FRANKLIN STREET PROPERTIES CORP quarterly report, Q1 FY2014

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Franklin Street Properties Corp. — Q1 2014 Form 10-Q

Reporting period: Three months ended March 31, 2014; unaudited. Comparisons are with Q1 2013 unless stated otherwise. The company is a REIT focused on office-property operations, leasing, secured lending and management services. At quarter-end it owned 39 properties totaling approximately 9.7 million rentable square feet and managed 14 sponsored REITs.

Financial performance and position

  • Revenue: $63.3 million, up $18.8 million (42.2%). Rental revenue rose to $61.6 million, primarily because of three properties acquired in 2013.
  • Profit: Net income was $3.6 million, down from $4.4 million; diluted EPS was $0.04 versus $0.05. Continuing-operations income fell to $3.6 million from $4.3 million. Net income margin was approximately 5.6%, compared with 9.9%.
  • Expenses: Total expenses increased to $59.1 million from $39.9 million. Depreciation and amortization rose $8.5 million, real estate operating expenses and taxes/insurance together rose $7.0 million, and interest expense increased $3.0 million to $7.2 million.
  • FFO: Company-defined Funds From Operations increased to $28.8 million from $21.2 million. FFO is a non-GAAP measure and is not a substitute for net income or operating cash flow.
  • Property operations: Property NOI from the continuing portfolio was $36.6 million, up 45.3%, largely reflecting acquired properties. Same-store NOI rose 5.4% to $26.5 million; comparative same-store NOI, excluding specified nonrecurring items, increased 2.9% to $25.8 million.
  • Cash flow: Operating cash flow was $16.4 million versus $10.0 million. Investing used $7.0 million, mainly for property/equipment additions and $2.2 million of sponsored-REIT loan advances. Financing used $9.0 million: $19.0 million of shareholder distributions was partly offset by $10.0 million of revolver borrowings. Cash increased $0.4 million to $20.0 million.
  • Debt and liquidity: Bank debt totaled $936.5 million at March 31, comprising a $316.5 million revolver, a $400.0 million term loan and a $220.0 million term loan. Total liabilities were $993.3 million and stockholders’ equity was $1,032.4 million. The company reported compliance with credit-facility covenants and said cash, operating cash generation and existing financing should cover working capital and anticipated capital expenditures for at least 12 months.
  • Distributions and shares: The company paid $0.19 per share, totaling $19.0 million, and had 100,187,405 shares outstanding. A further $0.19-per-share distribution was declared for payment May 15, 2014.

Material changes and management commentary

  • Revenue growth was substantially acquisition-driven, following office-property purchases in Denver and Atlanta during 2013. The acquisitions also increased property operating costs, depreciation and debt-related interest expense.
  • Portfolio leased occupancy was 94.5% at March 31, up from 94.1% at December 31, 2013. The company leased approximately 180,000 square feet in Q1; weighted average lease term was 6.75 years. GAAP base rents on those leases averaged $23.95 per square foot, reported as 11.9% above average rents in the relevant properties.
  • Management described the portfolio as well stabilized and cited improving occupancy and rental trends in most major markets. It anticipated moderation in tenant-improvement and leasing costs relative to rental revenue, but gave no specific earnings or revenue guidance.
  • Management characterized the U.S. economy as in an early, prolonged upswing, while warning that economic conditions could still pressure office demand, rents, occupancy and property values. Dividend capacity depends significantly on rental income.

Risks, contingencies and unusual items

  • Sponsored-REIT loans outstanding were $101.9 million across six facilities, against $111.8 million of total commitments. These related-party loans expose the company to borrower and property credit risk. The maturity of the $37.5 million drawn Interlocken construction loan was extended from April 30, 2014 to April 30, 2015 after quarter-end.
  • Debt-rate exposure remains, particularly on the floating-rate revolver. Interest-rate swaps hedge the term loans; the company reported a $3.8 million swap liability and a $4.8 million swap asset at quarter-end. Derivatives carry counterparty and valuation risks.
  • Leases covering approximately 4.8% of portfolio square footage expire in 2014 and 9.5% in 2015. Tenant nonrenewals, defaults or bankruptcies could reduce rental income and cash available for distributions.
  • The company sold a Richardson, Texas property in October 2013 for $12.3 million, recognizing a $2.2 million gain; its prior-year operating results were classified as discontinued operations. Q1 2014 had no discontinued-operations income.
  • The company reported no material changes to previously disclosed risk factors and stated that ordinary-course legal proceedings were not expected to have a material adverse effect. No material control changes were reported; disclosure controls were assessed as effective.

Investor verification priorities

  1. Assess how much of revenue, NOI and FFO growth reflects the 2013 acquisitions versus underlying same-store leasing and rent performance.
  2. Review debt maturities, revolver availability, variable-rate exposure and covenant headroom; verify the effect of interest costs on future cash generation.
  3. Compare recurring operating cash flow with distributions and planned leasing, capital and loan-funding requirements.
  4. Monitor sponsored-REIT loan repayment sources, maturities and related-party credit exposure, including the extended Interlocken loan.
  5. Track upcoming lease expirations, occupancy, renewal spreads, tenant-improvement costs and whether management’s expected leasing-cost moderation materializes.