Franklin Street Properties Corp. (FSP) Q4 2013 Earnings Report, Transcript and Summary

Good day, and welcome to the Franklin Street Properties Corp. Fourth Quarter 2013 Results Conference Call and Webcast. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Mr. Scott Carter, General Counsel. Please go ahead, sir.

Thanks. Good morning, and welcome to the Franklin Street Properties fourth quarter 2013 earnings call. With me this morning are George Carter, our Chief Executive Officer; John Demeritt, our Chief Financial Officer; Jeff Carter, our Chief Investment Officer; and Janet Notopoulos, President of FSP Property Management. Before I turn the call over to John, 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, 2013, which is on file with the SEC. In addition, these forward-looking statements represent the company's expectations only as of today, February 19, 2014. 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. I'll now turn the call over to John. John?

Thank you, Scott, and good morning, everyone. And welcome to our fourth quarter 2013 earnings call. On today's call, I will begin with a brief overview of the fourth quarter and full year 2013 results. After my remarks, our CEO, George Carter, will provide more detail on our operations and strategy as we look ahead to 2014. As a reminder, our comments today will refer to our earnings release, supplemental package and 10-K, all of which were filed yesterday and can be found on our website. For the fourth quarter, we reported FFO of $0.29 per share due to the 16% increase from the fourth quarter of 2012. The increase in FFO per share was driven by a 2.1% increase in same-store NOI and by the contribution from 5 acquisitions we completed since July of 2012. These benefits were partially offset by a decrease in interest income as a result of repayment of some of the secured loans we had made and also by slightly higher G&A costs. For full year 2013, FFO was $1.07 per share, which is a 10% increase from the prior year, which was $0.97 for the same reasons. I'd like to note that as of December 31, 2013, we modified our definition of FFO to more closely match the NAREIT definition and make our results more comparable to other REITs. We now include FFO from our nonconsolidated REIT investments rather than showing the dividend income received from them. FFO for Q4 this past year was $0.29 under both methods, so it would be the same under the new or the old definition. On an annual basis, the change results in higher reported FFO for Franklin Street of about $0.02 per share per year for the last few years, so each year is about $0.02 higher. So our year-to-year growth rate really wasn't changed significantly, maybe by a couple of decimal points. Please refer to page 12 and 13 of our earnings release for more detail on our FFO definition and also a schedule comparing results under the new definition compared to the prior definition. I'll now turn to our balance sheet and current financial position. At December 31, 2013, we had approximately $927 million of debt outstanding on our balance sheet, and a total market cap of about $2.1 billion. From a liquidity standpoint at quarter end, we had cash on hand of $19.6 million, and $194 million available on our $500 million unsecured credit facility for a total of $213.1 million of capital availability. Our debt-to-total market cap ratio was 43.6% at the end of the fourth quarter and our fixed charge coverage ratio is about 5.6x. 67% of our debt is at fixed rates and 33% floats. That's about $306 million in total on our balance sheet. We think that's a good number for us to work with to transact to buy assets or if we sell an asset, it gives us an opportunity to pay back some debt without having to pay a prepayment penalty or break a swap. All of our debt is unsecured and we believe it provides us maximum flexibility as we execute our operating and growth strategy. We remain comfortable with our current leverage and have ample dry powder, as well as additional capital leverage that we can pull to support our growth objectives as we enter 2014. Finally, I'd like to note for the first time, we are providing guidance for the coming year based on our current outlook. For the full year 2014, we anticipate FFO to be in the range of $1.08 to $1.12 per diluted share. Our guidance excludes the impact of future acquisitions, dispositions, debt financings or repayments or other capital events, and reflects estimates from our ongoing portfolio properties, other real estate investments we have, and G&A. The guidance is also based on our expectations from recent economic trends, which continue to provide a stable backdrop for our portfolio. We hope this helps you. That concludes my comments. And there will be some time for questions at the end. As a reminder, all of this information, including our supplemental, is available on our website and we're happy to answer your questions after George's remarks on the portfolio and results. Thanks for listening. George?

Thank you, John. Good morning, everyone, and thank you for taking the time to listen to Franklin Street Properties fourth quarter and full year 2013 earnings call. My remarks today will follow my written commentary in yesterday's earnings press release. After my comments, we will open the call for questions. For the fourth quarter of 2013, FSP's profits, as represented by FFO, totaled approximately $29.2 million, or $0.29 per share, an increase of approximately $1.6 million, or $0.01 per share compared to the third quarter of 2013. Dividend distributions for the fourth quarter of 2013 were approximately $19 million, or $0.19 per share. For the full year 2013, FSP's profits, as represented by FFO, totaled approximately $100.8 million, or $1.07 per share, an increase of approximately $20.5 million, or $0.10 per share compared to full year 2012. Our increase in year-over-year FFO per fully diluted share for 2013 was approximately 10.3%, one of the highest in the office REIT sector and continues our strong FFO per share growth performance of approximately 9% in 2012 and 6% in 2011. Our total growth in FFO per fully diluted share for the 3-year period of 2011, '12 and '13, totaled approximately 27.4% and is one of the highest aggregate 3-year growth rates in the office REIT sector. Our total FFO has grown 51.1% over the last 3 years, from $66.7 million to $100.8 million. As we begin 2014, we are for the first time providing FFO guidance. And as John has said, our FFO guidance for 2014 is in the range of $1.08 to $1.12 per fully diluted share. However, this guidance excludes the impact of future acquisitions, dispositions, debt financings or repayments or other capital market transactions and we do plan to update our guidance quarterly in our earnings releases. We are optimistic about potential growth prospects during 2014, producing FFO meaningfully higher than 2013 by continuing our organic same-store growth, which totaled about 2.1% in 2013, as well as through additional property acquisitions, which totaled about $560 million in 2013. We have a relatively small amount of tenant lease rollovers scheduled during 2014 and our core markets rental metrics continue to meaningfully improve. Over the last 5 years, we have positioned about 70% of our total office square footage in markets that we have been in for a long time, but 5 of these markets, we believe, have real significant macroeconomic drivers that will take occupancies and rent levels over the next 10 years higher than average office markets in the U.S. We have acquired heavily in these 5 core markets for us, primarily in-fill and CBD properties over the last 5 years. Those markets are: Houston, Dallas, Denver, Atlanta and Minneapolis. We believe our balance sheet is in excellent shape with no property-secured debt and no preferred stock outstanding. This gives us a lot of property portfolio flexibility, along with an approximately 5.6x total fixed charge debt service coverage ratio, one of the highest in the office REIT sector. Over the last 3 years, our total market capitalization has grown 46.9%, from $1.4 billion to $2.1 billion. Our directly-owned real estate portfolio of 39 properties, totaling approximately 9.7 million square feet, was approximately 94.1% leased as of December 31, 2013, up from approximately 93.8% leased at the end of the third quarter of 2013. Our property portfolio of primarily urban infill office assets has relatively modest lease expirations during 2014, which we have continued to proactively reduce. As of year-end 2013, only 5.6% of our commercial square footage is scheduled to expire in 2014. As of the end of the third quarter of 2013, most of the tenant improvement expenditures and leasing costs incurred over the last 3 years to help reach our current occupancy levels have been paid, and we expect future capital expenditures to continue to moderate in relation to the level of rental revenues being achieved. While there were no new property acquisitions made in the fourth quarter of 2013, there were 2 property dispositions completed. First, one of our single-asset REIT affiliates, FSP 505 Waterford Corp., sold its 13-story, 256,000-square foot office property in Plymouth, Minnesota for $33 million. FSP's first mortgage loan of $2.35 million was repaid in full. The second disposition was our Richardson, Texas, 2-story, 122,000 square foot office property known as 1410 East Renner. We sold that property for $12.5 million, on which we recognized a $2.2 million gain. We anticipate further disposition and acquisition activity during 2014. As 2014 begins, FSP will focus on continuing its profit growth by increasing occupancy and rents on its portfolio of properties, while pursuing the acquisition of additional real estate investments that have the potential to add to those profits. We are very optimistic about our prospects for continued strong growth during 2014 and beyond. With those comments complete, I will open the call for questions.

[Operator Instructions] And our first question will come from John Guinee of Stifel. John W. Guinee - Stifel, Nicolaus & Company, Incorporated, Research Division: John Guinee here. As you know, a lot of your FFO growth as of late has been from leveraging up and calling the debt markets correctly, leveraging up with some shorter duration debt. How much more leverage do you have factored into the equation? And will you continue to be relatively short in your debt duration?

John, this is George. In terms of guidance, we do not have more debt factored into the equation. Because guidance does exclude new acquisitions, dispositions, et cetera. So we're really looking at the existing portfolio as it stands. And that includes the debt as it stands. John Demeritt sort of gave you the view that we have of the revolver portion or floating-rate portion of our debt. Again, 67% is fixed, the rest is floating. For us, again on dispositions and acquisitions, back and forth with that flow, that amount of revolver seems appropriate to us and we are likely to keep that. But I think the bigger picture is one that, if you give me a little moment here, probably is worth explaining. And to look at the bigger picture, you have to go back to 2007, 2008, the financial crisis and subsequent recession. At that time, 2008, 2007, FSP, unlike many other real estate companies, had no debt, and that was the good news. And we had planned that. We did not plan or foresee the financial crisis portion, but we did think pricing was getting high and we thought leverage was getting high and we stayed on leverage, and that was really good news for us. The bad news for us in 2007 and '08, is that we had a profit source from our investment banking business that basically went away, investment banking all over the country shut down and ours was no exception. Ultimately, we exited that business. And the other piece of bad news is that we had a lot of lease rollover in the worst part of that recession. So the strategic business plan that flowed from 2007 and 2008 was to use our balance sheet and some new equity, which was, as you know, we've done; to acquire properties at hopefully, the bottom of the cycle; not to retire debt, we didn't have debt to retire; and to use capital to lease vacancies. So -- and again, not to retire debt. So we're acquiring and releasing vacancy, and that was the strategic business plan. So as you -- if you think about the rest of the world then, most people were raising capital then of various types to deal with their existing debt. We were raising capital to acquire and to lease space because of our large tenant rollover during that period of time. And so we started with a revolver. We then termed out a 5-year piece, we then termed out a 7-year piece. And the plan had always been that before we kept terming out to 10 years and went to the public or private markets, that if we could get our total market capitalization up around that $2 billion level, which we have done, then we would consider the possibility of going to the credit agencies and looking into getting a credit rating and if we could do that, accessing the 10-year markets would be less costly, both in terms of rate and in terms of covenants. And that's -- it's still the plan. At the core of it, John, is a view of this cycle, if you want to call it that, which may be right or wrong or somewhere in between, but everybody has to have a view. And our view of this cycle is that it is going to be on the upside here, a very long, slow growth cycle. And that there are some structural issues in the economy and in the demographics of our country, which probably prevents a high runaway inflation early on, which tends to be -- which tends to occur -- in the past has occurred primarily because of employment supply/demand imbalances. Structural issues like age of the population on consumption and technology. Again, demographics and technology are big, but this -- and government regulation and a lot of other things. If we're right about this slow cycle and Janet Yellen doesn't turn into Paul Volcker overnight, then we probably have some time to do just what we're doing and save a lot of interest money, which will help us acquire properties in this low part of the cycle, which -- I think it will pay dividends long haul. So we're -- we get it -- I mean, you don't borrow short to loan long. But again, from where we were coming from, from no debt, this makes a lot of sense to us. And we view the next tranche of debt, which is likely to be longer term, 10-year, and hopefully with a credit rating, we do keep that debt. And again, not to retire the floating rate or revolver portion, but to help with acquisition work and to continue to grow. We've been able to acquire and grow and be accretive on our FFO per fully diluted share, even with equity offerings in the very year that we've done them and we would anticipate that continuing to be our objective. I know it's a long-winded, and I'm sorry for being long-winded, but it is the context with which we think. John W. Guinee - Stifel, Nicolaus & Company, Incorporated, Research Division: Okay. Great summary. Let me just be a little more specific. Right now, you're at about 43% debt-to-total-enterprise value. Is that something you'll push up much higher? One. Two, if you won't and you grow, would you anticipate an equity offering? And then three, do you look at acquisitions matching dispositions, or exceeding dispositions in 2014?

John, this is John Demeritt. I think that is dependent on a lot of factors that are really kind of hard to press or predict right now. One is, our share price is not where we'd like it to be. The share price came down pretty significantly when there was a lot of talk about tapering. And the 10-year went up over 3%. I looked this morning and it broke 2.7% this morning, it's headed downwards. So some of the threat of that seems to have dissipated. I don't think we have a problem raising capital with the bankers that we are associated with and the lenders that we're associated with. With the right assets in hand to make acquisitions. And so I think you have sort of a number of factors you need to think about: Assets that you want to acquire, access to capital markets and where the pricing makes sense, but you're accretive to the shareholder. So we need to think about all those things before we move to the next steps. And right now, it's a little bit foggy. And given where our share price is and the debt level being high, where our next steps are, but also what assets that Jeff might be able to find for us to acquire.

And this is George, John. I think the sort of very specific answer to your question is we do not anticipate any sustainable, sustainable is the right word, higher percentage leverage on the company portfolio. What is happening is some potential dispositions, x any, as John said, x any access to the capital markets or stock or anything, dispositions of existing properties in the portfolio, that we might want to upgrade. And there are a couple of candidates for that this year. And that money is recyclable, obviously, money, which you hope to do better on the recycle side. And the other is some of the single-asset REITs are -- have been looking to dispose of their assets. And if they decide to dispose of their assets, we have some loans against that and that capital comes back, and we think we can redeploy that capital into new acquisition, potentially. So there's internal capital that can be generated x outside capital. But to be very specific to your question, debt-to-equity ratios, we do not anticipate rising significantly more than they are, at least on a sustainable level.

And our next question comes from Josh Patinkin of BMO Capital.

Looking at guidance, if I look at the fourth quarter and back out the disposition and the loan repayment, I get to about $0.28 a share for the fourth quarter. So annualized, about $1.12, which is the high end of your guidance range. So I'm trying to bridge that and understand what's baked in and what you're thinking about in terms of portfolio operating metrics?

This is John, Josh. Good to hear from you, good question. This is our first time we've worked on guidance. So this is a bit new to us. We were concerned about the downside of some of the things that could happen. We think about G&A expenses, interest rates and those sort of things when we thought about the range, and we wanted to give a $0.04 range so that we could update quarterly during the year to see how we did. So I understand your math and a run rate of $0.28 would be in that vicinity, so we thought about that when we gave the range and wanted to make sure that we covered ourselves appropriately when we put out the guidance. We can't -- we hope we're going to do better than that, honestly, depending on what we can do with growth, but we didn't want to have guidance included that. So...

Okay. And if I understood correctly, it doesn't include any capital events? There's about $85 million in loans to the REIT affiliates that are maturing this year. And so how are you managing that in guidance as they come -- as they expire, I think throughout 2014, ratably?

I think those are factored into -- I think those loans were repaid fairly late in the game, so I don't think they had a significant impact on the guidance.

I mean in 2014 loans to the REIT affiliates that will be burning off. Do you assume that you'll renew those at the current interest rates, or do you assume that those will get repaid in full?

Yes. This is George, Josh. We assume effectively, a renewal. Now Josh, just on those tones [ph] -- but as I said, when John was on the -- John Guinee from Stifel was on the call, some of the single-asset REIT affiliates that have those loans are considering potentially selling their properties during 2014. So again from a modeling point of view, you sort of model those as simply renewing. But the reality is that there very well could be transactions, which hand us back those loans, and then of course, it would be the reinvestment of those loans that would go into new modeling, again, which we would update quarterly.

Josh, those -- the bigger loans that are coming due are at 85 Interlaken and Energy Tower, those are on our 10-K and both of those properties are in very good markets and have good stories attached to them. We, of course, don't make the decision when those assets get sold. We might recommend to the shareholders that they sell it, so we can't say for sure we're going to liquidate them, but those would be 2 very good candidates.

Okay. And those 2 assets in particular are well-stabilized, so we could assume they could access the debt markets at more favorable pricing relative to the debt FSP has extended them?

They could definitely access the debt markets and take us out. Whether the terms would be more favorable would depend on what kind of loan they went after -- length and all of that sort of thing, terms.

[Operator Instructions] And our next question will come from Dave Rodgers at Baird. David B. Rodgers - Robert W. Baird & Co. Incorporated, Research Division: Maybe George, a question for you on the acquisition side. I think you've mentioned a couple of times that you'd like to stay active and remain so. In recent years, I think Denver, central perimeter, you've been very active and made some very good buys. What do you see as the opportunity for FSP today? I think that you talked about kind of distress in the 2008, '09, '10 time frame, most of that's kind of gone away. But what is it you're seeing, what opportunities to be out there, existing or new markets and any color, both quantitatively and qualitatively, that you can provide would be great.

David, this is Jeff Carter speaking. I'll give you a good sense what we're seeing out there. We've got an extremely healthy pipeline at the moment of deals that are either on the market currently, off the market or coming to the market. Right now, that total is in excess of $1 billion, actually closer to $1.5 billion, and those are primarily in our 5 core markets that we've been discussing, and George mentioned today, Atlanta, Denver, Minneapolis, Houston and Dallas. The breakdown of assets that I'm looking at is probably roughly 40% off market and 60% either on market or coming to market. And of the assets that I'm looking at, the profiles are very similar from what you've seen us acquiring since 2012. A mixture of value-add, last mile value-add or last miles value-add, as well as more stabilized assets that are below replacement costs, hopefully, and have in-place rents that are below current markets, in markets that we see growth potential in, such as those 5 core markets. The profiles of the assets are urban infill and/or CBD-quality assets, just as we've been acquiring. I would -- of the mix that I'm looking at, probably roughly 20% is in Atlanta, roughly 25% in Minneapolis, about 30% in Houston and 15% or so in Dallas and they are a really attractive pipeline at the moment. None of which are under contract, but we're working and working on large pipeline right now. David B. Rodgers - Robert W. Baird & Co. Incorporated, Research Division: Without singling anything out, Jeff, maybe how do these assets compare to your view of replacement costs? Are there still a decent amount of discounts out there? Are they getting tighter and how comfortable are you with being aggressive with these assets?

The pipeline has actually expanded for Franklin Street recently over what it had been in the previous years. So the activity I'm seeing is excellent, and a lot of it continues to stem from relationships that we've successfully built via past acquisitions. And so the profile of the deals is similar and the flow is similar. It's an aggressive market out there. There still are opportunities to block [ph] -- to buy deals below replacement cost that have upside stories, and that will continue to be our focus. David B. Rodgers - Robert W. Baird & Co. Incorporated, Research Division: And maybe a question for Janet on some of the leases that are coming due. I think in the next 12 months, you have RGA insurance, and then the U.S. government, I think, has 40,000 square feet coming up for renewal this year. Do you have any clarity on those 2 leases in particular? And then I guess, maybe some broader comments on retention in 2014 and an expected leasing spread?

I think on the GSA -- the GSA is the GSA and we were talking to them, we don't have any real reason to think that they're going anywhere, but we don't have any signed leases. RGA, I think, the press has pretty much indicated where they're going. We're feeling pretty good about positioning the building for replacing RGA. We just did a big lease in St. Louis, so we think that's a recovered or recovering market. And I think that in general, in our core markets that we focused on, I think that we really are seeing organic growth in the sense that we have tenants expanding and standing ready to take some of the vacancy as it comes up and we're pretty optimistic about how we're doing on leasing. Does that answer your question? David B. Rodgers - Robert W. Baird & Co. Incorporated, Research Division: And I guess any commentary on rates. I think in the past you've talked about how the portfolio is now, or the market has moved above the portfolio, you expect its spreads to generally be positive. Is that consistent with your expectation for 2014 as well?

Yes, with the caveat, as always, that we have different markets. Houston is racing way ahead of our existing rents and others are coming up above existing rents at a slower pace and then we have a few that are -- that still drag a little bit, but those aren't our core markets. David B. Rodgers - Robert W. Baird & Co. Incorporated, Research Division: Final question, stick with you, Janet, for a minute. I think you had a very good leasing quarter in the fourth quarter from what we could tell in terms of new leasing. I'm assuming most of the leases didn't commence in the fourth quarter. Do you have kind of the commencement schedule over the next 2 or 3 quarters, kind of known move-ins of any size that we should be aware of?

[indiscernible]

I can get part of that question. I think a lot of those leases have commenced. If you look at Page 26 of the supplemental, we do put on there, I think, 60,000 or 70,000 square feet of leasing commences in '14. I don't remember specifically, what...

Yes, there is a data point in one of the [indiscernible].

Yes, but it's about 60,000 or 70,000 square feet has not commenced yet.

So that spread between leased and occupied, it's shrinking.

Yes.

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

I'd just like to thank you all for tuning in to the earnings call. I very much look forward to the coming year and next quarter's call. Thank you, have a great day.

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