Franklin Street Properties Corp (FSP) Q4 2021 Earnings Call Transcript

Hello. Good morning everyone, and welcome to the Franklin Street Properties Corp. Fourth Quarter and Full Year 2021 Results. My name is Gemma and I will be the operator for today. I'd now like to hand the call over to Scott Carter, General Counsel. Please go ahead, Scott. Thank you.

Good morning, and welcome to the Franklin Street Properties fourth quarter 2021 earnings call. Joining me this morning are George Carter, our Chief Executive Officer; John Demeritt, our Chief Financial Officer; Jeff Carter, our President and Chief Investment Officer; John Donahue, President of FSP Property Management; and Will Friend, Executive Vice Presidents of FSP Property Management. 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, 2021, which is on file with the SEC. In addition, these forward-looking statements represent the company's expectations only as of today, February 16, 2022. 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. Reconciliations of FFO and other non-GAAP financial measures to GAAP net income are contained in yesterday's press release, which is available on the Investor Relations section of our website. Now, I'll turn the call over to John Demeritt. John?

Thank you, Scott and good morning everyone. I'm going to give a very brief overview of our fourth quarter and year-end results, and afterward, I'll pass the call to George for his comments. As a reminder, our comments today will refer to our earnings release, supplemental package, and 10-K, which as Scott mentioned, can be found on our website. We reported net income of about $78.6 million or $0.75 per share for the fourth quarter of 2021, and $92.7 million or $0.87 per share for the full year 2021. We reported funds from operations, or FFO, of about $11 million or $0.10 per share for the fourth quarter of 2021 and $58.5 million or $0.55 per share for the full year of 2021. During Q4, we completed the sale of three properties at a net gain of about $83.9 million and used the proceeds from those sales to repay $200 million of our 2023 term loan maturity and $15 million to repay a drawn balance on our revolver. Looking back, we had approximately $1 billion in debt at the end of September 2020. We sold a property at the end of December in 2020, and 10 properties were sold during 2021. We used asset sale proceeds primarily to repay about 53% of our debt. At December 31, 2021, we had $475 million of debt outstanding. We ended 2020 with a net debt to EBITDA ratio of 8.7 times, which has since decreased significantly to 6.2 times at the end of 2021, primarily as a result of our debt repayment strategy. Our debt service coverage ratio was over three times for the fourth quarter as well. We believe that in 2021 we have meaningfully lowered our leverage and strengthened our balance sheet. Shortly after year-end, we entered into a new revolver with availability of $237.5 million and terminated our existing revolver. We appreciate our bank group and believe this new revolver will serve us in our liquidity needs as we look ahead. As a reminder, all of our debt remains unsecured. With that, I'll turn the call over to George.

Thank you, John. And again, welcome to Franklin Street Properties fourth quarter and full year 2021 earnings call. I’d like to report that FSP executed very well on its primary 2021 strategies to reduce debt and to lease offices. 2021 achievements include the sale of 999 Peachtree in Atlanta for $223.9 million, a lease of approximately 100,000 square feet with a new tenant at our Pershing Park property in Atlanta and a lease renewal for approximately 250,000 square feet at Eldridge Green in Houston. For the full year 2021, we sold 10 properties for aggregate gross proceeds of approximately $603 million. We purchased approximately 3.4 million shares of our common stock for approximately $18.2 million. And we have reduced our total indebtedness since September 30, 2020 by approximately 53%, from approximately $1 billion to approximately $475 million. Looking forward, we are very optimistic that our remaining office portfolio has significant upside leasing potential in a post-COVID-19 environment. And so, in 2022, we will continue to focus all energies on leasing more of our available office space. We also continue to believe that the current price of our common stock does not accurately reflect the value of our underlying real estate assets and intend to continue our current strategy of seeking to realize that shareholder value through the sale of select properties, where we believe that short- to intermediate-term valuation potential has been reached. At this time, we are estimating property dispositions for 2022 to be in the range of $250 million to $350 million in aggregate gross proceeds. We intend to use the proceeds from any future dispositions for continued debt reduction, continued repurchases of our common stock, and any special dividends required to meet REIT requirements, as well as other general corporate purposes. With that, I would like to turn the call over now to John Donahue, President of FSP Property Management Corp. John?

Thank you, George. Good morning, everyone. The FSP portfolio was approximately 78.4% leased at the end of the fourth quarter as compared to 78.8% leased at the end of the third quarter. The decrease is primarily attributable to asset dispositions. FSP finalized over 1 million square feet of total leasing during calendar 2021, including new deals, expansions, and renewals. The leasing momentum that had been escalating on multiple occasions during 2021 was interrupted by the Delta variant surge and most recently by the Omicron variant surge. However, we are currently witnessing leasing momentum once again, with demand for office space in our portfolio improving on a weekly basis. In the majority of FSP's markets across the country, there are improving fundamentals, shrinking sublease space, additional office reopenings, and growth in the pipeline of new potential commitments. FSP is currently tracking approximately 700,000 square feet of potential new tenant prospects. Included in the 700,000 square feet of prospects are approximately 400,000 square feet of new tenant prospects that have shortlisted FSP assets identified an FSP building as their top choice or signed a letter of intent. We continue to be encouraged by meaningful growth and leasing activity and FSP's healthy pipeline of prospective tenants. Thank you. I will now turn it over to Jeff Carter.

Thank you, John. Good morning, everyone. We here at Franklin Street Properties hope that everyone remains safe and healthy. As we start 2022, FSP continues with our efforts to materially reduce corporate indebtedness at the company through select property sales. Importantly, we believe that our disposition efforts during 2021, which effectively began at the end of 2020, have served to highlight a disparity that exists between our public share price and the true market value of our real estate assets. And so, we believe our dispositions have been capturing associated embedded value for our shareholders. More specifically for the full year of 2021, FSP completed approximately $603 million in total property sales at an aggregate weighted average in-place cap rate of approximately 5.5%. During the fourth quarter, specifically, FSP completed three dispositions, totaling about $263.9 million that included 999 Peachtree in Atlanta for $223.9 million in October and Meadow Point and Stonecroft, both in Chantilly, Virginia, for $40 million in November. Looking at 2022, more specifically, FSP has confirmed expected disposition guidance of between $250 million and $350 million in aggregate gross proceeds for the calendar year, similarly to last year, with any potential upcoming property sales FSP intends to continue to utilize disposition proceeds primarily to pay down debt. FSP currently is, or will soon be seeking price discovery on Eldridge Green and Park Ten in Houston, Texas, 909 Davis in Evanston, Illinois, and 380 and 390 Interlocken in Broomfield, Colorado. And we will continue to provide updates as appropriate. Our criteria for selecting potential properties for dispositions continues to be asset-specific and not market-specific. We consider a variety of factors, including analyzing respective short to intermediate-term value potential. Lastly, in an effort to try to add a bit of color around what we are experiencing in the marketplace on investment sales, FSP has generally been seeing strong demand for well-located and high-quality office properties from a diverse group of buyers. To date, the strongest interest has been from private buyers, but public buyers are also increasingly looking and participating. Interest has also grown for mostly single or few tenant properties with strong weighted average lease terms to also select interest in core plus and even value-add. The strongest interest has been in the suburbs, but infill is also seeing exploration as well. Winning bidders are underwriting a return to a more normalized economy and office use landscape. Most interest that we have seen has been domestic in nature, but some international groups have been looking as well. And with that, we thank you for listening to our earnings conference call today. And now, at this time, we'd like to open the call for any questions, Gemma?

Thank you. Our first question today comes from Rob Stevenson of Janney. Please go ahead, Rob. Your line is now open.

Good morning, guys. On the dispositions, does the $250 million to $350 million reflect just the five properties that you guys have identified and they're roughly 1.1 million square feet or does it include other stuff as well?

Hi Rob. This is Jeff Carter. Good morning. It includes the assets that we've noted.

Okay. So, is there anything else you plan to do that would be in addition to the current guidance?

That would be correct, and we'll update quarterly.

Okay. George, how is the Board approaching the ongoing asset sales and other options? The stock price hasn’t changed. I assume you and the Board, along with the management team, are somewhat disappointed by this, as it doesn’t reflect more value from your efforts to reduce leverage and improve asset quality. If the stock remains in the $5 to $6 range, how long is the Board prepared to sustain that, and what are the next steps for your team?

Hi, Rob. That's a good question. The answer is a bit complex. First, I want to point out that the strategy we implemented in 2021 saw our stock valued higher at the end of 2021 compared to the end of 2020. When factoring in dividends, our return to shareholders for 2021 was reasonable when viewed in isolation. However, over a longer period, we are disappointed with our stock price. The Board is committed to finding the best approach to maximize shareholder value, which this year involves focusing on continued sales while also dedicating efforts to leasing our strong properties in promising markets that we believe will perform well in the next year or two. The Board is unwavering in this commitment. One thing to monitor this year is the overall office market in relation to COVID and office returns. We've experienced several false starts over the past couple of years, but we're hopeful this time will be different. The office market seems generally optimistic. Specifically, we've encountered challenges in energy markets like Houston and downtown Denver, but some of these challenges may be starting to shift in our favor. As we move through 2022 and 2023, how we lease and enhance properties in energy-centric markets will be crucial in adding value for shareholders. Furthermore, two key elements we believe will be significant for our shareholders are the continued reduction of debt and maintaining solid equity values in our portfolio, particularly through proceeds from asset sales. Lowering debt will strengthen our balance sheet and reduce risk, allowing us potential growth for future acquisitions. We also plan to return value to shareholders by distributing gains from successful dispositions, and stock repurchases will be another avenue. While it's a lengthy explanation, the path for 2022 appears promising, especially if our share price stays significantly below the net value of our ongoing real estate assets. We will keep the market informed as we proceed.

Okay. Fair enough. And then one last question for John Demeritt. Of the remaining $475 million of debt, you have some below two, some low fours, and some high fours. Assuming that you receive around $350 million from dispositions this year, what order will you address the debt in, and what type of prepayment penalties, if any, will be involved?

Well, the first, most likely would be the $110 million that remains on what was a $400 million term loan that matures in January of next year. So, the first $110 million will go against that. There is no prepayment penalty on that. We would be accelerating some deferred financing costs, depending on when we paid it off, but I don't think that's a significant amount of money. The second piece would be the $165 million term loan that we have, that was led by Bank of Montreal that one’s due in the end of January of 2024. That one does have a swap on it. So, if we were to repay that, we'd have to break the swap and incur some costs from that. And I looked at the value of that swap at the end of January, where rates have been rising that does have a tendency to reduce the amount of the swap liability we have on it. I think it was $5.3 million at year-end. And by the end of January, it was around $3.5 million, something like that. So, if we pay that $165 million back, there will be some portion of that, that we will need to break a swap on, let's see rates rise significantly.

Okay. So, the series A and B senior notes are not something that you're going to likely get to with this round of dispositions.

No, I don't think so. They have a yield maintenance component that is quite costly for those two pieces of debt.

And when do they start becoming more in the sort of less risky to take out?

Well, $116 million of it matures in December of 2024 and then $84 million matures in December of 2027. So, the 2024 maturity would start to come down over the next couple of years.

Okay. All right. Thanks guys. Appreciate the time.

Our next question on the line comes from Dave Rodgers of Baird. Please go ahead, Dave. Thank you.

Good morning, everyone. George, I wanted to revisit your earlier comment. Before the pandemic, the enterprise value was just under $2 billion. You are on track to sell about $1 billion in assets during that same period. General and administrative expenses are continuing to rise. If you're not particularly inclined to sell the entire company, what steps will you take to downsize? How do you plan to adjust the company to match the smaller scale you are aiming for while not considering that strategic alternative?

Well, as you've asked this question before, Dave, and I will say it again as clear as I can. We are constantly reviewing all strategic alternatives. The business plan for 2022, at this point, has laid out, and business plans have changed during the course of the year. But that is the business plan as we've started 2022. But all strategic alternatives, all strategic alternatives are always being reviewed and are on the table. And so, assuming that we are going to stay a much smaller company for a much longer period of time and have to right size G&A and all of the other things that you would do if that in fact is where we go is probably not a good assumption in the sense of, again, all options continuing to be on the table. And once a long-term option is chosen, and again, we'll learn a lot this year post-COVID, hopefully post-COVID, those long-term decisions and what strategic decision we make long-term, including growing again significantly in a number of potential ways, we will tackle what is necessary to tackle the company to be the most profitable it could be in whatever strategic scenario we choose.

Okay. Yeah. Fair enough on that. I think, on the disposition, you talked about the energy market is getting better, and I think, Jeff, you also might have mentioned kind of the value-add market improving for acquisitions or your disposition. That said, I think what you've just teed up this year is somewhere between 99% and 91% leased. So, obviously, adding more to the backlog of what needs to be leased and kind of pressuring the percentage. Why not pursue a little bit more, why not tag on some of those value-add assets in those markets, a Houston or a Denver, as opposed to just selling the well-leased, well-located assets?

Dave, this is Jeff. We are evaluating assets on an asset-specific basis, not a market-specific basis. And so, we're selling assets when we feel like the value potential is correct to sell them. And the assets that we are not selling are assets that we believe have tremendous upside potential for our shareholders and great opportunity for continued ownership.

Okay. That's fair. And then, I guess, maybe John Donahue, one question for you on the leasing front. You mentioned 700,000 square feet. Obviously, quite a bit of wood to chop about a million six of vacancy in the portfolio right now. Can you talk about kind of known move-ins and known move-outs at this point and how you see that impacting kind of the cadence of 2022?

Sure. Good morning, Dave. When it comes to move-ins and move-outs, which relate to economic occupancy, it will mainly depend on the timing and which assets are sold. Currently, we are experiencing a significantly improved decision-making pipeline and are moving more swiftly toward finalizing actions, something we've been anticipating for quite some time. If this trend continues without any surprises, I would expect success to not just progress slowly or linearly, but to potentially increase rapidly. COVID remains a significant factor, and prospects considering long-term commitments need to overcome that decision-making hurdle. Right now, I feel we are in a better position than we were in September or October, slightly improved, although it remains fragile due to COVID. Nonetheless, there is greater optimism and more positive discussions in the market today compared to several instances last year. If I had to predict, I would say this year is unlikely to see gradual or linear progress, but rather it could escalate quickly.

Thank you for that. Specifically on Ovintiv, is that about two-thirds backfilled and then any update on the DirecTV space?

So, in regards to Ovintiv, we have released between 60% and 66% of that space and looking at new prospects for the balance. So, we believe that we're done at this time with the subtenants. So, Denver is the lion's share of our vacancy followed by Texas, but the market has been improving greatly in Denver, especially downtown. And we do have a prospect that would backfill to DirecTV. We expect DirecTV to vacate over the next three, four months.

Downtown on that space.

Well, hard to say. I think we do have one very strong prospect, but we're probably looking at downtime of at least a quarter or two, maybe three quarters, but it's just hard to say.

Lastly, just to move in of Blue Lagoon, the lease you just announced subsequently the end of the quarter, timing on that.

The move-in timing would be as soon as the build-out is completed, which we estimate would be sometime in the fourth quarter.

Okay. I had one more question about WPX Energy. There are about four months left on that term. What will happen to it? Will it be sold or renewed?

That's a known move-out re-lease.

Okay. Thank you for all the details. Appreciate it.

We should now move to our final question on the line from Craig Kucera from B Riley Securities. Please go ahead, Craig. Thank you.

Thanks. Good morning everyone. I wanted to follow up with another question regarding Ovintiv. You made some progress in the fourth quarter. Can you provide an update on when the three leases are expected to start generating rental income at the property that vacated?

Hi, Craig. It's John Donahue. I'll pass that along to Will Friend. On average, between six and 12 months.

Okay. Great. That's helpful. Okay. Great. And just thinking about capital allocation, you have brought down the leverage considerably from last year and beginning this year kind of in the low sixes. Do you have a target leverage that you're thinking about what Franklin Street looks like maybe post all of these dispositions that you're contemplating this year?

This is John Demeritt. We don't have a target leverage in mind. No. We've just got the disposition guidance that we're going to follow. I don't know if you want to add anything to that, George?

No, I think that's correct, Craig. John Demeritt mentioned earlier in the call the two term loans, and if we were able to achieve our target dispositions and aggregate gross proceeds, we could essentially get through the bulk of those two term loans, which would leave us with the private placement debt. This assumes we successfully navigate the dispositions. We could adjust that disposition guidance in future quarters, which would result in the private placement debt being the only remaining debt, aligning with our current expectations regarding dispositions. That would reflect 15% to 20% indebtedness.

Got it. And I guess, just how is the Board thinking about the cost of capital when you're buying back debt at below 2%, and then maybe 4% sort of beyond.

Our focus at the Board level is on the trading volume and the average trading volume as we move forward with purchasing shares for increased share repurchases. If there are potential block trades available in the market that align with the program, those would require significant effort to identify. The feasibility of these actions will largely depend on our volume levels and the programs under which most companies operate when buying back shares.

Okay. I appreciate the color. Thank you.

We have no further questions on the line. So, I'll hand back over to George Carter for closing remarks. Thank you.

Just thank everybody for tuning into the call today. 2022 will be an exciting year for us and for the whole office market for that matter. We are looking forward to it. We're excited. The energy markets are interesting, but certainly, there are a lot of moving parts for the office market and FSP, in particular, to look forward to talking to you next quarter.

Thank you very much for joining us today. Ladies and gentlemen, you may now disconnect your lines. Have a good afternoon. Thank you.