Franklin Street Properties Corp.

Good morning and welcome to the Franklin Street Properties Corporation second quarter 2021 earnings conference call. All participants will be in a listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your telephone keypad. To withdraw your question, please press star then two. Please note this event is being recorded. I would now like to turn the conference over to Scott Carter, General Counsel. Please go ahead.

Good morning and welcome to the Franklin Street Properties second 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, and John Donahue, President of FSP Property Management. Also joining me this morning are Toby Daly and Will Friend, both 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, 2020, which is on file with the SEC. In addition, these forward-looking statements represent the company's expectations only as of today, August 4, 2021. 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 in the investor relations section of our website at www.fspreit.com. Now I'll turn the call over to John DeMeritt. John?

Thank you, Scott. Good morning, everyone. I'm going to give a very brief overview of our second quarter results. 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 10Q which as Scott mentioned, can be found on our website. We reported funds from operations or FFO 14.7 million or 14 cents per share for the second quarter of 21. During Q2, we completed the sale of four properties and used the proceeds to repay our 2021 debt maturities and the drawing balance on our revolver. We incurred about 2 million in costs to complete the debt repayment which was primarily a payment to break interest rate swaps on the debt we repaid. The amount paid is roughly equal to what we would have paid on the swaps through their maturity on November 30th of 21. So these expenses were accelerated into Q2 and lowered our FFO per share by about two cents a share. Turning to our balance sheet at June 30, 21, we had a total of 765 million of unsecured debt outstanding and no amounts drawn on our revolver. At quarter end, between cash on hand and availability on our line, we had total liquidity of about $624.2 million. As a reminder, all our debt is unsecured and we have no remaining debt maturities this year. Although our revolver matures in early 2022, we can extend that maturity for a year. Our debt is at fixed rates other than the revolver, which is at a floating rate on amounts drawn. With that, I'll turn the call over to George. George.

Thank you, John. And again, welcome to Franklin Street Properties' second quarter 2021 earnings call. I would like to begin my comments today by thanking FSP investors, our tenant customers, associated professionals, property personnel, FSP employees and our directors for their continued support and extraordinary work effort during these turbulent times. As the U.S. and the entire world continue in the battle to overcome COVID-19 through vaccination efforts and public health measures, FSP continues to see hopeful signs of recovery within our markets and at our properties. We remain grateful to all individuals on the front lines of this critical healthcare work. While uncertainties such as the Delta variant persist, there is legitimate reason to be optimistic about the normalizing of life and as a result, a measured return to office occupancy. To this end, our pipeline of potential new leases continues to strengthen. John Donahue will further discuss what we are seeing his remarks ahead. We believe that 2021 has the potential to be a significant year for FSP as we work to materially reduce corporate indebtedness through select property dispositions. During this past quarter, FSP saw its total outstanding debt decline by approximately 19% from $947 million to $765 million. During the second quarter, we repaid approximately $155 million of term loan indebtedness and all of the approximately $47.5 million that had been drawn under our revolving line of credit. As of June 30, 2021, our full $600 million revolving line of credit was available for use, and we had approximately $24 million of cash on our balance sheet. This in-progress balance sheet reset is intended to reduce risk while at the same time increase our flexibility to consider well-suited opportunities to enhance value for our shareholders. During 2021 to date, FSP has sold four properties, reflecting total gross proceeds of approximately $237 million. These completed dispositions unlocked embedded value for our shareholders that we believe may not be accurately reflected in our share price. And planned for upcoming sales should do the same. We believe the four completed dispositions during 2021 have had a positive impact on the value of shareholder equity, directly reducing indebtedness risk. Since September 30th of 2020, we have repaid approximately $235 million in debt for approximately 23.5% of what was approximately $1 billion in debt at that time. Currently, we believe that one of our best potential future investments is our own stock. And so we may use a portion of proceeds from asset sales for the repurchase of up to $50 million of our standing common shares as market conditions warrant pursuant to our previously announced stock purchase plan. As 2021 progresses, we are continuing with our current suspension of net income and FFO guidance, primarily due to uncertainty surrounding the timing and amount of proceeds from further property dispositions. We are reaffirming our 2021 disposition guidance range of between $350 million to $450 million and will continue to keep the market informed as we move through the remainder of the year. Lastly, FSP remains committed to its Sunbelt and Mountain West office focus, which emphasizes markets and properties with compelling long-term population and employment growth potential. We continue to look forward to 2021 with anticipation and optimism. Now I will turn the call over to John Donahue, president of FSP Property Management Company, to discuss the portfolio and leasing prospects. John?

Thank you, George. Good morning, everyone. The FSP portfolio, including redevelopment, was approximately 78.5% leased at the end of the second quarter, as compared to 81% leased at the end of the first quarter. The decrease is primarily due to multiple dispositions and secondarily due to lease expirations and known departures. Rank collections were greater than 99.5% for the first half of 2021. We continue to witness the return of additional tenants employees and higher office space utilization across the FSP portfolio. particularly in the Sunbelt markets and in suburban assets. More companies have announced plans for inviting employees back to their respective offices, including those in urban and infill locations. Many of our tenants have made similar announcements, with the prevalent expectation being that offices will be back to a post-pandemic normal as the new school year arrives in the fall. The new normal might include some form of full-time in the office, part-time in the office, and or a hybrid approach. These are all positive signs and we expect this trend to continue. The list of potential tenant prospects continues to grow with increasing anticipation and optimism in regards to improving leased occupancies in the months ahead. We continue to be encouraged by meaningful growth in FSP's pipeline of prospective tenants. Although the typical summer season prior to the pandemic brought with it slower demand, FSP has witnessed more activity this summer, including property tours, submitted RFPs, and counter proposals. FSP is currently tracking approximately 850,000 square feet of new prospective tenants that have shortlisted FSP assets. Barring any surprises, the potential for portfolio net absorption over the next nine months is approximately 500,000 square feet. During the first half of calendar 2021, FSP has finalized over 560,000 square feet of total leasing, including new deals and renewals. For the second half of 2021, FSP has approximately 139,000 square feet of tenants expiring, or 1.7% of the portfolio. Due to the limited role or exposure coupled with improving demand for space and FSP's assets, we believe that our portfolio is well-positioned to make meaningful progress regarding net absorption and higher lease occupancy by the end of the year. Thank you. I will now turn it over to Jeff Carter.

Jeff Carter Thank you, John. Good morning, everyone. We here at Franklin Street Properties hope that everyone is continuing to remain safe and healthy. This morning, I will discuss FSP's efforts to achieve our disposition goals for 2021. And then I will endeavor to provide some color as to what we are seeing on the ground with our price discovery work in the marketplace. With that in mind, FSP is reaffirming our existing disposition guidance of between 350 and 450 million and select dispositions for calendar year 2021. The objective of our disposition plan is primarily to pay down debt in order to gain greater financial flexibility, reduce risk, and to position the company for stronger returns to our shareholders. Importantly, we believe that our completed dispositions to date, as well as the sales that we are currently working on, are capturing embedded value for our shareholders. that may not be accurately reflected within our share price. Assuming success at the conclusion of our disposition process, FSP will have fundamentally reset our balance sheet and be positioned to pivot towards the best suited opportunities to enhance value and returns to our shareholders. Specific to the just completed second quarter, FSP sold properties for gross proceeds of approximately 237 million. which reflects about 68% of the bottom end of our $350 million target range, and about 53% of the top end of our $450 million target range. Our dispositions for the quarter were comprised of Loudon Tech Center in Northern Virginia, which sold on June 29th for gross proceeds of approximately $17.25 million, and as previously announced, 1 and 2 Ravinia Drive, as well as one over Tin Park, which sold on May 27th to a single purchaser for a combined purchase price of $219.5 million. Due to confidentiality, we are unable to discuss specific transaction metrics. However, with regard to the sales completed thus far, we believe with conviction that the pricing achieved has captured embedded value for our shareholders. In terms of what is in our pipeline currently, We are working with specific buyers or are in price discovery on the following properties, River Crossing in Indianapolis, Timber Lake Corporate Center in Greater St. Louis, both Meadow Point and Stonecroft in Northern Virginia, and Innsbruck Corporate Center in Richmond, Virginia. And we will keep the market apprised as we move forward. Lastly, we wanted to share once again what we are seeing, at least in an aggregate sense, within the investment marketplace. We continue to experience generally positive interest in the properties that we have sought price discovery on. The majority of interest we have seen has come from private investors and operators who are bullish on the long-term reopening narrative within the US. Pricing has been largely in line with our own internal expectations, such that we are seeing values that, if closed, would realize value for our shareholders that may not be accurately reflected within our share price. Interest has been in both single-tenant and multi-tenant properties, and we are witnessing demand for both stabilized as well as value-add assets. In sum, we continue to see that there is indeed a market to be made for price discovery, and over the coming months, we will continue to keep the market posted. And with that, we thank you for listening to our earnings conference call today, and now at this time, we'd like to open up the call for any questions. Danielle?

We will now begin the question and answer session. To ask a question, you might press star then one on your telephone keypad. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then two. The first question comes from Rob Stevenson of JANI. Please go ahead.

Good morning, guys. Can you talk about where tenant utilization is in the portfolio today and where that is versus the end of first quarter and year-end 2020?

Good morning, Rob. It's John Donahue. So the utilization across the portfolio varies. We're in 12 broader markets or metropolitan strategic areas and approximately 20 submarkets. So it varies pretty widely. We're hearing and witnessing that Texas, Dallas, and Houston are above 50%. So that is trending even higher versus the first quarter. And we're hearing that Dallas is approaching that 60% range. We're hearing that Atlanta is trailing that just slightly. We're hearing that Miami is trailing slightly. The urban markets with public transportation are behind, but we're hearing that people are starting to get back somewhere in that 20% to 30% range. Denver, Chicago, Minneapolis in particular. are probably a little bit behind the Sunbelt markets. And then Virginia is probably somewhere in between in that 30 to 40% range, depending on the sub market. So hopefully that gives you a sense of it.

Okay. And while I have you, how should we be thinking about new leasing and the impact on 2021 earnings? In other words, if you sign a new lease for vacant space today, when you do the build out and factor in the free rent, Is it really just going to be a 2022 FFO impact, or is there enough time to actually start getting, you know, sort of effective rents after all the sort of free stuff in 2021?

I would answer that question, Rob, by saying that the larger the deal, We certainly believe that the majority of those will be in the first quarter and second quarter of 22. We have been working on a large number of smaller deals between 5,000 square feet and 15,000 square feet or so that we are very close to. And we do have a chance of those having more impact on earnings in the fourth quarter of this year, in 2021. So as we've explained on the prior calls, many of these tenants that are making decisions now have urgent needs, and they have to make a decision. They're up against it. They've kicked the can down the road, and now it's time to move, renew, and get it done. And they don't have much time left. So we'll see some of the absorption, the net absorption that we're expecting occur in the fourth quarter. And I would say weighted average on square feet, we'll see a larger amount of square feet in Q1 and Q2 of next year.

Okay. And then sitting here, Jeff, sitting here halfway through the third quarter, are any acquisitions likely to close over the next seven weeks in the third quarter? Is this more likely if you guys do execute on these additional deals that the timing is more likely to be sometime in the fourth quarter or drifting into 2022?

You said acquisitions. I think you meant dispositions?

Yes, please.

Okay. On the disposition side, you can see in our disclosures in the 10-Q on page 19 that the purchase and sale agreement for the Northern Virginia property, if things move the way that they are expected to move, that the closing would be expected to take place on that at around September 9th, and the Timberlake would be around September 16th.

Okay, very helpful. And then just last one for me. I know that you guys aren't talking about pricing on the deals that you've announced or that are under contract, but when you take a look at what you've sold year-to-date and what you're marketing. Is there anything fundamentally different about the operating expenses of those assets versus the portfolio as a whole? In other words, using whatever I would ascribe to the NOI margin for the existing portfolio or whatever it's doing, anything that's dramatically different either to the plus or the minus side on the dispositions that would skew things?

I will I'll start with that and maybe John wants to add but just you know although we are bound by confidentiality as I mentioned on the disposition side just from a sort of straight look if you look at all four property sales that we've completed so far in aggregate the average in place cap rate on NOI is roughly about five percent on those on those transactions and John I'm not sure if if you had anything on the expense side?

Sure. Rob, I would look at the dispositions as a whole as having slightly lower net rents or NOI versus the remaining portfolio at this time. So I would consider the In a supplemental you'll find the in place gross rents And you'll also find the leasing activity on what we've done for for gross gap rents And as those have inched up For the for the majority of the portfolio, I would say that the net rents have as well and so the assets that remain in the portfolio are on a weighted per square foot basis should be seeing a slightly higher NOI or net rent, if you will.

Okay. Very helpful, guys. Thank you.

As a reminder, if you have a question, please press star 1. The next question comes from Dave Rogers of Baird. Please go ahead.

Yeah. Good morning, everybody. Jeff, I was wondering if you could talk a little bit more about the asset sales that you discussed, not necessarily the ones that you've completed, but you talked about good demand for both single-tenant, multi-tenant buildings as well as both core and value-add. I guess from a value-add perspective, how actively have you shopped those assets and what's your thought process around taking more vacancy to market as opposed to some of the more occupied buildings you've been selling?

Good morning, Dave. We are seeing good interest in both value-add and stabilized assets. It depends on the asset and the market, of course. And so for us, the benchmark is really going to continue to be looking at assets where we can achieve valuations and pricing that on a near-term to short-term basis makes sense and has captured the value that we think gets full value for those assets for us and the returns that we need there. So for example, we were marketing, I'll give you an example. We were marketing our Meadow Point property in Northern Virginia in Chantilly, and we have that Stonecroft property in that same sub-market. We were not marketing that property directly because we have intent and have intended to release and stabilize that property. It's a great property. We received interest from the group we're under contract with, as well as interest from other groups that were interested in not only looking at the stabilized asset, but the value add play as well. And so we're judging these things as they come in, but really the benchmark for us is making sure we capture the value that we see is the full value and the best value for us in the short to near term.

So most likely anticipate that you'd continue to sell some of the higher occupied assets where you've achieved most of the value except on these kind of one-off situations. I mean, is that a fair way to think about it as we look forward?

You know, I think that that's generally fair. I think if you look at what we've done so far, Dave, it's about 83% leased in aggregate for what we've sold so far. And I think that you'll see a spread of that again continuing, so they're not fully leased assets in every instance. There's a mix. And so if we sell, obviously, if we blend Stonecroft with Meadow Point, it's a different type of leased occupancy range. So, you know, so far we've sold about 83%, and, you know, we've got things in play that are, you know, roughly in that type of range, too, in aggregate.

That's helpful. I appreciate that, Jeff. John Donahue, maybe a couple of things. DirecTV showed up on the expiration schedule. I think maybe that's due to some of the asset sales. Can you talk about whether they'll stay or leave at the end of the year? And then maybe just remind me, on Ovinative, you signed a portion of that subtenancy, I think, on a direct lease, and that was in the sub. But can you talk a little bit about the remaining portion of that space, I think, which still expires, and if you're still having negotiations there as well?

Sure, Dave. In regards to expirations, we have just 1.7% of the portfolio remaining this year. And so we're expecting a few tenants to depart and maybe get a few renewals as well. So that could be a mixed bag. And there are no significant tenants above 50,000 square feet that we're aware of at this moment with a known departure over the next six months. So we're feeling pretty good about our probability of success there. In regards to OVINTIV, on the supplemental, you'll see that we still have that listed as 234,000 square feet expiring next year. And we have executed one direct deal with a sub-tenant there for approximately 68,000 square feet. So that's been mitigated down to approximately 170,000 square feet. And then we are in dialogue with a couple of other sub-tenants that could be another couple of floors, as we discussed last quarter, and those are progressing. And then we do have a growing pipeline as well for new prospects. So things are looking very good in Denver right now, and the momentum is headed in the right direction.

Thanks, John. I appreciate that. George, maybe finish with you, bigger picture question and Take it how you will, but I guess, have you and the board, you know, had any strategic alternative discussions about kind of how to go forward? Clearly, you know, there's a strategy that we're going to lease and sell, and that's going to be part of the near-term strategy, but as you look forward, stock's down 80%, you're facing a second dividend cut, you've kind of abandoned the strategy, you're talking about stock buyback, EBITDA's run rate's down 30% or so. I guess as you look at all of that, At what point do you guys have to say, hey, you know, this isn't working. The stock's below $5. You know, we need to do something a little bit better here. Are we getting to that point of we need to kind of either rubber hitting the road or move the road in a different direction?

So all strategic alternatives, all of them, are are discussed all the time and thought about all the time and looked into by the board and with many of our outside professionals. The change this year, which I think is significant, is the change really sort of started in the fourth quarter last year with the disposition of Emperor Boulevard. was to, in fact, get NAB values from properties that, again, we don't believe are reflected in the lower share price that we currently have up in the marketplace. And while most office REITs, I would say, are trading with some discount to NAB, depending on who they are and where they are, We believe our discount is pretty significant and want to take advantage of that with this disposition and balance sheet reset, which we think is a big change. And if you look at the vacancy in the remaining portfolio and analyze those properties and those markets the way we do, We think we have a tremendous opportunity to lease that vacant space on top of a reset balance sheet and improve dramatically our rental income. And so that is the plan for this year. That's the plan we are trying to articulate to the marketplace and are executing on and all other strategic options and opportunities and avenues are always being considered and always being explored and i am no doubt that always look for and find the best opportunities that lay in front of us whatever direction that takes us i appreciate the color thanks george

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

Thank you all for listening to our earnings call, and I look forward to talking with you all next quarter. Thank you.

This concludes our conference call. Thank you for attending today's presentation. You may now disconnect.