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Edited Transcript of FSP earnings conference call or presentation 14-Feb-18 3:00pm GMT

Q4 2017 Franklin Street Properties Corp Earnings Call

WAKEFIELD Feb 14, 2018 (Thomson StreetEvents) -- Edited Transcript of Franklin Street Properties Corp earnings conference call or presentation Wednesday, February 14, 2018 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* George John Carter

Franklin Street Properties Corp. - CEO & Chairman

* Jeffrey B. Carter

FSP 50 South Tenth Street Corp. - VP and Director

* John F. Donahue

Franklin Street Properties Corp. - EVP

* John G. Demeritt

Franklin Street Properties Corp. - Executive VP, CFO & Treasurer

* Scott H. Carter

Franklin Street Properties Corp. - Executive VP, General Counsel & Secretary

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Conference Call Participants

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* David Bryan Rodgers

Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst

* John W. Guinee

Stifel, Nicolaus & Company, Incorporated, Research Division - MD

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Presentation

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Operator [1]

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Good morning, and welcome to the Franklin Street Properties Corp. Fourth Quarter and Full Year 2017 Results Conference Call.

(Operator Instructions)

Please note that the event is being recorded.

I would now like to turn the conference over to Scott Carter. Please go ahead.

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Scott H. Carter, Franklin Street Properties Corp. - Executive VP, General Counsel & Secretary [2]

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Good morning, and welcome to the Franklin Street Properties Fourth Quarter and Full Year 2017 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; Will Friend, Senior Vice President and Regional Director of Denver and Minneapolis; 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, 2017, which is on file with the SEC.

In addition, these forward-looking statements represent the company's expectations only as of today, February 14, 2018. While the company may elect to update these forward-looking statements, it specifically disclaims any obligation to do so. Any forward-looking statement 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?

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John G. Demeritt, Franklin Street Properties Corp. - Executive VP, CFO & Treasurer [3]

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Thank you, Scott, and good morning, everyone. On today's call, I'll begin with a brief overview of our fourth quarter and year-end results. And afterwards, our CEO, George Carter, will discuss our performance in more detail and provide some of his remarks. John Donahue, our President of Asset -- 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 questions.

As a reminder, our comments today will refer to our earnings release supplemental package and 10-K, which were filed with the SEC last night and, as Scott mentioned, can be found on our website.

We reported funds from operations, or FFO, of $26.3 million or $0.25 per share for the fourth quarter of 2017 and $111.4 million or $1.04 per share for the full year ended December 31, '17. Compared to the full year of 2016, FFO was about $5.1 million higher and a $0.01 per share higher based on our weighted average share this year.

Turning to our balance sheet. At December 31, 2017, we had just over $1 billion of unsecured debt outstanding, and our debt service coverage ratio was about 3.9x. From a liquidity standpoint, we had $522 million available on our revolver and about $10 million in cash on our balance sheet or total liquidity of about $532 million at year-end.

During the fourth quarter, we recast our bank debt and completed our inaugural issuance of a private placement of debt. We also had our investment-grade rating reaffirmed during Q4. The debt transactions we completed addressed near-term maturities and created a better debt stack for FSP. With the debt stack more termed out, we believe we have aligned our capital structure with the more long-term value-add properties that we have on our 5 core markets.

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

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George John Carter, Franklin Street Properties Corp. - CEO & Chairman [4]

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Thank you, John, and welcome, everyone, to Franklin Street Properties Fourth Quarter Full Year 2017 Earnings Call. As John said, for the fourth quarter of 2017, FSP's funds from operations, or FFO, totaled approximately $26.3 million or $0.25 per share. For the full year 2017, FSP's FFO totaled approximately $111.4 million or $1.04 per share.

During the fourth quarter of 2017, FSP took advantage of a flattening yield curve and lengthened the average maturity of its debt stack as the Federal Reserve continued to move up shorter-term interest rates. In the process, the company fixed interest rates on over 78% of its total debt, while increasing its line of credit availability to about $522 million at December 31, 2017, from $220 million at December 31, 2016, a year-over-year increase of over $300 million in liquidity. These actions culminated with the closing of our first-ever private placement of senior notes on December 20, 2017, and moved our weighted average debt maturity to approximately 4.5 years from 2.6 years.

We estimate the weighted average interest rate on our debt will increase to 3.7% for 2018 from a weighted average interest rate of approximately 3% in 2017, and that assumes the effect of the one fed fund rate increase in December, which has already happened and then 3 anticipated fed fund rate increases in 2018.

As we began 2018, our fixed-rate debt as a percentage of total debt is 78%, which is up from a weighted average of 59% in 2017. While this balance sheet action and anticipated fed fund increases will result in an estimated increased borrowing cost of about $7 million in 2018, it provides better matching of longer-term fixed cost capital characteristics with the longer-lived office assets we now own. At the same time, this action helps to reduce rising interest rate risk and other potential capital market disruptions. Over the past several years, our portfolio transition efforts have resulted in positioning a significant portion of our office properties square footage into more urban and infill locations, resulting in about 78% of our portfolio now being located within our 5 core markets of Atlanta, Dallas, Denver, Houston and Minneapolis. As of year-end 2017, the company's portfolio of 34 office properties totaling approximately 9.8 million square feet was 89.7% leased, up from 88.7% leased as of the end of the third quarter of 2017. FSP leased more square footage in the last 2 quarters of 2017 than in any 6-month period in its history.

As 2018 begins, we are continuing to see the increased leasing momentum we experienced in the third and fourth quarters of 2017 and consequently are optimistic about the potential for improved occupancy during the course of the year. The energy-sensitive markets of Houston and Denver that have struggled over the last few years now appear to be stabilizing. When combined with broader value-add opportunities at many of our recently acquired urban-infill properties, we believe this trend should contribute to more positive leasing outcomes in 2018 and 2019.

The transition of FSP's property portfolio from a suburban to a primarily urban orientation has generally resulted in higher leasing costs per square foot in exchange for longer leases and higher rents. With the anticipation of continued strong leasing of vacant space during 2018, we believe our net operating income, or NOI, from existing properties will continue to increase. While we can't be sure what our leasing volume and leasing costs will be in 2018 and in 2019, our objective is to reach 92% to 94% stabilized occupancy in our property portfolio. FSP is in a stronger financial position with more readily available liquidity than ever before to help it reach that objective.

At this time, we are initiating our full year FFO guidance for 2018, which is estimated to be in the range of $0.96 to $1 per basic diluted share. Compared to our 2017 FFO per share, we estimate an approximately $0.07 per share reduction will be a result of projected rising interest rates in the fourth quarter reset of our debt stack toward a higher percentage of longer-term fixed-rate debt and an additional approximately $0.02 per share reduction is a result of the sale of our East Baltimore property in the fourth quarter, the proceeds of which have not been reinvested in any new properties.

With those comments, let me turn the call over now to John Donahue, President of our Property Management Company, to give some updates on leasing and the property portfolio. John?

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John F. Donahue, Franklin Street Properties Corp. - EVP [5]

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Thank you, George. Good morning, everyone. At the end of the fourth quarter, the FSP portfolio was 89.7% leased, which represents a 1% increase compared to the 88.7% leased at the end of the third quarter. As of year-end 2016, the portfolio was 89.3% leased. As expected, the portfolio lease occupancy improved during 2017.

As forecasted, the surge in leasing momentum that we experienced in the third quarter carried over into the fourth quarter. The total leasing activity for the year finished at the high end of our projections at 1.47 million square feet with nearly 1 million square feet executed in the second half of 2017. The 6 months and 12 months of total leasing represent new highs for FSP.

During 2017, the best-performing core markets for FSP were Dallas, Denver and Minneapolis. Denver, our largest core market, improved over the past 12 months from 87% leased to approximately 90% leased with 4 straight quarters of increasing leased occupancy. Our Denver portfolio is now in a 3-year high for leased occupancy. Dallas continued to be the hottest core market jumping from 90% to 96% leased during the year. Minneapolis also improved significantly from 79% leased to approximately 90% leased. This excludes the redevelopment of 801 Marquette. There's still quite a bit of upside remaining in our core portfolio, especially in Houston at 76% leased, Atlanta at 84% leased and in Minneapolis.

We expect 3 of the 5 core markets to be in a range of 90% to 95% leased within the next 6 to 9 months. As we look out farther for the next 2 years in calendar 2018 and into calendar 2019, we expect more net absorption from a higher percentage of new leasing, which is expected to drive the total portfolio occupancy to 92% and above.

With that, I will turn it over to Jeff Carter.

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Jeffrey B. Carter, FSP 50 South Tenth Street Corp. - VP and Director [6]

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Thank you, John. Good morning, everyone. Our focus at FSP is on long-term property NOI growth and value creation for our shareholders. FSP's property portfolio has continued its evolution and is now almost 80% located within our target markets. As John Donahue noted, FSP saw strong leasing trends during the second half of 2017, and we are optimistic that this can continue. As we look forward, our primary efforts will be focused on leasing and tapping into potential upside in our vacancies and primarily within our target markets.

On the disposition and asset recycling front, as part of our 5 target market urban-infill strategy, FSP has selectively explored potential dispositions of non-core properties when pricing and value maximization makes sense to do so. During calendar year 2017, FSP disposed of 3 non-core assets totaling approximately $48.1 million with 120 East Baltimore Street having been sold during the fourth quarter on October 20 for $31.6 million in net proceeds. Since 2014, we have sold properties or had mortgages repaid to us of approximately $230 million.

While we do not provide specific disposition guidance for competitive marketing reasons, there is the potential for a couple of situations that we're exploring for the second half of 2018. And if price discovery were to be positive and we will keep the market posted over the coming quarters with any appropriate updates. And the expectation here at FSP would be to use any disposition proceeds received to pay down debt and to work to reinvest into new investments.

On the acquisition and new investment front, FSP favors infill and urban properties within our targeted 5 markets that possess the ability to credibly have value added over the short to intermediate term. The acquisition's environment is highly competitive in our target markets. And while it is difficult to find credible value-creation opportunities, our 5 market focus is providing insights into opportunities that are both off and on market. With respect to any potential new investments, FSP would intend upon any such activity by utilizing the proceeds of any potential dispositions. We are not seeking to acquire for any increase in indebtedness.

With that, I'd like to thank you for listening to our earnings conference call today and at this time turn it over to Q&A. Operator?

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question comes from Dave Rodgers of Baird.

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David Bryan Rodgers, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [2]

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Yes. Maybe first question for John. Obviously, the leasing has picked up nicely during the last 2 quarters of '17. Curious if you can share with us. There's about 195,000 square feet of signed but not yet commenced leases, I think, which is embedded between your leased and occupied percentage. Can you talk about kind of what the timing of the commencement are or is on those leases?

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John F. Donahue, Franklin Street Properties Corp. - EVP [3]

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Dave, sure. They're spread out. There isn't a spike in any of the quarters. They'll be fairly evenly spread out over the first 3 quarters of the year. As you would expect, because so much of the leasing happened in the second half of the year, there'll be, on average, a 4- or 5-month lag of the commencement dates. So you'll see a pretty evenly spread out commencement over the first half of the year.

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David Bryan Rodgers, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [4]

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Okay. That's helpful. And then I guess with regard to maybe some of the upcoming expirations, as you look out into '18, any additional color, renewal or backfill opportunities on -- you got (inaudible) and U.S. government all looking for possible expirations this year?

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John F. Donahue, Franklin Street Properties Corp. - EVP [5]

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Yes, absolutely. So we have roughly 10.6% of the total portfolio expiring in 2018. There are 3 significant tenants expiring. The IRS with approximately 180,000 square feet has been engaged, and we expect them to renew, might be a slight downsizing. Burger King, 212,000 square feet or so, may hold over for a number of months. But they will eventually depart, either late in the year or early next year. That property Blue Lagoon in Miami is very well positioned. It will likely be multi-tenanted, but we're very excited about that property. Fannie Mae, 123,000 square feet or so, will depart early at Addison Circle in Dallas. We've already gotten a jump-start on that pre-leasing and we have great activity, might even have a lease or 2 signed before the Fannie Mae lease expires and as the Circle in Dallas have been -- continue to be very strong performers. So once you subtract those 3 tenants, our exposures down to about 5.3% and barring any surprises, we expect to renew approximately 60% to 70% of those tenants, which reduces our exposure further to about 2% of the portfolio. So we're feeling pretty good about that. And if our wave of surge of leasing continues, which we expect it to do, we think we'll be in great shape by midyear.

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David Bryan Rodgers, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [6]

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Great. And then throw in 801 Marquette into that, do you anticipate to have any physical occupancy or economic occupancy in 2018? Or will that mostly be kind of an early '19 event?

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John F. Donahue, Franklin Street Properties Corp. - EVP [7]

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We don't expect meaningful FFO in calendar 2018, but we're still holding out hope that we'll get a commencement in Q4, the lion's share that will slip into 2019.

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David Bryan Rodgers, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [8]

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Okay. Then lastly, if I could, George, maybe a question for you on the dividend. Obviously, you're targeting much higher occupancy rate over time. But just kind of given the rising cost of TIs that everybody is seeing in the office landscape given where the dividend coverage is today, do you really continue to see the opportunity to be able to cover that dividend even at a 93%, 94% occupancy level and selling non-core assets?

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George John Carter, Franklin Street Properties Corp. - CEO & Chairman [9]

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Yes, Dave. The FSP Board of Directors makes the decision on the amount of dividends to be paid each quarter and has not yet decided the dividend level for next quarter. But I can assure you, that along with all other factors that entered into their calculus for dividend levels, the CapEx associated with our anticipated increased level of leasing in 2018 and 2019 are being very focused on.

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Operator [10]

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(Operator Instructions) Our next question comes from John Guinee of Stifel.

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John W. Guinee, Stifel, Nicolaus & Company, Incorporated, Research Division - MD [11]

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John Carter, the way you phrased that answer was you, I think, said that your board was very, very focused on the escalating cost of CapEx, and you answered that when asked about the dividend, which sort of implies that for the first time in the 9 years I've been covering you that maybe the dividend cut might be on the table?

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George John Carter, Franklin Street Properties Corp. - CEO & Chairman [12]

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The answer is what I've given, John, and it's the answer that I want to stay with.

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John W. Guinee, Stifel, Nicolaus & Company, Incorporated, Research Division - MD [13]

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Okay. And then the second and this is maybe for John Demeritt, John D. It's kind of interesting that BofA has $522 million -- you have $522 million of more capacity. By my math, your debt to TEV is in the mid-50s. And if you -- if they were to fully -- you were to fully draw down that revolver, it would get up into the low 60s. I'm surprised BofA would extend you that significant of revolver. Any thoughts on that?

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John G. Demeritt, Franklin Street Properties Corp. - Executive VP, CFO & Treasurer [14]

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Well, I think -- I'm not sure how you calculate the TEV, John, but we work within covenants that have a sort of bank-defined leverage gap and we didn't come close to that. And that was talked out of using their definition at 60%, so the covenants worked out quite well. We have a bank group of 11 banks in total, and we worked really hard with them in October and prior to that to put those deals together and brought in a couple of big banks, too. So our group is pretty excited.

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John W. Guinee, Stifel, Nicolaus & Company, Incorporated, Research Division - MD [15]

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And then on the Burger King and the Fannie Mae move-outs, is this a rehab of the building and taking it out of service somewhere to 801 Marquette? Or is this just demising the floor place and releasing?

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John F. Donahue, Franklin Street Properties Corp. - EVP [16]

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Yes. Good morning, John. It's John Donahue. The -- neither one of the Burger King and Fannie Mae situations require significant repositioning of the property. Both buildings are late '90s or approximately 2000 vintage buildings in great shape and were built to accommodate multiple tenants. Addison Circle has been multi-tenanted from the get-go and so there won't be any significant capital there other than reworking those floors for either single or multiple occupants. And then Blue Lagoon has been a single-tenant building, and so there'll be some modifications required but nothing significant.

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Operator [17]

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

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George John Carter, Franklin Street Properties Corp. - CEO & Chairman [18]

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Thank you all for tuning into the conference call, earnings call. We look forward to next quarter. Thank you.

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Operator [19]

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