Franklin Street Properties Corp. — Q2 2018 Form 10-Q
Business context and reporting period
Quarterly report for the three and six months ended June 30, 2018. Franklin Street Properties is a REIT focused on office real estate operations, including leasing, property management and secured lending to related Sponsored REITs. At quarter-end, it owned 34 operating properties totaling about 9.76 million rentable square feet, plus one substantially redeveloped property in lease-up. About 78% of its owned portfolio was in its five core markets: Atlanta, Dallas, Denver, Houston and Minneapolis.
Key financial metrics
Amounts below are in millions, except per-share data and percentages.
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Total revenue | $66.7 | $68.4 | $133.6 | $137.1 |
| Net income (loss) | $0.7 | ($17.4) | $2.1 | ($12.9) |
| Net income (loss) per share | $0.01 | ($0.16) | $0.02 | ($0.12) |
| Funds from Operations (FFO), non-GAAP | $25.4 | $28.6 | $51.8 | $57.1 |
| Operating cash flow | Not separately presented for the quarter | $33.7 | $40.1 |
- At June 30, total assets were $1.98 billion, total liabilities $1.13 billion, and stockholders’ equity $852.4 million. Cash and restricted cash totaled $10.4 million.
- Balance-sheet debt, net of financing costs, was about $1.06 billion: $98 million revolving borrowings, $765.6 million term loans and $198.8 million senior notes. Contractual principal debt was $1.068 billion.
- Six-month property improvements and equipment spending was $24.3 million. Cash distributions to stockholders were $30.0 million; net cash decreased by $10.0 million from financing activities and increased by $0.6 million overall.
- Interest expense was $9.8 million in Q2 and $19.2 million for the first half, versus $7.9 million and $15.5 million in the comparable 2017 periods. The filing does not provide a single consolidated operating-margin figure.
- Same-store NOI, a company-defined non-GAAP measure, was $70.1 million for the first half, down 1.8% from $71.4 million after excluding specified nonrecurring items.
Material changes versus prior comparable periods
- Q2 revenue fell $1.7 million year over year; first-half revenue fell $3.5 million. Management attributed the decline mainly to lease expirations and the sale of two properties in 2017, with lower Sponsored REIT loan income also contributing.
- Leased occupancy was 89.0% at June 30, down from 89.7% at December 31, 2017. Vacancy increased to about 1.071 million square feet from 1.007 million. The filing’s property table separately reports 87.0% weighted occupied space based on its stated methodology.
- Interest expense increased, partly reflecting the $200 million senior notes issued in December 2017, higher short-term rates on the revolver and higher average borrowing rates. Lower depreciation and amortization and lower operating costs partly offset this increase.
- Reported net income improved substantially from 2017 losses, but the comparison is heavily affected by the prior-year Baltimore property loss: a $20.5 million after-tax provision in Q2 2017, followed by the property’s sale in October 2017 for $31.6 million net proceeds and a total after-tax loss of $20.8 million.
- FFO declined about 11% in Q2 and 9% for the first half. The 2018 results included a $0.3 million impairment charge on an investment in a non-consolidated REIT.
Outlook, risks and unusual items
- Management expected positive leasing activity during 2018, citing steady or improving rental conditions in most major markets and increased potential activity in Houston and Denver. It described the portfolio as well stabilized and vacancy as actively marketed; these are expectations, not guaranteed results.
- Management believed available cash, internally generated cash and debt financing would cover working capital and anticipated capital expenditures for at least 12 months. It also said dividends depend significantly on rental income. No earnings or FFO numerical guidance was provided.
- The Board declared a Q3 2018 distribution of $0.09 per share, payable August 9. The Q2 2018 distribution was also $0.09 per share, down from $0.19 per share in each of the first and second quarters of 2017.
- A $150 million JPM term loan matures November 30, 2018. Other stated debt maturities include $220 million in 2020, $98 million of revolver borrowings in 2022, and $600 million thereafter. The company had a $600 million revolver with $98 million drawn at quarter-end and reported compliance with its credit-facility financial covenants.
- Interest-rate exposure remains relevant: the JPM loan and revolver are floating-rate, while swaps fixed the base LIBOR rates on the $400 million BAML and $220 million BMO term loans through September 2021 and August 2020, respectively. Management estimated a 10% increase in revolver rates would reduce annual earnings and cash flow by about $0.8 million.
- The company had committed up to $79.5 million to Sponsored REIT loans, of which $71.2 million was drawn. These related-party loans carry borrower credit risk; management reported none impaired. Following a July 2018 Sponsored REIT property sale, the company expected about $6.3 million in distributions as its investment was liquidated.
- Management cited economic conditions, office-space demand, interest rates, tenant defaults or bankruptcies, property expenses and real-estate tax reassessments as risks. It said ordinary-course legal matters were not expected to materially affect financial position or results. No material risk-factor changes were reported.
- Management expected adoption of the new lease standard in 2019 to add about $3 million to assets and liabilities for its office lease, with no material effect on results or liquidity.
Important facts for investors to verify
- How the company will refinance or repay the $150 million JPM loan due November 2018, and the terms and availability of replacement financing.
- Whether occupancy and rental revenue stabilize or improve, particularly at properties with notable vacancies and at the redeveloped 801 Marquette Avenue.
- Whether operating cash flow and leasing activity support the reduced $0.09 quarterly distribution, given first-half distributions exceeded net income and cash was only $10.4 million.
- The effect of higher interest rates and refinancing costs on interest expense, covenants and cash available for distributions.
- Repayment and credit quality of Sponsored REIT loans, and realization of the expected $6.3 million distribution from the Grand Boulevard investment.
- Changes in FFO and same-store NOI, recognizing that both are non-GAAP measures and may not be comparable to similarly named measures at other REITs.