Franklin Street Properties Corp (FSP) 2016 Q3 法說會逐字稿

Good day, and welcome to the Franklin Street Properties Corp. third quarter 2016 results conference call. All participants will be 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. Please go ahead.

Good morning, and welcome to the Franklin Street Properties third quarter 2016 earnings call.

With me this morning 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 morning are Toby Daley, Senior Vice President and Regional Director of Atlanta and Houston; and Will Friend, Senior Vice President and Regional Director of Denver and Minneapolis.

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, October 26, 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.FspReit.com.

Now I'll turn the call over to John Demeritt. John?

Thank you, Scott, and good morning, everyone.

On today's call, I'll begin with a brief overview of our third quarter results. Afterward, our CEO, George Carter, will discuss our performance in more detail and provide some of his remarks. 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. After that, we'll be happy to take your questions.

As a reminder, our comments today will refer to our earnings release and our supplemental package in the 10-Q, all of which were filed yesterday and, as Scott mentioned, can be found on our website.

We reported funds from operations, or FFO, of $26.7 million or $0.26 per share for the third quarter of 2016, and $79.4 million or $0.78 per share for the 9 months ended September 30, 2016. Compared to 2015, our 2016 FFO is about $300,000 lower for the third quarter and about $400,000 lower for the 9-month period.

The FFO decrease was primarily from the impact of asset sales and loan repayments we've received during that time, and was partially offset by three acquisitions we've made, one on April 8 of 2015, June 6 of 2016, and lastly, this past August on the 10th, August 10th.

FFO on a per-share basis decreased $0.01 quarter-over-quarter for the third quarter and $0.02 year-to-date comparative due mostly to a higher share count than we have in 2016 compared to 2015. Our FFO per share of $0.26 for the third quarter was in line with our expectations.

Turning to our balance sheet and current financial position at September 30, 2016, we had about $898 million of unsecured debt outstanding, and our total market cap was $2.2 billion.

Our debt to total market cap ratio was 39.9% at quarter's end, and our debt service to coverage ratio was about 4.9 times.

The debt to adjusted EBITDA ratio decreased this quarter to 6.9 times as of September 30. So if you adjusted for the EBITDA from the property we acquired on August 10, it would be slightly lower than that.

From a liquidity standpoint, we had free cash balance of about $13.4 million at September 30, and $220 million in availability on our $500 million unsecured line. As a result, we had approximately $235 million of liquidity as of the end of the quarter.

We had a very busy third quarter with respect to capital activities. We closed on an extension of our $400 million term loan and placed a forward swap that fixes LIBOR at 1.12% for the forward period from September 2017 to the new maturity date of September 2021.

At our current spread of BAA3 rating with Moody's, it would be at 1.45% in the loan agreement currently. So the all-in rate would be 2.57% and would start at the end of September 2017. We think moving the $400 million maturity out of 2017 and into 2021 cleared some uncertainty around debt maturity and interest costs for us for some period of time.

We also were very busy with an equity offering we completed during our August raising, about $82.9 million in net proceeds. And we issued just over 7 million shares, including the overlap on that transaction.

We remain very 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 the properties as we've demonstrated. 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 to Franklin Street Properties' third quarter 2016 earnings call. As John just said, for the third quarter of 2016, FSP's funds from operations, or FFO, totaled approximately $26.7 million or $0.26 per share. These results are within our guidance range for the quarter.

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.

At this time, our FFO guidance for full-year and fourth quarter of 2016 is being adjusted to an estimated $1.03 and $0.24 per diluted share respectively. These adjustments to our FFO guidance primarily reflect the increased shares outstanding from our recent equity offering.

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 and beyond, propelled primarily from our projected realization of increased rental income from select new property investments, select new development or redevelopment efforts such as 801 Marquette, and additional leasing in our more recently acquired urban office properties, many of which contain meaningful value-add square footage. Prospective new tenant leasing activity at these properties remains strong.

We anticipate providing the market initial full year 2017 FFO guidance before year-end.

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

Thank you, George. Good morning, everyone.

The third quarter can be summarized as a continuation of the second quarter. There was positive momentum for new deals and we are encouraged by the solid activity, including tours and letters of intent.

FSP remains bullish on Minneapolis and Denver, which happen to be the same markets with our most significant upside due to the current vacancy. The upcoming transformation underway at 801 Marquette, Minneapolis, has been well received and is gaining momentum and serious interest.

Atlanta continues to be very consistent with steady activity and that market has the largest amount of rollover for FSP in the next 12 to 15 months.

Dallas incurred several expirations in Q3 and we are excited for that market to contribute to (inaudible) growth in the near future.

Houston has witnessed a slight pickup in touring action, which may be a sign that the energy sector is looking forward to 2017.

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

Thank you, John. Good morning, everyone. I will discuss and update our current investment picture and strategy. At first though, the strategic investment focus at FSP remains on building sustainable FFO growth and value creation within our portfolio, and in particular, within our five core markets.

And we continue to believe that there's three key drivers to achieve those results. The first is through select new investments. The second is through leasing and the third driver is through select new development and redevelopment efforts, such as those occurring at 801 Marquette in downtown Minneapolis.

On the disposition and asset recycling front during the third quarter, FSP continued our efforts to selectively dispose of noncore assets if appropriate pricing results. We're looking at currently, and working on at various stages, several potential dispositions, none of which are firm or hard on their deposit at this time; but that could result in up to $100 million-plus in gross proceeds over the coming quarters.

Again, it is uncertain and too early to say whether any or all of these respective transactions will occur, but we'll keep the market notified on any specifics if warranted. Also, FSP is currently identifying properties for potential disposition and our further properties for potential disposition in our portfolio, and we'll keep the market posted on that when warranted.

To date in 2016, FSP has disposed of approximately $58.19 million of assets -- Lakeside Crossing One in St. Louis in the second quarter for $20.19 million and the repayment of our first mortgage loan on 385 Interlocken during the first quarter for about $38 million.

Since 2014, we've sold properties or had mortgages that we held repaid to us of approximately $180 million through our repositioning program. This program has allowed us to recycle out of a number of noncore and more commodity-oriented properties and loans and into a more focused urban infill portfolio within our core five markets that we believe have stronger long-term FFO and profit growth upside.

On the acquisition front, on August 10, we added to our position in midtown Atlanta with the 160,000 square foot acquisition of Pershing Park Plaza for $45.5 million.

As a reminder on June 6, we added to our position in downtown Minneapolis with the 326,000 square foot acquisition of Plaza Seven for $82 million.

FSP is currently actively working on about $150 million worth of additional potential new urban and CBD acquisitions within our core markets. And it is too early to give any specifics on those or any assurance that any of them will transact, but we're working on those opportunities.

On the development front, we're continuing with our efforts at 801 Marquette to transform that property into a premiere quality asset with a similar experience to a brick-and-timber themed building. Interior demolition and construction work began during this past third quarter. We expect the project construction completion to occur at the end of the first quarter of 2017. We're expecting rents in the $15 to $18 net range versus previously expired rents of about $4.75 on a net basis.

Thank you for listening to our earnings conference call today. And now at this time, we'd like to open up the call for any questions.

Thank you. We will now begin the question-and-answer session. (Operator Instructions) John Guinee, Stifel.

I realize that raising the equity was probably a very smart move at the time that you did it. And we've got this inevitable short-term erosion of FFO. The scary part is, is that you can buy a limited amount of assets I think, given that your debt to total market cap is 40% and your debt to EBITDA is about 6.9 times. So you really, it appears to me, don't have a lot of FFO growth simply through acquisition.

Can you talk a little bit about, assuming no equity is raised in 2017, what the maximum acquisitions exceeding dispositions would be? And then talk a little bit more about this, it seems to me, a lot of lease rolls that are going to happen in 2017.

John, this is George. I think on the acquisition front, our view is acquisitions will match off against disposition proceeds, so that the transition from suburban to urban will continue. The timing differential there between disposition proceeds and acquisitions will vary. But I think you're exactly right, that sort of net [net] additional acquisitions over and above disposition proceeds are not likely.

The equity offering that raised that capital was earmarked for a couple of things, but the two major ones were the Pershing Park purchase in midtown, which we completed, but also capital to in fact complete the re development of Marquette and hopefully the successful leasing of Marquette, which will be, if we lease Marquette at the rates and goal that we have, will be actually very accretive to that equity compared to again what was there before we did the redevelopment.

So there is some -- as you said, some near-term dilution until when the new Marquette gets redeveloped and leased. But again, I think the matching of acquisition and disposition proceeds is where we go in 2017 and where we raise -- where we really raise the bar and where we really raise the -- get the FFO rising again. And we absolutely believe that we'll be in leasing space that we have in the portfolio.

And to that regard, let me just -- to the second part of your question, turn it over to John Donahue.

Thank you, George. John, as you probably have noticed, the bulk of the leasing activity over this year and last year have been predominantly renewals. And we have been chipping away with early renewals at the exposure in 2017. So there really are not too many significant hits in 2017, in fact for the next 15 months, Murphy Oil being the one exception, which is a known departure. And we're already seeing activity there.

So the combination of the remaining expirations in 2016, which include a bunch of month-to-month leases that we don't expect to go away, along with the expirations in 2017, is a little bit less than 9% of the portfolio. So we feel that that's very manageable and as you probably read and seen the bullet points, we're gaining momentum and encouraged by the activity. Hopefully that answers your question.

Okay. Do you think you'll end 2017 at a higher or lower occupancy than you have right now?

The absolute --

Because --

Yes, we would be absolutely expecting it to go up quarter-by-quarter. We will have the hit into the second quarter for Murphy, but we're expecting the 801 Marquette property to come on line near the end of the first quarter. We've got great activity, steady activity, in Atlanta, which has the bulk of the role in 2017. And on current vacancies in Minneapolis and Denver, we've had encouraging, increasing momentum.

In fact, for the quarter, we actually had slight net absorption in Denver, which is a great sign. We've improved those buildings with great amenities and we're looking forward to seeing the results.

So 801 receives the C-of-O, certificate of occupancy, in late 1Q, but my understanding is there's no leasing. So potentially, that's a 2018 income event.

The majority of it, yes, I would say that that's fully ramped up and contributing fully, but we are marketing and would hope that we would get ahead on the leasing and have some contribution in 2017 as well. And the rest of the TCF vacancy from that space in 121 South 8th as well. So we'll enjoy (inaudible) on the color of Minneapolis, but we've had great activity. So we would think that 2017 would have meaningful contribution in Minneapolis.

Great. Thank you.

Dave Rodgers, Baird.

Maybe I'll start with George and Jeff. I just want to talk about asset recycling a little bit more. You just look through the supplement and I think you get to 36 assets in total; 15, by your own definition, are kind of in that noncore bucket. You sold one asset in 2016 so far. You're in San Francisco, Seattle, markets that are pretty healthy or varieties of those markets.

What should we expect from asset recycling? What's the path and the plan here? Because as you talk about being kind of a neutral capital deployer, that seems to be the best source of your capital, but we really haven't seen that accelerate. So maybe you can dive into that a little bit.

Dave, this is Jeff. On the asset recycling front, we are -- we continue every quarter to look at our portfolio to determine which assets we think we've maximized value on already to test and see what the results are in the market. Right now, we're looking at and working on several potential dispositions that could total up to about $100 million. We're also identifying a couple of other assets that would be in excess of that for potential marketing in 2017.

And so for us, asset recycling is going to be a prominent part of our investment plan and the determination of which ones get sold and when will be a function and part of do we get pricing that matches, or as close to our expectations of value? Or is there more value that we think we can add to the properties?

But I do think that you'll see 2017 even through the end of this year, continue to see us focus on dispositions at the right moments. And we're going to identify the right assets at the right time to do that with.

And Jeff, you talked about $150 million of acquisitions of urban assets kind of in the pipeline right now. Obviously, you must have a pretty good comfort with some of those to kind of talk about them. Do you have the amount of assets to be able to put into the market and sell fairly quickly to fund that if you need to?

Yes, we do anticipate being able to fund acquisitions with dispositions. The timing, as George mentioned, of when exactly that occurs, is difficult to predict. But we do anticipate dispositions in 2017 and through the end of this year that would fund acquisitions.

Okay. Thanks. And then a couple of questions for John. John, in the quarter, the leasing economics that you achieved were a little bit lower than what you've been achieving. Was that a function of space, mix, location? Just curious on kind of what drove that. Are you trying to lease up some of the under-leased noncore assets to position for sale? Some color on that would be helpful.

Yes, sure. I think what you're looking at is probably the result of some early renewals in noncore markets. As you saw in our bullet points, we had a few deals that were in the Midwest that were noncore markets. The numbers that I'm looking at for comparing 2015 to 2016, we're seeing an increase in GAAP rents from expiring leases.

And the average cost of deals actually this year is slightly down versus last year, but it continues to be in the $4.25 to $4.50 range per year, which I think is on the low side for CBD urban assets, and I think is reflective of quite a few renewals in the noncore market suburban assets. So I would expect the cost to be trending closer to $5 a foot per year for TI leasing costs. I would expect the rents to be increasing.

I was looking at the most significant 23 leases that we've done year-to-date. And on a GAAP gross rent basis, those new rents compared to the expiring leases, are up approximately 8%. And on a net GAAP rent basis, those are up even more in the 13% to 14% range. So I think those trends are positive, and as you see more urban leasing, you'll see those rents -- the weighting towards urban properties, you'll see those rents increase. Hopefully that answers your question.

It did, and I'll just throw two more in there, very specific questions. One I think Burger King for 2018, do you have any color on that? And then can you dive a little bit more into 121 South 8th and kind of what you're seeing activity-wise for [backfill].

Sure. I'll tackle Burger King and then let Will Friend talk about Minneapolis. The Burger King space, as you probably have heard, is an expected departure. We have gotten out in front of it and we've had some rate credit tenant prospects for multiple floors.

Working with Burger King is proving a little bit challenging to try to arrange those tenants to take over and create a multi-tenant property, but the reception of that property has been really great. It's a beautiful building and just trying to get burger King out of the way and get started. So all things static, if there's no significant changes, we expect that property to do well.

Will, do you want to spend a little bit of time on 21 South?

Yes, sure. Good morning. We're seeing, as John said, activity in Minneapolis has been very good at 121. We're also seeing activity in tracking fields on 801 Marquette. And I think the two go hand-in-hand as 801 Marquette's development is moving along in the market has a better understanding of what's going to be happening right next door, or actually right in the lobby of 121 South 8th. We're starting to see more real activity and interest in the Tower Building or 121.

So we're tracking about 200,000 square feet of real active deals right now in the market that have expressed interest in 121, toward it, and we're working on a number of exchanging proposals on some of those. And some of those are looking at both projects. So I think all in all, we're really positive about the activity of the building. And as 801 progresses, I think it just bolsters the activity in the Tower as well.

Great. Thanks for all the answers, guys.

Tom Lesnick, Capital One Securities.

I guess first on 801 Marquette, assuming that it's going to take 60, 90 days for a TI buildout, what's kind of the internal deadline by which you guys would need to have a tenant in hand in order to hit that end of first quarter target?

This is John Donahue, Tom. The end of first quarter is when we expect the development to be completed. As far as the leasing effort goes, we're canvasing a wide range of prospects. And so whether that be a single tenant for the building or multiple type tenanted is unknown at this time. But it has been very well received. And so I'm expecting over the next few months, hopefully the next quarter, we'll have some news for you to share details.

Will, am I missing anything? Is there anything else that --

No, I think that answers the question. We are seeing increasing activity at the property. It is a construction site right now; it's not a building that a prospect can tour physically. So it's a lot of presentation of materials and what's coming. But so the activity is good, but as far as the timing of leasing, that's all to come.

We continue to work with prospects and market the property and we are delivering I think one of the most exciting projects in the market and with best-in-class amenities. And we're getting the commensurate reaction and response to that.

I appreciate that insight. And then I appreciate the color earlier on the disposition front. But regarding the acquisition strategy, given where we are at this point in the cycle, I have to imagine that the [lessor] market, bills are coming in at (inaudible) pricing. Especially in some of your more institutionally heavy markets like Atlanta, Dallas and Houston, are you guys seeing a lot of off-market deals come about? And was the Atlanta acquisition in 3Q off-market as well?

Hi, Tom, this is Jeff Carter. The Atlanta acquisition was a marketed deal. The acquisitions that we're working on right now, which comprise one or more deals in our five core markets that are similar to what you've seen us acquire this year in downtown Minneapolis and midtown are either CBD, urban deals, really in terrific locations.

We're looking at one or more deals that comprise a total of about $150 million and all of what we're looking at right now is off-market. Every property that we're looking at is off-market and so which is why I'm not going to give very much detail right now for competitive reasons and we're not under firm on any contract or anything with that.

So the deals we're looking at are off-market and we think have very similar characteristics to what you've seen us acquire this year and before this year, i.e., prices that are well below their estimated replacement costs, properties that have compelling value creation opportunities in the near, intermediate or longer term, depending on the asset; and properties that have good in-place intrinsics as well. So but they are off-market deals at this time.

Got it. Thank you. And then just one last one for me -- on the $0.24 guide for 4Q, I was a little confused, just given -- on the basis of that guide. The $1.03 for the full year makes complete sense, given the equity offering in 3Q.

But last quarter, I asked for clarification on whether guidance this quarter reported and you guys said it was on a recorded basis. And from that standpoint, it appears that consensus is mostly clustered around $0.26 and that's inclusive of the offering. So is there anything there that we're missing?

Tom, this is John. I think what may be missing is the effect of the offering in the fourth quarter. With other analysts' reports, I think if you look at where we were in the range, we reported in Q3, which was absent any of the capital activity we did in Q3, it numerically makes sense to come out where we did.

The full amount of shares outstanding for the fourth quarter would be the full 107 million we have close equity offering. So that would definitely impact the fourth quarter. Hopefully that answers the question for you.

Tom, this is George. I think again, the main effort from the offering was to put that equity into the rent-producing real estate. And a great part of that equity has not yet done that. That is really the Marquette property deal. It did pay down debt, but that -- when we do our projections, or our guidance, it is always guidance that is given without regard to capital market activity. And that includes major acquisitions, dispositions, and equity offerings or debt offerings.

So when those occur, then the former guidance does need to be adjusted. We haven't done an equity offering in a number of years and again, this deployment into rent division real estate has yet to occur for a large part of that equity offering. Hence, the lower fourth quarter.

No, I know, I fully understand and appreciate that. I was just confused between kind of full year consensus at $1.03 and 4Q consensus at around $0.26 and the 4Q guide coming in at $0.24. So I'll follow up offline, but I appreciate the insight. Thanks, guys.

(Operator Instructions) Craig Kucera, Wunderlich.

We had the big drop in occupancy at the Legacy Tennyson Center at -- I think that was Denbury, but can -- I know you said in the past that market has been pretty strong. Can you give some color on kind of how things are progressing there and how much down time you think you might have at that asset?

Yes, sure. Craig, it's John Donahue. So as you know, yes, you're right that that is primarily due to the Denbury expiration, a little over 100,000 square feet. We had mitigated that partially with one of the subtenants by leasing about a third of the building. So 60,000, 70,000 square feet roughly still remains to be leased.

That property was a single-tenant building and self-managed by Denbury, and so it's taking some time to take over the building which we did in the middle of the third quarter and put in some amenities, give it a bit of a facelift and get the leasing activity ramped up.

The summer slowdown due to the heat in Texas certainly was felt, but Dallas, as you know, is extremely strong. The Legacy market in general is one of the best submarkets in Dallas and so we're expecting that to yield great results. The early interest in the property again, some household names of some good credit tenants. And so just a matter of time, we believe, before we get that property restabilized.

Got it. And was the rent rolling off because that -- where was that relative to current market?

It's comparable. It was in the $17 net range as far as expiring rent and we're seeing rents in the core of Legacy between $23 and $27 net. So we think that property, which is not in the core of Legacy, just a little bit off-center [Rice], we certainly think that we can get in that $18 to $22 range net. So we would expect it to increase slightly.

Got it. And I just want to double-check. I appreciate the color on your lease rollover here over the next 12 to 15 months. Sounds like it's mostly Atlanta, but is that where the Murphy E&P building is located?

No, no, the Murphy building -- the Murphy lease is at Park Ten at Houston.

Got it. Okay. And what about the Houghton Mifflin's tentative space? Is that in Atlanta? Where is that located?

That's in the Chicago suburbs and we did a long-term renewal and a downsizing. We've had great reception there from the subtenants going direct, as well as activity for new tenants. So that is -- Evanston is a very small urban environment. And we have a great competitive advantage there, so we're expecting good things in short order there.

Okay. Thanks, guys.

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

Thank you, everyone, for tuning into our earnings call. We look forward to our next earnings call, for sure, and seeing many of you in Phoenix. Thank you.

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