Franklin Street Properties Corp. — 2018 Form 10-K
Reporting period: Fiscal year ended December 31, 2018. This is an annual filing, not a standalone fourth-quarter report. Franklin Street Properties is a REIT focused primarily on office real estate, with 35 owned properties: 32 operating and three in redevelopment. About 78% of its owned portfolio by area was in its five core markets: Atlanta, Dallas, Denver, Houston and Minneapolis.
Financial and operating performance
| Metric | 2018 | 2017 | Change / context |
|---|---|---|---|
| Total revenue | $268.9 million | $272.6 million | Down $3.7 million; rental revenue declined $3.5 million. |
| Net income (loss) | $13.1 million | $(15.9) million | Improved by $29.0 million, principally reflecting the absence of 2017 property-sale losses and positive equity income from non-consolidated REITs. |
| Diluted earnings per share | $0.12 | $(0.15) | Net income was modest relative to revenue and included investment-related items. |
| Funds from Operations (FFO) | $102.5 million | $111.4 million | Down $9.0 million, or about 8%; company-defined non-GAAP measure. |
| Operating cash flow | $80.2 million | $95.9 million | Down $15.7 million. |
| Same-store comparative NOI | $131.7 million | $137.4 million | Down 4.2%; company-defined non-GAAP measure. |
| Cash and cash equivalents | $11.2 million | $9.8 million | Up $1.4 million. |
| Total assets | $1,898.1 million | $1,990.5 million | Down $92.4 million. |
| Total liabilities | $1,060.5 million | $1,119.2 million | Down $58.8 million. |
| Stockholders’ equity | $837.6 million | $871.3 million | Down $33.7 million. |
Property operations: Operating properties were 89.0% leased at year-end, versus 89.7% a year earlier. The operating portfolio had approximately 1.046 million square feet vacant. During 2018, the company leased about 1.681 million square feet, at a weighted average lease term of 7.3 years; reported average GAAP base rents on those leases were 7.3% above average rents in the respective properties.
Debt, liquidity and distributions
- Year-end principal debt was approximately $995 million: $25 million on the BAML revolver, $400 million BAML term loan, $220 million BMO term loan, $150 million JPM term loan and $200 million in senior notes. The properties were reported as having no mortgage debt.
- 2018 interest expense rose $6.0 million to $38.4 million, reflecting the senior notes, higher rates on variable-rate borrowings and financing-cost amortization. The BAML and BMO term loans were partly hedged; the revolver and JPM term loan were variable-rate exposure.
- Cash from operations was $80.2 million; investing activities provided $25.6 million, including $74.9 million in liquidating distributions from two non-consolidated REIT investments, offset partly by $51.1 million of property improvements and equipment investments. Financing activities used $104.5 million, including $49.3 million of shareholder distributions and $53.0 million of net revolver repayments.
- Management said cash, anticipated operating cash flow and existing debt financing should cover working capital and anticipated capital expenditures for at least 12 months. The filing provides no numerical earnings or FFO guidance.
- Declared distributions were $0.46 per share in 2018, versus $0.76 in 2017. The quarterly rate fell from $0.19 to $0.09 beginning in the second quarter of 2018; the board declared another $0.09 per share in January 2019.
Material changes and unusual items
- Revenue fell despite leasing activity, as expirations and terminations, dispositions made in 2017, and two properties’ reclassification as redevelopment assets reduced rental income. Leased occupancy declined 0.7 percentage points.
- Net income turned positive from a 2017 loss. A major factor was the $6.8 million of equity income from non-consolidated REITs in 2018, including a $7.1 million gain associated with East Wacker’s liquidation; 2017 included an $18.5 million property-sale loss and $1.9 million of hedge ineffectiveness expense.
- The company made no property acquisitions or direct property sales in 2018. It received liquidating distributions after Sponsored REIT properties Grand Boulevard and East Wacker were sold.
- Redevelopment and lease-up remained significant: expected total investment was $28.4 million at 801 Marquette, $22.5 million at Blue Lagoon and $3.5 million at Forest Park. At year-end, 801 Marquette was 37% leased and 15.8% occupied; Blue Lagoon redevelopment began in December 2018, and Forest Park redevelopment began in January 2019.
- The company reported a Moody’s Baa3 credit rating and compliance with financial covenants at year-end. It identified refinancing, covenant compliance, interest-rate changes and the transition away from LIBOR as financing risks.
Outlook, risks and contingencies
Management described U.S. economic conditions as improving and expected positive leasing activity during the remainder of 2019, including increased potential activity in Houston and Denver. It also noted that local and national economic conditions, office-space demand, occupancy and rents could weaken. These comments are expectations, not assured results.
- Three Sponsored REIT lending arrangements had commitments of up to $79.5 million, of which $70.7 million was drawn and outstanding at year-end. Repayment depends on underlying property cash flows, refinancing or other capital events; a borrower default could reduce cash available for distributions.
- Key property risks include tenant defaults or bankruptcies, lease expirations, concentrated exposure to energy-influenced markets and tenant industries, redevelopment cost and lease-up risk, and competition. Approximately 16% of tenant rentable area was associated with energy services and 10% with legal services.
- Other disclosed risks include debt refinancing and covenant requirements, variable interest rates, credit-rating downgrades, REIT qualification, environmental and building-compliance costs, cybersecurity incidents and possible uninsured losses.
- Management said ordinary-course legal matters were not expected to have a material adverse effect. The filing reported effective disclosure controls and internal control over financial reporting; the auditor issued unqualified opinions on the financial statements and internal controls.
Investor verification points
- Verify the durability of rental income and the causes of the occupancy and same-store NOI declines, including the exposure to energy-related markets and tenants.
- Assess whether the reduced $0.09 quarterly distribution is supported by recurring cash flow, considering FFO, operating cash flow, leasing costs and redevelopment spending.
- Review debt maturities and floating-rate exposure, particularly the $205 million of JPM and BMO tranche A debt due in 2021, the revolver’s 2022 maturity, and hedge expirations in 2020 and 2021.
- Track lease-up, remaining investment and completion milestones at 801 Marquette, Blue Lagoon and Forest Park; compare actual costs and occupancy with management’s estimates.
- Separate recurring operating results from the REIT liquidation gain and other equity-method items when evaluating the 2018 return to profitability.
- Review the detailed financial statements and notes for the full debt terms, covenant headroom, Sponsored REIT loan collateral and repayment prospects; the summary does not provide covenant headroom figures.