Franklin Street Properties Corp. Q2 2008 Earnings Call Transcript

Jul.30.08 | About: Franklin Street (FSP)

Franklin Street Properties Corp. (NYSEMKT:FSP)

Q2 2008 Earnings Call

July 30, 2008 9:30 am ET


Scott H. Carter – General Counsel

John G. Demeritt – Chief Financial Officer

George J. Carter – President & Chief Executive Officer


William F. Ford – Reinhart Partners

Eric B. Anderson – Hartford Financial


Welcome to the second quarter 2008 Franklin Street Properties earnings conference call. (Operator Instructions) I would now like to turn the call over to Scott Carter, General Counsel.

Scott H. Carter

With me this morning are George Carter, our Chief Executive Officer, and John Demeritt, our Chief Financial Officer. 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 Item 1A, Risk Factors of our annual report on Form 10-K for the year ended December 31, 2007, which is on file with the SEC. In addition, these forward-looking statements represent the company’s expectations only as of today, July 30, 2008. 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 Relation section of our website at

Now I will turn the call over to John Demeritt

John G. Demeritt

We are going to talk with you about our second quarter 2008 results and we will start with a short overview. Afterwards George Carter, our CEO, will further discuss the quarter and FSP. I am going to be brief and I will be referring to the earnings release and 10-Q that both went out last night.

As we have said before, we measure our performance with three key drivers, which are Real Estate Operations, Investment Banking, and Gains On Sale of Assets, or what we call GOS. Investment Banking and GOS are both transactional in nature and even in normal markets the quarter-to-quarter results from them can be very choppy. We believe our overall performance is better evaluated over the long term.

For the second quarter of 2008 we had net income of $10.5 million and EPS of $0.15 per share. We measure performance of Real Estate Operations and Investment Banking through FFO, which for the second quarter was $20.3 million, or $0.29 per share. We did not sell any properties during the second quarter and as a result there was no Gains on Sale, or GOS, in our results for Q2.

Comparing the second quarter of 2008 to 2007, EPS was $0.31 lower in 2008, pretty much entirely as a result of GOS of that same amount per share that we had in 2007, which we did not have this year. If you strip that out of 2007, EPS was $0.15 per share for Q2 2008 and Q2 2007.

FFO was up $0.01 at $0.29 in the second quarter of 2008 compared to $0.28 in 2007. The reason for the increase in FFO was primarily from performance of our Real Estate assets, which is about $1.0 million ahead of the second quarter of 2007. The most significant reason for the increase was the benefit of leasing that we’ve had since the second half of 2007 that positively impacted the second quarter of 2008, compared to the second quarter of 2007.

The increase in FFO from Real Estate was partially offset by a decrease from our Investment Banking segment of about $650,000, which was because we had lower banking fees in the second quarter of 2008 compared to the second quarter of 2007. We earn these fees from investment banking based on the value of the shares that we sell in private placements. For the quarter we sold shares of these private placements of about $49.9 million, which was much better than our first quarter of 2008. But these sales were about $10.2 million lower than the comparative second quarter in 2007.

Income derived from the Investment Bank is essentially syndication and transaction fee revenues on our income statement less the impact of direct expenses, which are commissions and related income taxes and some G&A. George will be talking more about Investment Banking and GOS as we believe broader external factors in the market have affected these.

And that covers our financial performance. The press release and 10-Q filing go into further detail about our results. And I also wanted to point out that the press release has our supplemental schedules, including information about the twelve single-asset REITs that we manage and include two of those that we currently have investments in. The results of our current-owned real estate portfolio are in the press release if you’re interested.

That concludes our financial highlights and at this point our CEO, George Carter, will tell you more about the quarter and where we are.

George J. Carter

My comments this morning, as usual, will follow my written comments in our earnings press release.

As John has said, total profits of the second quarter of 2008 were approximately $20.3 million, or $0.29 per share. Franklin Street represents its profits as a combination of FFO, funds from operations, and GOS, gain on sale of properties. For the second quarter of 2008, as in the first quarter of 2008, there were no gains on property sales so effectively 100% of the profits were FFO.

Very generally speaking, we believe the current market environment does not offer the best opportunity to achieve efficient and aggressive pricing on the sale of commercial properties. If you don’t have to sell a property now, and we don’t, a better market is likely to develop when more liquidity returns to the commercial mortgage product that is used to help finance the more traditional acquisition process.

Having said that, FSP does have a couple of smaller properties that we have owned for quite a while that we continue to receive activity on from potential purchasers and knowledgeable local brokers. It is possible that a sale of one or more of these properties could take place in the current mortgage environment.

However, we certainly cannot see at this time a broad-based, dynamic property sales market returning this year. Consequently, GOS, or gain on sale of property, is not likely to play a significant role in FSP’s profit picture in 2008, as it has in the last several years.

Our other transactional source of profits is our Real Estate Investment Banking business. For the second quarter of 2008 our Investment Banking Group raised about $49.9 million of equity capital, up substantially from the $2.7 million volume achieved in the first quarter of 2008, but as John said, still far short of the $109.2 million level of business done during the first half of last year.

As I mentioned on last quarter’s earnings call, we expected to see a pickup in our banking business in the second quarter but I would tell you that I believe that we will continue to see extreme volatility quarter-to-quarter in that business, at least for the balance or the year or at least for the foreseeable future.

While profits continued to suffer in second quarter of 2008 from our transactional businesses being negatively impacted by the broader capital market conditions, our ongoing recurring source of rental revenue from our portfolio of 27 properties continued to grow and provided $0.24 per share out of the total $0.29 per share quarterly profit total.

The property portfolio remained about 93% occupied for the quarter, with very lease turnover remaining for the balance of 2008, and approximately 11.4% lease turnover scheduled for 2009. We are obviously working on those lease turnovers as we speak. The property portfolio still has no property-secured debt associated with it, however, the company does have approximately $110.0 million drawn on its $250.0 million line of credit, with those funds having been used for property purchases directly into Franklin Street Properties, as well as a current private placement offering of a sponsored entity through our Investment Banking Group.

During the second quarter FSP completed the $35.4 million purchase of its 27th property, a recently built, 157,000 square foot office building located in Houston, Texas. This property was originally spec-developed by FSP through one of its Investment Banking-funded private placements. The property was completed in late 2006 and is now approximately 98% leased and is adjacent to a look-alike sister building, also owned by FSP.

It will be FSP’s primary objective to continue to grow its property portfolio and rental income business during this period of liquidity-constrained capital markets by using its balance-sheet strength to help finance and fund new acquisitions. We continue to be very optimistic about FSP’s position in the current commercial real estate investment market and the opportunities that may present themselves as a result of the current distress surrounding some aspects of those markets.

Before opening up to questions, I did want to make a couple of comments on the recent dividend cut. First, we cut the dividend because we were not earning it. Specifically starting in the third quarter of 2007, our two transactional businesses, the Investment Banking business and our Property Sale business, really took a hit, really pretty much shut down. The capital market turmoil directly and quickly affected those businesses.

And looking forward, since the third quarter of 2007, we cannot see, sitting here today, exactly how wide and deep this credit-crunch canyon will turn out to be. I think that while every quarter the Board makes a decision on the dividend, I can tell you the Board’s philosophy is not to pay, for any extended period of time, a dividend that we are not earning, especially when there is no visibility into the future for those businesses that are causing the issue.

There was one year in our history that profits did not cover dividends; that was 2004 and we did not cover that year by about $0.01 per share. Again, we view dividends as a return on investment, not a return of investment. Our objective is to grow this company’s real estate portfolio and ongoing recurring rental revenues, not to shrink the company by paying out a dividend not covered by profits.

Quickly, if you know the history of FSP and its dividend, you know that 15 years ago in our predecessor firm we started solely as an investment bank. Effectively all of our revenues were investment banking revenues. About 10 years ago, when we declared our first dividend, virtually all of those dividends were transactional investment banking fees. None of those were ongoing recurring rental revenues. Over the years, through acquisitions and mergers, we brought properties into Franklin Street and more and more of that dividend became ongoing recurring rental revenue and less of that dividend, as a percentage, became investment banking.

When we lifted our company three years ago, we had a much higher percentage of our dividend as investment banking and we certainly kept that investment banking portion of our dividend. This sort of watershed event that started as the credit crunch in the third quarter of 2007 has really, again, as I said, hurt those two business in terms of current sales. We very much believe in their long-term viability and long-term contribution. It was the right time and the right reason to reduce that dividend that was effectively generated from profits from those two businesses.

A second point that I want to make has to do with what I would call regular dividends versus special dividends, going forward. Our real objective is to grow the regular dividend and to grow that regular dividend from our existing property portfolio, and as I mentioned on the last few calls, from new property acquisitions, adding to the ongoing recurring rental income. We do view, however, an annual special dividend as a real possibility, based solely upon the contributions in any one year from our Investment Banking and Property Sales transactional businesses.

I guess what I’m saying is now that we’ve made this split, keeping the regular dividend associated with real estate operations and the special dividend on an annual basis, if there is one, based upon the contributions from Investment Banking and Property Sales, is certainly the philosophy that exists here at the company today.

To finish the dividend section here, I will say that one of the by-products of this dividend structure that is a regular dividend and a special, flowing from our transactional businesses, allows us to add to our options of capitalizing on our balance-sheet strength for growth. And that is by providing better access to traditional REIT space within the public, underline public, capital markets when and if the time and the opportunities are right. It is quite clear to us that public markets do not like regular dividends, or do not value them very much, coming from transactional sources of profit, such as our Investment Banking and GOS.

We have never accessed the public capital markets before. We have raised internally virtually every dollar that has grown this firm, equity-wise, ourselves and borrowed directly from our banking group to help us with that growth. The reason most companies go public is to access those public capital markets. Three years ago we simply listed this company. We’ve never done an IPO and never done any financing through the public capital markets.

We are now adding that arrow to the quiver with the sole objective of now viewing the public capital markets as simply an option, amongst many other options, for us to raise capital of many different types to grow our property portfolio and consequently grow our ongoing recurring rental revenue.

With that I will be happy to open it up for questions.

Question-and-Answer Session


(Operator Instructions) Your first question comes from Bill Ford with Reinhart Partners.

William F. Ford – Reinhart Partners

I was just going through a couple of things looking at it here and sort of looking at how things have gone over the past couple of quarters. One thing being talking about the acquisition environment and you guys have been talking about how it’s becoming more and more of an opportunity and what you’re seeing there. Can you give a little more commentary on sequentially do you feel like you’re moving closer and closer to doing a more significant number of acquisitions now versus three months ago versus six months ago? Or how is that progressing and what are the indications of where things are going there?

George J. Carter

The short answer is yes, we see more opportunity today than we did three months or six months ago. I think the one thing that is pretty clear from this credit-crunch capital-markets event that we’re all witnessing, particularly as it relates to mortgages and real estate and liquidity financing for those products, is that patience may be a virtue here. Every time the market thinks the bottom is in or the worst has happened, you know, you sort of get another leg here.

There clearly has been a move up in cap rates. We have, I believe, taken advantage of that in a couple of properties. We have, certainly, our eye on other properties. The owners of much of the commercial office properties that we would be interested in acquiring have loan sort of deadlines for refinancing associated with those properties. A lot of the opportunity that may present itself and the pricing that may present itself is going to relate to how long this liquidity crunch goes, how deep and how wide this canyon is, and how much pressure owners of properties that are highly leveraged feel as they come to a point in time where they have to refinance the debt on those properties.

We are patient, we are disciplined, there are more opportunities today than there were yesterday. Now, what tomorrow brings and what the future brings, we will all have to see. But we’re optimistic that you will see acquisitions by FSP, using its balance sheet, that those acquisitions will be additive to our rental revenues and our ongoing recurring revenues, and potentially significantly so in the future.

William F. Ford – Reinhart Partners

You mentioned the commercial mortgage financing market, obviously you guys have your line of credit and balance sheet. Is that what’s going to fund the acquisitions or are you guys feeling any constraints in terms of availability or cost of commercial mortgage financing?

John G. Demeritt

We are considering other forms of debt, perhaps; term debt, perhaps secured debt, and have been talking with a number of bankers about that. The credit market is tightened up quite a bit, you can read that in the newspaper quite a bit, so I don’t have any news there to talk about. But we do have a $250.0 million line of credit. We’ve got about $110.0 million drawn on it at this point so we’ve got $140.0 million available on that.

William F. Ford – Reinhart Partners

One other questions would be, just as you guys look at your rental operations, is there anything you’re seeing, again sequentially, in sort of which direction things are moving in terms of the credit outlook for your tenants. You guys have a lot of financial firms and real estate-related firms in your leases. What are your thoughts on that and where do you see that going?

John G. Demeritt

I can speak for the properties in the portfolio, the owned portfolio. We’ve been through a pretty good analysis of the financial service-related firms that may or may not be impacted by the credit crunch, and looked at our bad debt reserves at the end of the quarter, same thing with the end of the first quarter, and feel pretty comfortable with it an feel like we’re in good stead with the tenants that we have. So I don’t think we have any real holes there.

George J. Carter

I agree. I think the credit quality in industries that our tenants are in, we feel real good there. I think the big question is, Bill, and I think it’s a question for everybody in commercial real estate, not just us, but what kind of main-street, on-the-ground, economic environment do we have as we get lease rolled, particularly in 2009 and 2010? Are we in a deep recession where companies are reducing space and laying off people, or are we in a stable and hopefully growing environment where companies are not reducing space and adding people? For us, I think that is the flex point. That is the point that will make the difference. Existing tenants, though, appear real solid.


Your next question comes from Eric Anderson with Harford Financial.

Eric B. Anderson – Hartford Financial

George, I wonder if you could just elaborate a little bit on sort of the strategy you’re going to use, given the credit environment, in deciding when to acquire properties for the investment bank for their syndication, in terms of if the demand has fallen off in that area, at least temporarily, how will you manage that process so that it doesn’t get too loaded up with stuff you might have to sit with a while?

George J. Carter

It’s a good question, Eric. That process, acquisition for syndication, acquisition for the bank, has always been you buy too much or you buy too little. In this environment, clearly our investor group, who’s been with us just a long time and we have a great group, mostly high-net-worth investors and institutions, many of the institutions representing high-net-worth investors, they have become very, very sensitive in terms of their confidence and mood for investing, really sort of based upon the day-to-day headlines.

I think, as I mentioned in the last quarter, when the whole Bear Stearns thing happened, and people thought that might have been a watershed and confidence sort of flowed back in for the capital markets and the financial system, you know, we definitely saw a pickup in willingness to invest and then the more recent downtown has, again, crippled that quite a bit. So that’s the environment. We see a more jagged than ever volatile environment than ever for our Investment Banking business and it really lies with the investor.

So we’re going to have to, number one, limit product so we don’t get caught with product for the bank, until when and if that starts to stabilize. We did this in another life and we’ve been through these cycles before and we’ll stabilize again is our belief and we can be more consistent. But we will have to be careful. And when we purchase a property for syndication that we believe is a good syndication property, the real key for FSP is to make sure that property, while it’s in inventory, carries itself on the line of credit, which is what we use to buy these properties with, i.e. that the NOI from that property will more than pay the debt service on the line so that it’s not a negative carry while we’re holding it in inventory.

But it is a little bit of an art form, I’ve got to tell you, and it always has been.

Eric B. Anderson – Hartford Financial

Along those lines, I notice in some of the material that your Phoenix Tower property looks like it has a fair amount of space available. Has that been remarketed? I think that’s the one that had Capital One in it.

George J. Carter

We have an investment in that property, FSP does, but that is one of our private placement entities that set out on its own, is a separate public company and has its own separate reporting. And actually as a public company, you can look at the report on that company.

But I can tell you that that was a property that we syndicated that Washington Mutual had a large block of space in, that we pretty much anticipated when we bought the property that that space was going to become vacant and available for us to re-lease. That was a property that we were positioning dramatically in terms of physically recapitalizing the property. We actually are re-skinning the whole property, major lobby renovations, major work to the infrastructure of the property. That work is continuing. That vacancy was anticipated. We’re working on re-leasing that vacancy, the objective, as stated in that public company that owns that property, is to finish the leasing of that space and then, assuming the markets are good, which right now, as we speak today, Houston is a good market, one of the better markets in the country, to put that property on the market for sale.

John G. Demeritt

On that property, there will be a 10-Q filed on that in a couple of weeks, which will update where we were through six months.

Eric B. Anderson – Hartford Financial

If and when that property does become put on the market, will you look to buy it for cash, possibly, or sell it outright to another investor?

George J. Carter

It is our anticipation that we would list that property with a third-party broker and it will be sold to the highest bidder.

Eric B. Anderson – Hartford Financial

Would Franklin Street be one of the potential bidders?

George J. Carter

Franklin Street could be a bidder.


There are no further questions.

George J. Carter

Thank you very much for attending the call. I hope it was helpful. I look forward to talking to you next quarter.

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