of financing costs, was $1.061bn; gross principal debt was $1.065bn. The $500m BAML revolver had $295m drawn. The company reported compliance with all financial covenants.
Interest expense increased 23% in Q2 to $7.9m and 20% for the half to $15.5m, primarily due to higher rates, additional borrowings and deferred financing-cost amortization.

Material changes and operating developments

Rental revenue growth from 2016 acquisitions was partly offset by property dispositions and lower occupancy. Real estate operating costs, taxes and insurance, and depreciation also rose with the larger acquired portfolio.
Same-store NOI weakness was concentrated in the Midwest and South: down 9.3% and 8.1%, respectively, for the first half; West increased 3.9%.
The company classified an office property in Baltimore, Maryland, as held for sale and recorded a $20.5m after-tax loss provision. Management expects a sale within one year. The property was carried at $31.9m as an asset held for sale at June 30.
The 801 Marquette Avenue redevelopment in Minneapolis was substantially completed at the end of Q2. Approximately $15m of an estimated $20m total project cost had been incurred; the redeveloped property has about 128,000 net rentable square feet and remains in lease-up.
The company leased approximately 476,000 square feet in the first half. New and renewed leases averaged 5.8 years, with average GAAP base rent of $28.64 per square foot, 7.2% above the relevant prior rents. Tenant improvements averaged $18.87 per square foot, commissions $7.82, and concessions about three months’ free rent.

Outlook, risks and unusual items

Management said it expects positive leasing activity in 2017 and considers the portfolio generally stabilized, while acknowledging that leasing, renewals and rents depend on market conditions. It expects existing cash, internally generated cash and current debt financing to cover working capital and anticipated capital expenditures for at least 12 months; this is not earnings guidance.
Management described the U.S. economy as growing slowly and noted that potential further Federal Reserve rate increases could raise borrowing costs. Office demand, occupancy, rents and property values are exposed to national and local economic conditions.
Floating-rate exposure includes $295m drawn on the BAML revolver and the $150m JPM term loan, both due in 2018. The filing estimates a 10% increase in market rates on the revolver would reduce annual earnings and cash flow by about $1.1m. Interest-rate swaps fix base rates on the BMO and BAML term loans, but hedge mismatch and counterparty risks remain.
Contractual principal maturities include $445m in 2018, $220m in 2020 and $400m in 2021. The revolver may be extended to October 2019 subject to conditions and a fee.
The company had committed up to $79.5m to Sponsored REIT loans, of which $72.3m was drawn. These related-party secured loans expose the company to borrower and property-level credit risks; management stated none were impaired.
Management stated that ordinary-course legal matters are not expected to have a material adverse effect. No material changes to the risk factors in the 2016 Form 10-K were reported. Disclosure controls were assessed as effective.
The board declared a $0.19-per-share distribution payable August 10, 2017. The filing does not provide a full-year earnings or FFO forecast.

Most important facts for investors to verify

Whether and when the Baltimore asset sells, and the realized proceeds compared with the $31.9m held-for-sale carrying value and recorded loss.
Whether occupancy and same-store NOI stabilize, particularly in the South and Midwest, and whether redevelopment and newly vacant space lease as anticipated.
How the company will refinance or repay the $445m of 2018 maturities, including the revolver and JPM term loan, and the cost and availability of refinancing.
Whether operating cash generation can sustain the $0.19 quarterly distribution alongside leasing costs, capital spending and related-party lending commitments.
How much of revenue and earnings growth reflects acquired assets versus underlying same-store performance; FFO and NOI are non-GAAP measures and should be considered alongside GAAP results and cash flows.