Franklin Street Properties Corp. — Q2 2014 Form 10-Q
Business context and reporting period. This unaudited quarterly filing covers the three and six months ended June 30, 2014. Franklin Street Properties is a REIT focused primarily on office properties, alongside property and asset management and secured lending to affiliated Sponsored REITs. At quarter-end it owned 39 properties totaling approximately 9.69 million rentable square feet and managed 13 Sponsored REITs.
Financial performance and position
- Q2 revenue: $62.7 million, up $15.1 million (about 32%) year over year. Rental revenue was $61.0 million; management fees and interest income from related parties were $1.7 million.
- Q2 earnings: Net income was $3.7 million, versus $4.7 million a year earlier; diluted EPS was $0.04 versus $0.05. Continuing-operations income was also $3.7 million versus $4.6 million. Total expenses increased to $58.4 million from $42.7 million.
- First-half results: Revenue was $126.0 million versus $92.2 million; net income was $7.3 million versus $9.1 million; diluted EPS was $0.07 versus $0.10. Expense growth, including depreciation, property costs and interest, exceeded revenue growth.
- FFO: Management-reported Funds From Operations was $28.3 million for Q2 versus $22.8 million, and $57.0 million for the first half versus $44.0 million. FFO is a non-GAAP measure and is not a substitute for net income or cash flow.
- Property operating measures: Management reported the portfolio was 94.1% leased at June 30, unchanged from December 31, 2013. First-half comparative same-store NOI increased 2.8%; property NOI increased 37.5%, substantially reflecting acquisitions. A separate property table reports 93.7% weighted occupied space, so the differing occupancy measures merit review.
- Cash flow and liquidity: First-half operating cash flow was $43.1 million versus $34.2 million in 2013. Investing activities provided $3.8 million, compared with $194.4 million used in 2013, when major property purchases occurred. Financing activities used $48.1 million, primarily distributions and net debt repayments. Cash was $18.5 million at June 30, down from $19.6 million at year-end. Management said available cash, operating cash flow and existing financing should cover working capital and anticipated capital expenditures for at least 12 months.
- Debt and equity: Debt totaled $916.5 million: $296.5 million outstanding on the revolver and $620.0 million in term loans. Total assets were $1.99 billion and stockholders’ equity was $1.01 billion. The company reported compliance with both credit facilities’ financial covenants. Quarterly and first-half distributions were $0.19 per share; the board declared another $0.19 distribution payable in August.
Material changes versus prior comparable periods
- Revenue rose mainly because properties acquired in May, July and August 2013 contributed for a full comparable period in 2014. Management cited a roughly 0.3 percentage-point lower portfolio occupancy than at June 30, 2013 as a partial offset.
- Expenses also rose with the acquired properties. Interest expense increased to $6.9 million for Q2 from $4.2 million and to $14.1 million for the first half from $8.4 million, reflecting higher debt outstanding and the 2013 term loan.
- Equity-method losses from non-consolidated REITs increased to $0.6 million for Q2 and $1.0 million for the first half, primarily due to greater losses from the East Wacker investment.
- Net income comparisons also reflect the absence of income from a Richardson, Texas property sold in October 2013; its prior-period results were classified as discontinued operations.
- First-half 2014 included $7.6 million of real estate and equipment purchases and a $13.9 million repayment of a related-party mortgage loan. The company issued no ATM shares during Q2; approximately $34.3 million remained available under the program.
Outlook, commentary, risks and unusual items
- No quantified earnings, revenue or occupancy guidance was provided. Management described the portfolio as well stabilized, cited positive occupancy and rental-rate trends in most major markets, and expected leasing costs and tenant-improvement spending to moderate relative to rental revenue. It also said further investment opportunities were being explored.
- Management characterized the U.S. economy as slowly improving but emphasized uncertainty around office-space demand, local market conditions, rents and property values. It cautioned that tenant defaults or bankruptcy could reduce rental income and cash available for distributions.
- Interest-rate exposure remains, particularly on the $296.5 million revolver, priced at 1.60% at quarter-end. Swaps fixed the base LIBOR rates on the $220 million 2013 term loan and $400 million 2012 term loan; reported rates were 3.97% and 2.20%, respectively. The 2013 swap was a $6.0 million liability and the 2012 swap a $2.6 million asset. Changes in derivative fair value contributed a $6.6 million first-half loss in other comprehensive income.
- Sponsored REIT loans create related-party credit exposure. At June 30, the company had committed up to $96.8 million, of which $88.4 million was drawn. After quarter-end, it extended a $33.0 million loan and entered into a new revolving commitment of up to $20.0 million; total commitments were then $116.8 million.
- The filing reports ordinary-course legal claims but says their resolution is not expected to materially affect the company. It reports no material change to previously disclosed risk factors. Management said disclosure controls were effective and there was no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether acquisition-driven revenue and FFO growth translates into sustained same-store performance and improved net income.
- The basis and comparability of the 94.1% leased figure versus the 93.7% weighted occupancy shown in the property table, and the effect of upcoming lease expirations.
- Debt maturities, revolver availability and interest-rate sensitivity, including the assumptions behind management’s view that rate exposure is not material.
- Repayment prospects and credit quality for Sponsored REIT loans, including the post-quarter increase in committed lending.
- Cash available after distributions, leasing commissions and capital spending; management’s liquidity outlook is not a guarantee of future funding or distributions.
- The effect of derivative fair-value changes and related reclassifications on reported comprehensive income and future interest expense.