Franklin Street Properties Corp (FSP) 2016 Q2 法說會逐字稿

Good afternoon, and welcome to the Franklin Street Properties Corp. second quarter 2016 results conference call. All participants will be a listen-only mode. (Operator Instructions) After today's presentation, there will be an opportunity to ask questions. (Operator Instructions) Please note this event is being recorded. I would now like to turn the conference over to Scott Carter, General Counsel. Please go ahead.

Good afternoon, and welcome to the Franklin Street Properties second quarter 2016 earnings call. We apologize for the delayed call. Our service provider had technical issues. We understand this is a busy time for everyone, and appreciate you being able to join us. With me this afternoon are George Carter, our Chief Executive Officer; John Demeritt, our Chief Financial Officer; Jeff Carter, our President and Chief Investment Officer; and John Donahue, President of FSP Property Management. Also with me this afternoon are Toby Daley, Senior Vice President and Regional Director of Houston; Will Friend, Senior Vice President and Regional Director of Denver; and Patty McMullen, Senior Vice President and Regional Director of Dallas.

Before I turn the call over to John Demeritt, I must read the following statement. Please note that various remarks that we may make about future expectations, plans, and prospects for the Company may constitute forward-looking statements for purposes of the Safe Harbor provisions under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors, including those discussed in the risk factors section of our Annual Report on Form 10-K for the year ended December 31, 2015, which is on file with the SEC.

In addition, these forward-looking statements represent the Company's expectations only as of today, July 27, 2016. While the Company may elect to update these forward-looking statements, it specifically disclaims any obligation to do so. Any forward-looking statements should not be relied upon as representing the Company's estimates or views as of any date subsequent to today.

At times during this call we may refer to funds from operations or FFO. A reconciliation of FFO to GAAP net income is contained in yesterday's press release, which is available in the Investor Relations section of our website at www.franklinstreetproperties.com. Now I'll turn the call over to John. John?

Thank you, Scott, and good afternoon, everyone.

On today's call, I'll begin with a brief overview of our second-quarter results and afterward, our CEO, George Carter, will discuss our performance in more detail and provide some guidance. John Donahue, our President of the asset management team, will then discuss recent leasing activities, and then Jeff Carter, our President and CIO, will discuss our investment and disposition activities. And after that, we'll be happy to take your questions.

As a reminder, our comments today will refer to our earnings release supplemental package in the 10-Q, all of which were filed yesterday and, as Scott mentioned, can be found on our website. I also wanted to point out that we made some changes to the format of our earnings release this quarter that we hope you find to be more informative than what we did before.

We reported funds from operations, or FFO, of $26.7 million for the second quarter of 2016, and $52.8 million for the six months ended June 30, 2016. On a per-share basis, these results matched our second quarter and year-to-date from 2015. On a dollar basis, we were slightly lower in 2016 compared to 2015. It was only about a -- on a six-month number about $100,000 decrease but the FFO decrease was primarily from the impact of asset sales and loan repayments that we've received in the last year and was partially offset by the acquisition of a property we acquired in April of 2015 and another property that we acquired at the beginning of June 2016, June 6. So for the quarter -- second quarter of 2016, our FFO per share was $0.27 and that was in line with our expectation.

Turning to our balance sheet and current financial position at June 30, 2016, we had about $930 million of unsecured debt outstanding, and our total market cap was $2.2 billion. Our debt-to-total-market-cap ratio was 43.1% at quarter's end, and our debt service coverage ratio was about 5 times. The debt-to-adjusted-EBITDA ratio was 7.2 times at June 30, although if you adjust for the property we acquired on June 6, it would be 7.1.

From a liquidity standpoint, we had a cash balance of $7.5 million, and $190 million available on our $500 million unsecured line of credit. So we had liquidity of about $198 million at quarter end.

Last week, we closed on an extension of our unsecured $400 million term loan and placed a forward swap that fixes LIBOR at 1.12% from September of 2017 to the new maturity date in September 2021. Our spread at our current investment grade rating is 1.45%, so the all-in rate would be 2.57% and would start at the end of September of 2017. We think moving a $400 million maturity out of 2017 and into 2021 clears uncertainty around debt maturity and fixes our interest costs for some period of time. We were also very happy to work with our bank group on this transaction.

We remain comfortable with our leverage and have managed our unsecured debt as part of our strategy. We can opportunistically sell some noncore assets and reinvest proceeds into properties like Plaza Seven. We continue to focus on acquisition of assets in our core markets as we find the right opportunities.

With that, I'll turn the call over to George. George?

Thank you, John, and welcome, everyone, to Franklin Street Properties' second quarter 2016 earnings call.

As John said, for the second quarter of 2016, FSP's funds from operations, or FFO, totaled approximately $26.7 million or $0.27 per share. These results are very close to our guidance range for the second quarter of 2016. Our dividend was $0.19 per share for the quarter, and the FSP Board of Directors continues to feel very comfortable with that level of dividend payout for a full year 2016.

At this time, our initial FFO guidance for full-year 2016 is being narrowed to an estimated range of $1.03 to $1.06 per diluted share and, more importantly, we continue to believe that 2016 will mark the bottom of the reductive effects that our ongoing property portfolio transition is having on FFO. We are reiterating our forecast for resumed FFO growth in 2017, propelled primarily from our projected realization of select new property investments, select new developments or redevelopment efforts such as 801 Marquette Avenue in Minneapolis, and increased leasing in our more recently acquired urban office properties, many of which contain meaningful value-add square footage. Currently, prospective new tenant leasing activity at these properties is significant.

Finally, as we move through July, we are estimating third-quarter 2016 FFO to be in the range of $0.25 to $0.26 per diluted share.

With that, I will now turn the call over to John Donahue, President of our property management company. John.

Thank you, George. Good afternoon, everyone.

The FSP portfolio remains slightly above 90% leased at the end of the second quarter. Leasing velocity and volume increased in the second quarter as compared to the first quarter. Approximately 421,000 square feet were leased, bringing the year-to-date total to approximately 599,000 square feet. The quarter was highlighted by three significant renewals of approximately 273,000 square feet, two of which were scheduled to expire December 2016.

At Northwest Point in the Chicago suburbs, Citicorp renewed 146,000 square feet for 10 years. That lease was scheduled to expire December 2016. And at Timberlake Corporate Center in the St. Louis suburbs, Amdocs renewed 70,000 square feet for five years. That lease was also scheduled to expire in December. Also, at Meadow Point in Northern Virginia, American Systems renewed 57,000 square feet for 11 years. FSP is encouraged by the recent leasing activity in a number of our core markets, and we are optimistic about the next 18 months.

With that, I'll hand it over to Jeff.

Thanks, John. Good afternoon, everyone. I will discuss and update our current investment picture and strategy. On the disposition and asset recycling front during the second quarter, FSP sold our Lakeside Crossing I property in greater St. Louis for about $20.2 million.

Since 2014, we've sold properties or had mortgages repaid to us that we held of approximately $180 million through our portfolio repositioning program. This program has allowed us to recycle out of a number of noncore and more commodity-oriented properties and loans into a more focused urban infill portfolio within our core five markets. We believe that such efforts have positioned FSP to realize greater long-term FFO and profit growth. We will continue to keep the market up to date on any further disposition news during 2016.

On the acquisition front, on June 6, we added to our position in downtown Minneapolis with a 326,000 square foot acquisition of Plaza Seven office tower for $82 million or about $252 a foot. Additionally, and as mentioned in our earnings release, we're currently under purchase-and-sale agreement to acquire an urban infill Class A office property in the midtown submarket of Atlanta for $45.5 million.

We're very pleased to be working on adding more high-quality, Class A square footage to our already existing 620,000 square feet at 999 Peachtree in the dynamic and growing midtown submarket. The acquisition remains subject to closing conditions and confidentiality provisions, and so we will not provide full details at this time. If successful, though, we expect to close by the end of August and anticipate first full-year yields of about 6.7% on both a GAAP and a cash basis.

Subject to finding more credible value-creation acquisition opportunities and being able to able to match-fund them against any remaining dispositions, we will continue to evaluate more potential purchases.

On the development front, since our last quarterly call we've been working on final property specs at 801 Marquette in downtown Minneapolis with our architects and our development contractor. We expect interior demolition work to commence during this third quarter. We are seeking to transform 801 Marquette into a premiere quality asset that has a similar feel to a brick-and-timber style property that is in the core of downtown Minneapolis and that is intended to attract high-quality and creative tenant customers. Our total estimated costs, including all leasing expenses, are expected to be between $15 million and $20 million, and should result in about 120,000 square feet.

We also anticipate launching a full and formal marketing campaign with CB Richard Ellis during this third quarter that includes finalized project materials, which will further support the marketing efforts that have been underway. We expect to achieve rents in the $15 to $18 net range versus expiring rents at the property that were about $4.75 on a net basis. We expect the final project completion for 801 Marquette to occur during the first quarter of 2017.

In summary, the strategic investment focus at FSP is clear. Our primary emphasis is on sustainable FFO growth and value creation within the portfolio, and in particular within our five core markets. We believe that there are four key drivers to achieve these results.

The first driver is through leasing. The second driver is through select new investments. The third driver is through select new development and redevelopment efforts. And the fourth driver is through prudent balance-sheet management.

Now at this time, I'd like to turn the call back over to George Carter. George?

Thank you, Jeff, and everyone in Austin. We can open up the call for questions now.

We will now begin the question-and-answer session. (Operator Instructions) Dave Rodgers, Baird.

Good afternoon, guys. Jeff, thanks for your comments around the drivers going forward. I want to touch on leasing to start with. Can you talk about what the activity is across the portfolio right now? I think in the second quarter here you leased about 4% of the availability. Seems like that's going to need to step up in pace in order for you to drive the goals and achieve what you're trying to do. I don't know if you've got thoughts about maybe pushing the brokers harder or replacing some brokers, if you feel that you're happy with the performance. But if you could dive in on some of that, either Jeff or George, I'd love to hear some thoughts around that, please.

I'm going to actually have John Donahue start with that question.

Dave, happy to. The -- robust activity that we've been seeing is really in what we have been referring to as the Midwest region. So Minneapolis, Chicago, St. Louis are among our most active markets and we're expecting good news over the coming quarters there.

We also were encouraged over the past three months with better action than anticipated in Denver and Houston, a little surprising but that's true. We have witnessed increasing velocity volume towards proposals, et cetera, despite the typical summer slowdown.

We're cognizant of the energy headwinds and lower demand in some of these markets that are influenced by energy. But we were encouraged by the activity and are expecting good things over the coming quarters.

So asfar as details on what we're doing, every deal is different. We're attacking and pressing for all deals that are worthy appropriately. We're expecting that velocity for the vacant space to pick up.

Okay. Good. Yes, thanks for that color. Jeff, back to the investment side, new acquisitions. Sounds like you've been working actively on the pipeline. Can you talk about the depth of the pipeline that you have there in addition to the $45 million that you're under contract with in midtown Atlanta?

Sure, Dave. It's been, this year, particularly after the start of the first quarter, the pipeline activity just of what we're underwriting and looking at has increased. For us, it really has been centered upon just still very few things that we're seeing active in Houston, but the other markets have had a fair amount of opportunities in them both off- and on-market opportunities. So we have been active looking at things and had some success this year in June, obviously, with the Plaza Seven acquisition. And we're excited about adding new square footage into midtown with this acquisition we're working on currently.

So it's an active pipeline and, as I said in the -- early after the first quarter, at this stage still expecting to be a net acquirer for the year.

Last one for me, maybe two parts on really funding. You talked about balance-sheet management is an appropriate way to fund this. You're talking about being a net acquirer. So how do you fund the continued growth that's external here at this point? How to you think about that? And how comfortable are you -- the second question is how comfortable are you doing equity at this point?

We have talked about, over the last couple of years, this disposition/acquisition organic growth activity and trying to match off disposition proceeds with acquisition proceeds. And we have in the main had dispositions ahead of acquisitions and, consequently, that has been one of the factors that's hurt FFO growth a bit as you take that out before you replace it.

The midtown Atlanta deal that Jeff has talked about briefly and that we hope to close would actually be the first time in a while that we truly sort of bought forward of dispositions. So at the cornerstone of funding acquisitions, at the cornerstone is dispositions. And we feel very comfortable about match funding those without getting out over our skis at all. Again, there are some times where cash accumulates or dispositions accumulate before acquisition and then there are some times, like midtown, where you're buying ahead.

More than that, the broader capital markets are watched by us all the time. Certainly, the extension of our $400 million term loan was just the ability to go ahead and fix that rate for the foreseeable future so that we just didn't have to deal with that uncertainty. But new capital in any and all of its forms are just constantly being looked at relative to the capital markets and relative to our acquisition opportunities.

All right. Great. Thanks.

Kyle McGrady, Stifel.

Essentially over the last six years, you've jumped up from debt-to-total-enterprise value up to around from under 20% to somewhere in the mid-40s. You're now at a net-debt-to-EBITDA of seven times. The good news is you guys have borrowed short, which has turned out to be a very, very smart decision. The bad news is you are sort of bumping up against the outer limits of what people think is appropriate leverage. Is there a place at which you top out?

Then the second question is $12, $12.20, is a mid-six cap rate by our number, pretty healthy. How are you thinking about raising equity vis-a-vis your leverage constraints?

On the leverage equation, I looked at the last couple of years. When you think about the disposition and acquisition strategy, our leverage hasn't changed all that much when you go back -- you look at 2014, 2015 and 2016. We, I think, topped out at a high in the line of credit of about 316 and a low of about 265. And we just did an acquisition to sop up a lot of the proceeds from the asset sales that we've made previously, and ended the quarter at about 310. I think in the last three years our leverage has not moved that dramatically. So I wanted to point that out. And I think George wanted to talk about the other part of your question.

John, again, we watch the equity markets all the time and your point about price of equity and cost of capital relative to equity is right on and appropriate. And we watch all the time. One of the things that's happening now and over the next few months is we do have some properties that may, in fact, be sold and, again, we don't know that. But if those properties are sold and proceeds are applied against the line, which is exactly what we do, at least for an interim period of time, that ratio will drop. And having extra equity at that time without -- and this is the key -- without the appropriate investment acquisition opportunity to place that equity money in, in effect dropping the equity-to-debt ratio but acquiring assets that can grow and give you a positive greater return on that equity is just something that's abhorrent to us.

So we're trying to balance all of the things -- the disposition proceeds that may come, the opportunity and cost of capital for equity -- against, and this is the key thing, against the real acquisition opportunities that will over time give us a good return on that cost of capital. It is a balancing act but everything's on the table all the time.

Great. Thanks a lot.

Tom Lesnick, Capital One Securities.

Thanks for taking my questions. First, I just wanted to touch back on leasing. It looks like you guys executed early renewals at a handful of properties that are not in your core markets. As you look out to 2017, are there any additional re-leasing opportunities that we should be aware of any significance? Just looking at your supplement, it looks like maybe Murphy and Northrop Grumman are in there.

Yes, there are certainly other tenants that we are engaged with and will be having further discussions with on early renewals. And there are some tenants that have already departed. So we expect the third quarter of 2016 to be more heavily weighted towards new leasing versus what we saw for the first half of the year. And, as I mentioned, we've been seeing the robust activity in the Midwest region, and activity is also picking up in the other core markets as well.

So we don't talk specifically about tenants that we're in negotiations with but it is certainly possible that you'll see a few more renewals over the balance of the year, especially when it makes sense to renew those tenants early. But we'll see a heavier weighting, we believe, over the balance of the year on new leasing. Hopefully, that answered your question.

Yes, appreciate your candor there. One housekeeping question for me. To be clear on guidance, does that reflect core or reported FFO?

That would be reported FFO.

Reported FFO. Great. That's all I've got.

Craig Kucera, Wunderlich.

Good afternoon guys. When I look at your leasing trends, I appreciated the color. It appears that the REIT roll-off is slowing down a bit, at least from where we were a year or two ago when centers were up maybe a month, four months versus three months. You're paying more on leasing commissions and tenant improvements per square foot. Those things always shift around, but do you think this was more property-specific this quarter or were you maybe willing to push a little harder, to give a little bit more to get occupancy or is this more just where the market's going right now?

I think there's a number of factors in those numbers. I think the length of the term of the significant deals that we did had something to do with the concessions as compared to the first quarter or prior quarters. The average cost per year being in the $4 to $5 range seems just about right for most of our markets right now. And the rental rates have been bumping up and the IRRs have been very solid for the renewals that we've done. So I don't see anything that is not in tune with where things are. Concessions have, as you note, across the country have been going up over the last year or so, but thankfully the rental rates are in tune with that as well. Any other details that you're looking for?

No. I guess just trying to get some color on -- obviously occupancy is down and some of that's because you've sold fully occupied properties. Some of that's just you've lost the marketing I guess. Just trying to get a read on whether or not it was more market specific or kind of where things were at. But I think I'm good.

The second question is with Federal Way. That's a property that's been somewhat challenged from an occupancy perspective for some time. What was the -- why was the decision made this quarter to move that subsequent to the quarter to be potentially sold?

Federal Way -- we evaluate the portfolio every quarter and we make a determination when we think we have more value to add versus the cost of leasing versus the disposition. And we have decided on Federal Way that now is the time to, as we exit some noncore markets it's our only asset in that marketplace. Pricing across the country is strong. This is, well, technically greater Seattle really, the Tacoma Federal Way area, and we thought this was the right time to put that into the market and take those proceeds and reinvest into one of our core markets in a more urban infill-type property.

Okay. And I just wanted to follow up finally on the capital recycling. It sounds like you're going to be a new acquirer but outside of Federal Way it sounds like you have maybe soft circled some other properties that you may sell in order to match fund. Is that correct?

Exactly. We have more things that we're looking at and working on and I'll update at the end of the next quarter to see whether that shifts at all in that acquisition or that disposition. But we'll update.

Okay. Thanks very much.

(Operator Instructions) John Kim, BMO Capital Markets.

Thank you. I was wondering if you could provide some color on the $15 million to $20 million capital spend at 801 Marquette. How much of that is going to be spent on the lobby and common area? And is there any retail potential given the location next to the W?

Will Friend is in here. He is our Regional Director in charge of Minneapolis and Denver. I think he can give some better color on that.

The $15 million to $20 million all that includes, as Jeff's comments indicated, tenant improvements and leasing costs. But there will be some components of it that are dedicated to retail but the core of it will be office. We're really going after more either single-floor tenants or, hopefully, a whole-building tenant. So I don't have a cost allocation as to what goes to what component at this point but it's not going to be a -- it will be a mixed use and it will have a small component of retail but really more ancillary retail. Maybe a restaurant but nothing -- it's predominantly office.

Okay. So it sounds like it'd be sort of a minor reconfiguration of the asset, not a repositioning.

Yes, it's a minor reconfiguration of the bank building to include some retail on the first level and maybe the skyway level, which is in Minneapolis the traditional retail level. But it's really a repositioning or reconfiguration of the existing office building for more office, not a complete reconfiguration.

I may have missed this, but did you provide a development yield or IRR hurdle for it?

No, I have not provided an IRR or development yield but what we have provided is our prospective rental rate rage of $15 to $18 on a net basis on 120,000 square feet versus expiring rents from the previous tenant of about $4.75 on a net basis.

Okay. On the extension of the term facility, looks like you got a favorable rate on this, but did you explore the unsecured bond market? And where to you think you could price 10-year money today?

We looked at the public debt markets and we also looked at the private issuance markets, and the pricing on that was fairly wide compared to what we could do with our bank group. Particularly, the public debt markets were very wide. We looked at some transactions that occurred in the marketplace in the last few months and, although we're not a healthcare REIT -- well, I saw a couple of healthcare transactions go through it, very different interest rates. One went for about 5.25 on a 10-year and one went for, I think, 3.75.

We haven't issued public debt yet and as a first-time issuer we'd be asked to pay a higher rate. And looking at that and also risk-reward adjusted where we thought we'd be smarter to place debt, we thought we're better off going in the direction that we did. The loan is actually for -- the extended loan if you look at it in total is a little more than 5 years; it's about 5.2 years, taking us out to September of 2021. We thought that this was the best transaction for the Company and for the shareholders.

So in your estimate, do you think you would have raised north of 4%?

Yes, I think that's probably right.

Okay. And John, while I have you, I noticed you added hedge ineffectiveness into your core FFO this period.

Yes.

What is this in relation to? Is this out of money hedges?

No. It's -- I could give you a technical answer but I'd probably put you to sleep if I did. What it really is is a mark-to-market calculation that we're going to have to do going forward that'll never be settled in cash. We have in our credit agreements a definition of LIBOR that says if the interest rates in the United States go negative, the interest rate for purposes of the agreement would be zero. And that is what in accounting terms they call an embedded derivative, which has really not had any material value to it until this time.

But with the negative interest rate activity that's happened in the last few months, it rose to a level where we needed to record it. So each quarter I'm going to need to record to that but I'll never settle it in cash. When the swap matures, we'll just take the cumulative value of all of this and wipe it off the books. So where it's noncash, it didn't seem to make sense to me to include it in some of our metrics we provide like EBITDA, FFO and some other things that you'll see in the supplemental.

(multiple speakers)So it's a noncash deduction that you're adding back (multiple speakers).

Right.

Okay. Got it. All right. Thank you.

This concludes our question-and-answer session. I would like to turn the conference back over to George Carter for any closing remarks.

Thank you, everyone. Look forward to third-quarter call. Have a great day. And again, sorry for the delay on the earnings call. Thank you.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.