Business context and reporting period
Franklin Street Properties Corp. (NYSE MKT: FSP) filed this annual report for the fiscal year ended December 31, 2015. It operates as a REIT focused on office properties, with rental income, secured lending to Sponsored REITs, and property and asset management fees as principal revenue sources. At year-end it owned 36 office properties across 13 states; about 71% of its portfolio area was in its five priority markets: Atlanta, Dallas, Denver, Houston and Minneapolis.
Key financial metrics
Amounts below are in millions of dollars except per-share figures and percentages.
| Metric | 2015 | 2014 |
|---|---|---|
| Total revenue | $243.9 | $249.7 |
| Net income | $35.0 | $13.1 |
| Net income per diluted share | $0.35 | $0.13 |
| Funds from operations (FFO) | $106.9 | $112.5 |
| Net cash from operating activities | $102.9 | $103.2 |
| Cash and cash equivalents at year-end | $18.2 | $7.5 |
| Total assets | $1,921.4 | $1,936.4 |
| Total liabilities | $985.7 | $956.7 |
| Shareholders’ equity | $935.7 | $979.6 |
- Rental revenue was $237.9 million, down $5.5 million year over year. Real estate operating expenses were $61.9 million; real estate taxes and insurance were $38.7 million; depreciation and amortization were $91.4 million; and interest expense was $25.4 million.
- Property NOI was $134.7 million, down 5.9%; comparative same-store NOI fell 5.2%. Management reported 91.6% leased at year-end, versus 92.8% a year earlier.
- Investing activities used $38.1 million, including property acquisition, improvements and additional Sponsored REIT lending, partly offset by property-sale proceeds. Financing activities used $54.1 million, including $76.1 million of distributions.
- Debt totaled $910 million: $290 million drawn on the BAML Revolver, a $400 million BAML Term Loan and a $220 million BMO Term Loan. The debt is unsecured; the company reported no mortgage debt on its properties. It said it complied with facility financial covenants at year-end.
- Annual distributions were $0.76 per share, or $0.19 quarterly. A $0.19-per-share dividend declared in January 2016 was paid in February.
Material changes versus the prior comparable period
- Revenue decreased 2.3%, mainly due to four 2015 property sales and lower year-end occupancy, partly offset by the April 2015 acquisition of an Atlanta office property.
- Net income rose by $21.9 million, primarily because after-tax gains on property sales increased to $23.7 million from $0.9 million. The increase should not be read as equivalent growth in recurring operations.
- FFO declined by about 5.0% to $106.9 million. Same-store NOI also declined, despite higher GAAP base rents on leases signed during 2015: those leases averaged $28.66 per square foot, 10.4% above rents in the respective properties.
- Cash from operations was broadly steady. Year-end cash rose by $10.6 million, while total liabilities increased about $29.0 million and equity decreased about $44.0 million.
- The company acquired one property in 2015 and sold four, recording gains of $1.5 million, $9.0 million, $0.9 million and $12.3 million, respectively.
Outlook, risks and unusual items
- Management anticipated continued positive leasing activity in 2016 and said most major markets had steady or improving rental conditions. It described the economy as in an early, prolonged upswing, while cautioning that slower growth, higher interest rates and other economic factors could hurt occupancy, rents, property values and income.
- The strategy is to dispose of smaller suburban assets and reinvest in larger urban-infill and central-business-district properties, primarily in the five priority markets. Management acknowledged that execution could weigh on short-term results; it expects potential benefits over a longer period.
- Energy-sector exposure is a material risk: the filing cites tenant concentration in energy services and significant property concentrations in Denver, Atlanta, Dallas and Houston, and warns prolonged low oil or gas prices could weaken leasing and asset values.
- Interest-rate, refinancing, covenant, tenant-default and Sponsored REIT credit risks remain. The $290 million revolver was variable-rate; term-loan base rates were hedged through swaps. The BAML Term Loan matures in September 2017, the revolver in October 2018 (with a conditional one-year extension), and the BMO Term Loan in August 2020.
- At year-end, the company was committed to provide up to $132.3 million across Sponsored REIT loans, with $118.6 million drawn. One loan with $37.5 million outstanding was repaid on January 19, 2016, reducing drawn loans to $81.1 million across four Sponsored REITs.
- A Missouri property had an unusually high vacancy following tenant departures; its 2015 rental income of $0.8 million did not cover $1.0 million of operating expenses. A lease for 62,000 square feet had been signed but had not yet commenced at year-end.
- Management expected existing cash, operating cash flow and debt financing to cover working capital and anticipated capital expenditures for at least 12 months. It said future dividends were not guaranteed and depended substantially on rental income. The filing reports an upcoming executive departure: Janet Prier Notopoulos planned to resign as Executive Vice President in May 2016.
- Ernst & Young issued unqualified opinions on the financial statements and internal control over financial reporting. The company reported effective disclosure controls and internal controls.
Important facts for investors to verify
- Whether leasing and occupancy recover, particularly in energy-exposed markets, and whether signed leases commence as expected.
- Whether recurring operating performance supports the $0.76 annual distribution, given lower FFO and same-store NOI and the sizable gap between net income and property cash generation.
- Refinancing plans and covenant headroom for the $400 million BAML Term Loan due in 2017, as well as the effect of variable-rate borrowing and credit-rating changes.
- Repayment and credit quality of Sponsored REIT loans, including remaining commitments and the post-year-end repayment.
- Progress and costs of the portfolio shift toward urban assets, and the sustainability of cash flows after property dispositions.