FRANKLIN STREET PROPERTIES CORP /MA/ - Quarter Report: 2013 June (Form 10-Q)

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

FORM 10 - Q

 

(Mark One)

[ X ]     QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2013.

 

OR

 

[   ]       TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the transition period from _________ to __________.

 

Commission File Number:  001-32470

 

Franklin Street Properties Corp.

(Exact name of registrant as specified in its charter)

 

 

401 Edgewater Place, Suite 200

Wakefield, MA 01880

(Address of principal executive offices)(Zip Code)

 

(781) 557-1300

(Registrant’s telephone number, including area code)

 

N/A

 (Former name, former address and former fiscal year, if changed since last report)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

 

YES

x

NO

o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

 

YES

x

NO

o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer x		Accelerated filer o
Non-accelerated filer    o (Do not check if a smaller reporting company)		Smaller reporting company o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

 

YES

o

NO

x

 

The number of shares of common stock outstanding as of July 26, 2013 was 100,187,405.

 

 

Franklin Street Properties Corp.

Form 10-Q

 

Quarterly Report

June 30, 2013

 

Table of Contents

 

Part I.	Financial Information		Page
	Item 1.	Financial Statements
		Condensed Consolidated Balance Sheets as of June 30, 2013 and December 31, 2012	3
		Condensed Consolidated Statements of Income for the three and six months ended June 30, 2013 and 2012	4
		Condensed Consolidated Statements of Other Comprehensive Income for the three and six months ended June 30, 2013 and 2012	5
		Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2013 and 2012	6
		Notes to Condensed Consolidated Financial Statements	7-15
	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	16-30
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	31
	Item 4.	Controls and Procedures	32
Part II.	Other Information
	Item 1.	Legal Proceedings	33
	Item 1A.	Risk Factors	33
	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	33
	Item 3.	Defaults Upon Senior Securities	33
	Item 4.	Mine Safety Disclosures	33
	Item 5.	Other Information	33
	Item 6.	Exhibits	33
Signatures			34

 

 

 

PART I – FINANCIAL INFORMATION

 

Item 1.           Financial Statements

 

Franklin Street Properties Corp.

Condensed Consolidated Balance Sheets

(Unaudited)

 

		June 30,			December 31,
(in thousands, except share and par value amounts)		2013			2012
Assets:
Real estate assets:
Land		$	160,670		$	144,336
Buildings and improvements		1,325,919			1,178,144
Fixtures and equipment		960			904
		1,487,549			1,323,384
Less accumulated depreciation		199,524			180,756
Real estate assets, net		1,288,025			1,142,628
Acquired real estate leases, less accumulated amortization of $51,938 and $40,062, respectively		132,662			111,982
Investment in non-consolidated REITs		81,523			81,960
Cash and cash equivalents		24,962			21,267
Restricted cash		602			575
Tenant rent receivables, less allowance for doubtful accounts of $110 and $1,300, respectively		2,331			1,749
Straight-line rent receivable, less allowance for doubtful accounts of $135 and $135, respectively		37,952			35,441
Prepaid expenses		1,760			1,106
Related party mortgage loan receivables		97,846			93,896
Other assets		10,262			12,655
Other assets: derivative asset		6,739			-
Office computers and furniture, net of accumulated depreciation of $658 and $584, respectively		510			544
Deferred leasing commissions, net of accumulated amortization of $13,325 and $11,812, respectively		24,877			23,376
Total assets		$	1,710,051		$	1,527,179
Liabilities and Stockholders’ Equity:
Liabilities:
Bank note payable		$	181,500		$	216,750
Term loan payable		400,000			400,000
Accounts payable and accrued expenses		29,971			31,122
Accrued compensation		1,677			2,540
Tenant security deposits		3,074			2,489
Other liabilities: derivative liability		-			1,219
Acquired unfavorable real estate leases, less accumulated amortization of $5,644 and $4,870, respectively		12,785			8,310
Total liabilities		629,007			662,430
Commitments and contingencies
Stockholders’ Equity:
Preferred stock, $.0001 par value, 20,000,000 shares authorized, none issued or outstanding		-			-
Common stock, $.0001 par value, 180,000,000 shares authorized, 100,187,405 and 82,937,405 shares issued and outstanding, respectively		10			8
Additional paid-in capital		1,273,585			1,042,876
Accumulated other comprehensive income (loss)		6,739			(1,219)
Accumulated distributions in excess of accumulated earnings		(199,290)			(176,916)
Total stockholders’ equity		1,081,044			864,749
Total liabilities and stockholders’ equity		$	1,710,051		$	1,527,179

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

3

 

Franklin Street Properties Corp.

Condensed Consolidated Statements of Income (Loss)

(Unaudited)

 

		For the Three Months Ended June 30,						For the Six Months Ended June 30,
(in thousands, except per share amounts)		2013			2012			2013			2012
Revenue:
Rental		$	46,322		$	35,570		$	89,469		$	71,873
Related party revenue:
Management fees and interest income from loans		1,643			3,045			3,265			5,661
Other		12			39			43			73
Total revenue		47,977			38,654			92,777			77,607
Expenses:
Real estate operating expenses		11,116			8,604			21,886			17,301
Real estate taxes and insurance		7,311			5,493			13,908			11,189
Depreciation and amortization		17,124			13,003			33,111			26,074
Selling, general and administrative		3,204			2,236			5,736			4,313
Interest		4,174			4,037			8,382			7,714
Total expenses		42,929			33,373			83,023			66,591
Income before interest income, equity in earnings (losses) of non-consolidated REITs and taxes		5,048			5,281			9,754			11,016
Interest income		4			4			5			12
Equity in earnings (losses) of non-consolidated REITs		(196)			494			(383)			885
Income before taxes on income		4,856			5,779			9,376			11,913
Taxes on income		115			77			234			156
Income from continuing operations		4,741			5,702			9,142			11,757
Discontinued operations:
Loss from discontinued operations, net of income tax		-			(268)			-			(585)
Total discontinued operations		-			(268)			-			(585)
Net income		$	4,741		$	5,434		$	9,142		$	11,172
Weighted average number of shares outstanding, basic and diluted		91,847			82,937			87,417			82,937
Earnings per share, basic and diluted, attributable to:
Continuing operations		$	0.05		$	0.07		$	0.10		$	0.14
Discontinued operations		-			-			-			(0.01)
Net income per share, basic and diluted		$	0.05		$	0.07		$	0.10		$	0.13

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

4

 

Franklin Street Properties Corp.

Condensed Consolidated Statements of Other Comprehensive Income (Loss)

(Unaudited)

 

		For the Three Months Ended June 30,						For the Six Months Ended June 30,
(in thousands)		2013			2012			2013			2012
Net income		$	4,741		$	5,434		$	9,142		$	11,172
Other comprehensive income:
Unrealized gain on derivative financial instruments		7,517			-			7,958			-
Total other comprehensive income		7,517			-			7,958			-
Comprehensive income		$	12,258		$	5,434		$	17,100		$	11,172

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

5

 

Franklin Street Properties Corp.

Condensed Consolidated Statements of Cash Flows

(Unaudited)

 

		For the Six Months Ended June 30,
(in thousands)		2013			2012
Cash flows from operating activities:
Net income		$	9,142		$	11,172
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization expense		33,968			27,495
Amortization of above market lease		(82)			20
Equity in (earnings) losses of non-consolidated REITs		383			(885)
Distributions from non-consolidated REITs		-			993
Increase (decrease) in bad debt reserve		(1,190)			65
Changes in operating assets and liabilities:
Restricted cash		(27)			(40)
Tenant rent receivables, net		608			(8)
Straight-line rents, net		(1,842)			(2,571)
Lease acquisition costs		(669)			(2,026)
Prepaid expenses and other assets, net		(870)			(1,512)
Accounts payable and accrued expenses		(1,244)			(1,395)
Accrued compensation		(863)			(1,278)
Tenant security deposits		585			105
Payment of deferred leasing commissions		(3,711)			(1,513)
Net cash provided by operating activities		34,188			28,622
Cash flows from investing activities:
Purchase of real estate assets, office computers and furniture		(164,189)			(7,112)
Acquired real estate leases		(28,105)			-
Investments in non-consolidated REITs		4,752			(1)
Distributions in excess of earnings from non-consolidated REITs		54			834
Investment in related party mortgage loan receivable		(3,950)			(37,020)
Changes in deposits on real estate assets		(3,000)			-
Net cash used in investing activities		(194,438)			(43,299)
Cash flows from financing activities:
Proceeds from stock offering		241,500			-
Offering costs		(10,789)			-
Distributions to stockholders		(31,516)			(31,516)
Borrowings (repayments) under bank note payable		(35,250)			45,000
Net cash provided by financing activities		163,945			13,484
Net increase (decrease) in cash and cash equivalents		3,695			(1,193)
Cash and cash equivalents, beginning of period		21,267			23,813
Cash and cash equivalents, end of period		$	24,962		$	22,620
Non-cash investing and financing activities:
Accrued costs for purchase of real estate assets		$	1,785		$	1,090

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

6

 

Franklin Street Properties Corp.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

1.     Organization, Properties, Basis of Presentation, Financial Instruments and Recent Accounting Standards

 

Organization

 

Franklin Street Properties Corp. (“FSP Corp.” or the “Company”), holds, directly and indirectly, 100% of the interest in FSP Investments LLC, FSP Property Management LLC, FSP Holdings LLC and FSP Protective TRS Corp.  FSP Investments LLC is a registered broker/dealer with the Securities and Exchange Commission and is a member of the Financial Industry Regulatory Authority, or FINRA.  FSP Property Management LLC provides asset management and property management services.  The Company also has a non controlling common stock interest in 15 corporations organized to operate as real estate investment trusts (“REIT”) and a non-controlling preferred stock interest in two of those REITs.  Collectively, the 15 REITs are referred to as the “Sponsored REITs”.

 

As of June 30, 2013, the Company owned and operated a portfolio of real estate consisting of 38 properties, managed 15 Sponsored REITs and held seven promissory notes secured by mortgages on real estate owned by Sponsored REITs, including one mortgage loan, one construction loan and five revolving lines of credit.  From time-to-time, the Company may acquire real estate, make additional secured loans or acquire a Sponsored REIT.  The Company may also pursue, on a selective basis, the sale of its properties in order to take advantage of the value creation and demand for its properties, or for geographic or property specific reasons.

 

Properties

 

The following table summarizes the Company’s investment in real estate assets, excluding assets held for sale:

 

			As of June 30,
			2013				2012
Commercial real estate:
Number of properties			38				36
Rentable square feet			8,529,752				7,052,592

 

On July 1, 2013, the Company acquired an office property with approximately 621,007 rentable square feet for $157.9 million located in Atlanta, Georgia.

 

Basis of Presentation

 

The unaudited condensed consolidated financial statements of the Company include all the accounts of the Company and its wholly-owned subsidiaries.  All significant intercompany balances and transactions have been eliminated. These financial statements should be read in conjunction with the Company’s consolidated financial statements and notes thereto contained in the Company’s Annual Report on Form 10-K for its fiscal year ended December 31, 2012, as filed with the Securities and Exchange Commission.

 

The accompanying interim financial statements are unaudited; however, the financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”) for interim financial information and in conjunction with the rules and regulations of the Securities and Exchange Commission.  Accordingly, they do not include all of the disclosures required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting solely of normal recurring matters) necessary for a fair presentation of the financial statements for these interim periods have been included.  Operating results for the three and six months ended June 30, 2013 are not necessarily indicative of the results that may be expected for the year ended December 31, 2013 or for any other period.

 

Financial Instruments

 

The Company estimates that the carrying values of cash and cash equivalents, restricted cash, receivables, prepaid expenses, accounts payable and accrued expenses, accrued compensation, tenant security deposits and the bank note and term loan payable approximate their fair values based on their short-term maturity and prevailing interest rates.

 

7

 

Franklin Street Properties Corp.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

1.     Organization, Properties, Basis of Presentation, Financial Instruments and Recent Accounting Standards (continued)

 

Recent Accounting Standards

 

In February 2013, the Financial Accounting Standards Board, or FASB, issued Accounting Standards Update No. 2013-02, Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income. This update  requires entities to report  the  effect  of  significant reclassifications   out   of   accumulated   other   comprehensive   income   on   the respective  line  items  in  net  income  if  the  amount  being  reclassified  is  required under U.S. generally accepted accounting principles (GAAP) to be reclassified in its  entirety  to  net  income. This update was effective for interim and annual reporting periods beginning after December 15, 2012. The adoption of this update did not have a material impact on the disclosures in, or presentation of, our condensed consolidated financial statements.

 

2.     Related Party Transactions and Investments in Non-Consolidated Entities

 

Investment in Sponsored REITs:

 

At June 30, 2013, the Company held a common stock interest in 15 Sponsored REITs, from which it no longer derives economic benefits or risks.  The Company also holds a non-controlling preferred stock investment in two of these Sponsored REITs, FSP 303 East Wacker Drive Corp. (“East Wacker”) and FSP Grand Boulevard Corp. (“Grand Boulevard”), from which it continues to derive economic benefits and risks.

 

In September 2006, the Company purchased 48 preferred shares or 4.6% of the outstanding preferred shares of one of its Sponsored REITs, FSP Phoenix Tower Corp (“Phoenix Tower”).  On December 20, 2012, the property owned by Phoenix Tower was sold and, thereafter, Phoenix Tower declared and issued a liquidating distribution for its preferred shareholders, from which the Company was entitled to $4,862,000 and received $4,752,000 on January 4, 2013.  As of June 30, 2013, the Company held a beneficial interest in the Phoenix Tower liquidating trust in the amount of $110,000, which is included in other assets in the accompanying consolidated balance sheet.

 

Equity in earnings (losses) of investment in non-consolidated REITs:

 

The following table includes equity in earnings (losses) of investments in non-consolidated REITs:

 

		Six Months Ended
		June 30,
(in thousands)		2013			2012
Equity in earnings of Phoenix Tower		$	-		$	25
Equity in earnings (loss) of East Wacker		(231)			968
Equity in loss of Grand Boulevard		(152)			(108)
		$	(383)		$	885

 

Equity in earnings of investments in non-consolidated REITs is derived from the Company’s share of income (loss) in the operations of those entities.  The Company exercises influence over, but does not control these entities, and investments are accounted for using the equity method.

 

Equity in earnings of Phoenix Tower was derived from the Company’s preferred stock investment in the entity.  On December 20, 2012, the property owned by Phoenix Tower was sold and the Company’s share of the gain was $1,582,000.

 

Equity in earnings (loss) of East Wacker is derived from the Company’s preferred stock investment in the entity.  In December 2007, the Company purchased 965.75 preferred shares or 43.7% of the outstanding preferred shares of East Wacker for $82,813,000 (which represented $96,575,000 at the offering price net of commissions of $7,726,000, loan fees of $5,553,000 and acquisition fees of $483,000 that were excluded).

 

Equity in loss of Grand Boulevard is derived from the Company’s preferred stock investment in the entity.  In May 2009, the Company purchased 175.5 preferred shares or 27.0% of the outstanding preferred shares of Grand Boulevard for $15,049,000 (which represented $17,550,000 at the offering price net of commissions of $1,404,000, loan fees of $1,009,000 and acquisition fees of $88,000 that were excluded).

 

The Company recorded distributions of $54,000 and $1,827,000 from non-consolidated REITs during the six months ended June 30, 2013 and 2012, respectively.

 

8

 

Franklin Street Properties Corp.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

2.             Related Party Transactions and Investments in Non-consolidated Entities (continued)

 

Non-consolidated REITs:

 

The Company has in the past acquired by merger entities similar to the Sponsored REITs.  The Company’s business model for growth includes the potential acquisition, by merger or otherwise, of Sponsored REITs.  The Company has no legal or any other enforceable obligation to acquire or to offer to acquire any Sponsored REIT.  In addition, any offer (and the related terms and conditions) that might be made in the future to acquire any Sponsored REIT would require the approval of the boards of directors of the Company and the Sponsored REIT and the approval of the shareholders of the Sponsored REIT.

 

The operating data below for 2013 and 2012 includes operations of the 15 and 16 Sponsored REITs the Company held an interest in as of June 30, 2013 and 2012, respectively.

 

At June 30, 2013, December 31, 2012 and June 30, 2012, the Company had ownership interests in 15, 15 and 16 Sponsored REITs, respectively.  Summarized financial information for these Sponsored REITs is as follows:

 

		June 30,			December 31,
(in thousands)		2013			2012
Balance Sheet Data (unaudited):
Real estate, net		$	698,697		$	659,655
Other assets		160,698			156,785
Total liabilities		(317,583)			(316,311)
Shareholders’ equity		$	541,812		$	500,129

 

		For the Six Months Ended
		June 30,
(in thousands)		2013			2012
Operating Data (unaudited):
Rental revenues		$	46,691		$	55,833
Other revenues		36			70
Operating and maintenance  expenses		(23,604)			(28,032)
Depreciation and amortization		(15,751)			(17,838)
Interest expense		(6,805)			(8,635)
Net income		$	567		$	1,398

 

Management fees and interest income from loans:

 

Asset management fees range from 1% to 5% of collected rents and the applicable contracts are cancelable with 30 days notice.  Asset management fee income from non-consolidated entities amounted to approximately $534,000 and $559,000 for the six months ended June 30, 2013 and 2012, respectively.

 

From time to time the Company may make secured loans (“Sponsored REIT Loans”) to Sponsored REITs in the form of mortgage loans or revolving lines of credit to fund construction costs, capital expenditures, leasing costs and for other purposes.  The Company anticipates that each Sponsored REIT Loan will be repaid at maturity or earlier from long term financings of the underlying properties, cash flows from the underlying properties or some other capital event.  Each Sponsored REIT Loan is secured by a mortgage on the underlying property and has a term of approximately two to three years.  Except for the mortgage loan which bears interest at a fixed rate, advances under each Sponsored REIT Loan bear interest at a rate equal to the 30-day LIBOR rate plus an agreed upon amount of basis points and most advances also require a 50 basis point draw fee.

 

9

 

Franklin Street Properties Corp.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

2.             Related Party Transactions and Investments in Non-consolidated Entities (continued)

 

The following is a summary of the Sponsored REIT Loans outstanding as of June 30, 2013:

 

(dollars in thousands)

Maximum

Amount

Interest

Maturity

Amount

Drawn at

Interest

Draw

Rate at

Sponsored REIT

Location

Date

of Loan

30-Jun-13

Rate (1)

Fee (2)

30-Jun-13

Secured revolving lines of credit

FSP Highland Place I Corp.

Centennial, CO

31-Dec-13

$

5,500

$

1,375

L+4.4%

0.5%

4.59%

FSP Satellite Place Corp.

Duluth, GA

31-Mar-14

5,500

5,500

L+4.4%

0.5%

4.59%

FSP 1441 Main Street Corp.

Columbia, SC

31-Mar-14

10,800

9,000

L+4.4%

0.5%

4.59%

FSP 505 Waterford Corp.

Plymouth, MN

30-Nov-13

7,000

2,350

L+4.4%

0.5%

4.59%

FSP Galleria North Corp.

Dallas, TX

30-Jan-15

15,000

9,080

L+5.0%

0.5%

5.19%

Secured construction loan

FSP 385 Interlocken

Development Corp.

Broomfield, CO

30-Apr-14

42,000

37,541

L+4.4%

n/a

4.59%

Mortgage loan secured by property

FSP Energy Tower I Corp. (3)

Houston, TX

5-Jul-14

33,000

33,000

6.41%

n/a

6.41%

$

118,800

$

97,846

 

(1)         The interest rate is 30-day LIBOR rate plus the additional rate indicated, otherwise a fixed rate.

(2)         The draw fee is a percentage of each new advance, and is paid at the time of each new draw.

(3)         The loan has a secured fixed mortgage amount of $33,000,000.  A loan fee of $300,630 was paid at the time of closing and funding of the loan on July 5, 2012.  The borrower is required to pay the Company an exit fee in the amount of 0.982% of  the principal repayment amount.

 

The Company recognized interest income and fees from the Sponsored REIT Loans of approximately $2,730,000 and $5,102,000 for the six months ended June 30, 2013 and 2012, respectively.

 

3.     Significant Acquisitions

 

On May 22, 2013, the Company acquired a property in Colorado with approximately 680,277 rentable square feet at a purchase price of approximately $183 million excluding closing costs and adjustments.  The Company expensed acquisition costs of approximately $110,000 related to this acquisition.

 

The purchase price of the property was allocated to real estate investments and leases, including lease origination costs.  Lease origination costs represent the value associated with acquiring an in-place lease (i.e. the market cost to execute a similar lease, including leasing commission, legal, vacancy, and other related costs).  The value assigned to buildings approximates their replacement cost; the value assigned to land approximates its appraised value; and the value assigned to leases approximates their fair value.  Other assets and liabilities are recorded at their historical costs, which approximates fair value.

 

The following table summarizes the estimated fair value of the assets acquired at the date of acquisition:

 

 

Real estate assets		$	154,060
Value of acquired real estate leases		31,024
Acquired unfavorable leases		(2,920)
Total		$	182,164

 

10

 

Franklin Street Properties Corp.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

3.     Significant Acquisitions (continued)

 

The Company assessed the fair value of the acquired real estate leases based on estimated cash flow projections that utilize appropriate discount rates and available market information. Such inputs are Level 3 in the fair value hierarchy.

 

Pro forma operating results for the Company and the acquisition are shown in the following table.  The results assume that the property was acquired on January 1, 2012.  The results are not necessarily indicative of what the Company’s actual results of operations would have been for the periods indicated, nor do they purport to represent the results of operations of any future periods.

 

		For the Three Months Ended						For the Six Months Ended
(unaudited)		June 30,						June 30,
(in thousands except per share amounts)		2013			2012			2013			2012
Revenue		$	50,780		$	42,978		$	100,482		$	86,255
Income from continuing operations		$	4,273		$	5,101		$	8,367		$	10,555
Net income		$	4,273		$	4,833		$	8,367		$	9,970
Weighted average shares outstanding		91,847			82,937			87,417			82,937
Income from continuing operations per share		$	0.05		$	0.06		$	0.10		$	0.13
Net income per share		$	0.05		$	0.06		$	0.10		$	0.12

 

During the six months ended June 30, 2013, the Company recognized approximately $2.2 million of revenues and $0.1 million of  net income from operations of this acquisition.

 

On July 1, 2013, the Company acquired an office property with approximately 621,007 rentable square feet for $157.9 million located in the midtown submarket of Atlanta, Georgia.  The pro forma operating results and the estimated fair value of the assets and liabilities acquired in this acquisition are not available at this time because the Company is in the process of determining such amounts.

 

4.     Bank note payable

 

2012 Credit Facility

 

As of June 30, 2013, the Company had bank notes payable to a group of banks for an unsecured credit facility comprised of both a revolving line of credit and a term loan (the “2012 Credit Facility”). The revolving line of credit portion of the 2012 Credit Facility is for borrowings, at the Company’s election, of up to $500,000,000 (the “2012 Revolver”). The term loan portion of the 2012 Credit Facility is for $400,000,000 (the “2012 Term Loan”).  The 2012 Revolver includes an accordion feature that allows for up to $250,000,000 of additional borrowing capacity subject to receipt of lender commitments and satisfaction of certain customary conditions.

 

On September 27, 2012, the Company and certain of its wholly-owned subsidiaries entered into an Amended and Restated Credit Agreement (the “2012 Credit Agreement”) with the lending institutions referenced in the 2012 Credit Agreement and those lenders from time to time party thereto and Bank of America, N.A., as administrative agent, letter of credit issuer and swing line lender, for the 2012 Credit Facility.  On September 27, 2012, the Company drew down the entire $400,000,000 under the 2012 Term Loan and $82,000,000 under the 2012 Revolver. The Company’s $600,000,000 revolving credit facility (the “2011 Revolver”) that was scheduled to mature on February 22, 2014 was amended and restated in its entirety by the 2012 Credit Agreement and the $482,000,000 in advances outstanding under the 2011 Revolver were repaid from the proceeds of the 2012 Credit Facility.

 

The 2012 Term Loan has a five year term that matures on September 27, 2017. Borrowings made pursuant to the 2012 Revolver may be revolving loans, swing line loans or letters of credit, the combined sum of which may not exceed $500,000,000 outstanding at any time. Borrowings made pursuant to the 2012 Revolver may be borrowed, repaid and reborrowed from time to time for four years until September 27, 2016, the initial maturity date of the 2012 Revolver. The Company has the right to extend the initial maturity date of the 2012 Revolver by an additional 12 months, or until September 27, 2017, upon payment of a fee and satisfaction of certain customary conditions.

 

The 2012 Credit Facility bears interest at either (i) a rate equal to LIBOR plus 135 to 190 basis points depending on the Company’s total leverage ratio at the time of the borrowing (LIBOR plus 145 basis points, or 1.65% at June 30, 2013) or (ii) a rate equal to the bank’s base rate plus 35 to 90 basis points depending on our total leverage ratio at the time of the borrowing (the bank’s base rate plus 45 basis points, or 3.70% at June 30, 2013).  The 2012 Credit Facility also obligates the Company to pay an annual facility fee of 20 to

 

11

 

Franklin Street Properties Corp.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

4.     Bank note payable (continued)

 

40 basis points depending on the Company’s total leverage ratio (30 basis points at June 30, 2013).  The facility fee is assessed against the total amount of the 2012 Credit Facility, or $900,000,000. The actual amount of any applicable facility fee, LIBOR rate or base rate is determined based on the Company’s total leverage ratio as described in the table below:

 

Leverage Ratio		Facility Fee		LIBOR Margin		Base Rate Margin
< 25%		20.0 bps		135.0 bps		35.0 bps
> 25% and < 35%		25.0 bps		140.0 bps		40.0 bps
> 35% and < 45%		30.0 bps		145.0 bps		45.0 bps
> 45% and < 55%		35.0 bps		165.0 bps		65.0 bps
> 55%		40.0 bps		190.0 bps		90.0 bps

 

For purposes of the 2012 Credit Facility, base rate means, for any day, a fluctuating rate per annum equal to the highest of: (i) the bank’s prime rate for such day, (ii) the Federal Funds Rate for such day, plus 1/2 of 1.00%, and (iii) the one month LIBOR base rate for such day plus 1.00%.

 

Although the interest rate on the 2012 Credit Facility is variable, under the 2012 Credit Agreement, the Company fixed the base LIBOR interest rate on the 2012 Term Loan by entering into an interest rate swap agreement. On September 27, 2012, the Company entered into an ISDA Master Agreement with Bank of America, N.A. that fixed the base LIBOR interest rate on the 2012 Term Loan at 0.75% per annum for five years.  Accordingly, based upon the Company’s leverage ratio, as of June 30, 2013, the interest rate on the 2012 Term Loan was 2.20% per annum.  In addition, based upon the Company’s leverage ratio, as of June 30, 2013, there were borrowings of $181,500,000 outstanding under the 2012 Revolver at a weighted average rate of 1.65% per annum.  The weighted average interest rate on all amounts outstanding during the six months ended June 30, 2013 was approximately 1.65% per annum.

 

As of December 31, 2012, there were borrowings of $216,750,000 outstanding under the 2012 Revolver at a weighted average rate of 2.23% per annum.

 

The 2012 Credit Agreement contains customary affirmative and negative covenants for credit facilities of this type, including limitations with respect to indebtedness, liens, investments, mergers and acquisitions, disposition of assets, changes in business, certain restricted payments, the requirement to join certain subsidiaries as co-borrowers under the 2012 Credit Agreement and transactions with affiliates. The 2012 Credit Agreement also contains financial covenants that require the Company to maintain a minimum tangible net worth, a minimum fixed charge coverage ratio, a maximum secured leverage ratio, a maximum leverage ratio, a maximum unencumbered leverage ratio, a minimum unencumbered debt service coverage ratio, a maximum ratio of certain investments to total assets and a maximum amount of secured recourse indebtedness. The 2012 Credit Agreement provides for customary events of default with corresponding grace periods, including failure to pay any principal or interest when due, certain cross defaults and a change in control of the Company (as defined in the 2012 Credit Agreement). In the event of a default by the Company, the administrative agent may, and at the request of the requisite number of lenders shall, declare all obligations under the 2012 Credit Agreement immediately due and payable, terminate the lenders’ commitments to make loans under the 2012 Credit Agreement, and enforce any and all rights of the lenders or administrative agent under the 2012 Credit Agreement and related documents. For certain  events of default related to bankruptcy, insolvency, and receivership, the commitments of lenders will be automatically terminated and all outstanding obligations of the Company will become immediately due and payable.  The Company was in compliance with the 2012 Credit Facility financial covenants as of June 30, 2013.

 

The Company may use the proceeds of the loans under the 2012 Credit Agreement to finance the acquisition of real properties and for other permitted investments; to finance investments associated with Sponsored REITs, to refinance or retire existing indebtedness and for working capital and other general business purposes, in each case to the extent permitted under the 2012 Credit Agreement.

 

5.     Financial Instruments: Derivatives and Hedging

 

On September 27, 2012, the Company fixed the interest rate for five-years on the 2012 Term Loan with an interest rate swap agreement. The variable rate that was fixed under the interest rate swap agreement is described in Note 4.

 

12

 

Franklin Street Properties Corp.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

5.     Financial Instruments: Derivatives and Hedging (continued)

 

The interest swap agreement qualifies as a cash flow hedge and has been recognized on the consolidated balance sheet at fair value.  If a derivative qualifies as a hedge, depending on the nature of the hedge, changes in the fair value of the derivative will either be offset against the change in fair value of the hedged asset, liability, or firm commitment through earnings, or recognized in other comprehensive income until the hedged item is recognized in earnings.  The ineffective portion of a derivative’s change in fair value will be immediately recognized in earnings, which may increase or decrease reported net income and stockholders’ equity prospectively, depending on future levels of interest rates and other variables affecting the fair values of derivative instruments and hedged items, but will have no effect on cash flows.

 

The following table summarizes the notional and fair value of our derivative financial instrument at June 30, 2013.  The notional value is an indication of the extent of our involvement in these instruments at that time, but does not represent exposure to credit, interest rate or market risks.

 

(in thousands)

Notional

Strike

Effective

Expiration

Fair

Value

Rate

Date

Date

Value

Interest Rate Swap

$

400,000

0.75

%

Sep-12

Sep-17

$

6,739

 

On June 30, 2013, the derivative instrument was reported as an asset at its fair value of approximately $6.7 million.  This is included in other assets: derivative asset on the consolidated balance sheet at June 30, 2013.  Offsetting adjustments are reported as unrealized gains or losses on derivative financial instruments in accumulated other comprehensive income of $8.0 million.  During the six months ended June 30, 2013, $1.1 million was reclassified out of other comprehensive income and into interest expense.

 

Over time, the unrealized gains and losses held in accumulated other comprehensive income will be reclassified into earnings as an increase or reduction to interest expense in the same periods in which the hedged interest payments affect earnings.  We estimate that approximately $1.6 million of the current balance held in accumulated other comprehensive income will be reclassified into earnings within the next 12 months.

 

We are hedging the exposure to variability in future cash flows for forecasted transactions in addition to anticipated future interest payments on existing debt.

 

The fair value of the Company’s derivative instrument is determined using the net discounted cash flows of the expected cash flows of the derivative based on the market based interest rate curve. This financial instrument was classified within Level 2 of the fair value hierarchy and was classified as an asset or liability on the condensed consolidated balance sheet.

 

6.     Net Income Per Share

 

Basic net income per share is computed by dividing net income by the weighted average number of Company shares outstanding during the period.  Diluted net income per share reflects the potential dilution that could occur if securities or other contracts to issue shares were exercised or converted into shares.  There were no potential dilutive shares outstanding at June 30, 2013 and 2012, respectively.

 

7.     Stockholders’ Equity

 

As of June 30, 2013, the Company had 100,187,405 shares of common stock outstanding.

 

Equity Offerings

 

On May 15, 2013, the Company completed an underwritten public offering of 17,250,000 shares of its common stock (including 2,250,000 shares issued as a result of the full exercise of an overallotment option by the underwriter) at a price to the public of $14.00 per share. The proceeds from this public offering, net of underwriter discounts and offering costs, totaled approximately $230.7 million (after payment of offering costs of approximately $10.8 million).

 

13

 

Franklin Street Properties Corp.

Notes to the Consolidated Financial Statements

(Unaudited)

 

7.     Stockholders’ Equity (continued)

 

On May 6, 2010, the Company entered into an on demand offering sales agreement whereby the Company may offer and sell up to an aggregate gross sales price of $75 million of its common stock from time to time (the “ATM Sales Program”).  The on demand offering sales agreement for the ATM Sales Program was amended on April 27, 2012 in connection with the Company’s filing of a new Registration Statement on Form S-3.  Sales of shares of the Company’s common stock depend upon market conditions and other factors determined by the Company and may be deemed to be “at the market offerings” as defined in Rule 415 of the Securities Act of 1933, as amended, including sales made directly on the NYSE MKT or sales made to or through a market maker other than on an exchange, as well as in negotiated transactions, if and to the extent agreed by the Company in writing.  The Company has no obligation to sell any shares of its common stock, and may at any time suspend solicitation and offers. During the three and six months ended June 30, 2013, the Company did not sell any shares under the ATM Sales Program.  As of June 30, 2013, the Company was authorized to offer and sell a remainder of approximately $34.3 million of its shares of common stock under the ATM Sales Program.

 

The Company declared and paid dividends as follows (in thousands, except per share amounts):

 

Quarter Paid		Dividends Per Share			Total Dividends
First quarter of 2013		$	0.19		$	15,758
Second quarter of 2013		$	0.19		$	15,758
First quarter of 2012		$	0.19		$	15,758
Second quarter of 2012		$	0.19		$	15,758

 

8.        Income Taxes

 

The Company has elected to be taxed as a REIT under the Internal Revenue Code of 1986, as amended (the “Code”).  As a REIT, the Company generally is entitled to a tax deduction for distributions paid to its shareholders, thereby effectively subjecting the distributed net income of the Company to taxation at the shareholder level only.  The Company must comply with a variety of restrictions to maintain its status as a REIT.  These restrictions include the type of income it can earn, the type of assets it can hold, the number of shareholders it can have and the concentration of their ownership, and the amount of the Company’s taxable income that must be distributed annually.

 

One such restriction is that the Company generally cannot own more than 10% of the voting power or value of the securities of any one issuer unless the issuer is itself a REIT or a taxable REIT subsidiary (“TRS”).  In the case of TRSs, the Company’s ownership of securities in all TRSs generally cannot exceed 25% of the value of all of the Company’s assets and, when considered together with other non-real estate assets, cannot exceed 25% of the value of all of the Company’s assets.   FSP Investments and FSP Protective TRS Corp. are the Company’s taxable REIT subsidiaries operating as taxable corporations under the Code.

 

Accrued interest and penalties will be recorded as income tax expense, if the Company records a liability in the future.  The Company and one or more of its subsidiaries files income tax returns in the U.S. federal jurisdiction and various state jurisdictions.  The statute of limitations for the Company’s income tax returns is generally three years and as such, the Company’s returns that remain subject to examination would be primarily from 2009 and thereafter.

 

Income taxes are recorded based on the future tax effects of the difference between the tax and financial reporting bases of the Company’s assets and liabilities.  In estimating future tax consequences, potential future events are considered except for potential changes in income tax law or in rates.

 

The Company is subject to business tax (the “Revised Texas Franchise Tax”).  The Revised Texas Franchise Tax is a tax at a rate of approximately 0.7% of revenues at Texas properties commencing with 2007 revenues.  Some of the Company’s leases allow reimbursement by tenants for these amounts because the Revised Texas Franchise Tax replaces a portion of the property tax for school districts.  Because the tax base on the Revised Texas Franchise Tax is derived from an income based measure it is considered an income tax.  The Company recorded a provision for income taxes on its income statement of $223,000 and $154,000 for the six months ended June 30, 2013 and 2012, respectively.

 

14

 

Franklin Street Properties Corp.

Notes to the Consolidated Financial Statements

(Unaudited)

 

8.                        Income Taxes (continued)

 

The income tax expense reflected in the consolidated statements of income relates primarily to a franchise tax on our Texas properties.  FSP Protective TRS Corp. provides taxable services to tenants at some of the Company’s properties and the tax expenses associated with these activities are reported as Other Taxes in the table below:

 

		For the
		Six Months Ended
		June 30,
(in thousands)		2013			2012
Revised Texas franchise tax		$	223		$	154
Other Taxes		11			2
Income tax expense		$	234		$	156

 

Taxes on income are a current tax expense.  No deferred income taxes were provided as there were no material temporary differences between the financial reporting basis and the tax basis of the TRSs.

 

9.              Discontinued Operations

 

The Company reports the results of operations of its properties either sold or held for sale as discontinued operations in its consolidated statements of income, which includes rental income, rental operating expenses, real estate taxes and insurance, depreciation and amortization.

 

The Company sold an office property located in Southfield, Michigan, on December 21, 2012, which has been classified as discontinued for all periods presented.

 

The operating results for discontinued operations are summarized below.

 

		For the Three Months Ended June 30,			For the Six Months Ended June 30,
(in thousands)		2012			2012
Rental revenue		$	259		$	624
Rental operating expenses		(224		)	(603		)
Real estate taxes and insurance		(82		)	(200		)
Depreciation and amortization		(221		)	(406		)
Loss from discontinued operations		$	(268	)	$	(585	)

 

 

10.                               Subsequent Events

 

On July 1, 2013, the Company acquired an office property with approximately 621,007 rentable square feet for $157.9 million located in the midtown submarket of Atlanta, Georgia.

 

On July 12, 2013, the Board of Directors of the Company declared a cash distribution of $0.19 per share of common stock payable on August 15, 2013 to stockholders of record on July 26, 2013.

 

On July 15, 2013, the Company entered into an agreement to acquire an office property that consists of a 20-story office building and a retail plaza containing an aggregate of approximately 655,565 rentable square feet of space located in the central business district of Denver, Colorado for $217 million. The purchase of the property is subject to customary conditions and termination rights for transactions of this type, including a due diligence inspection period for the Company.  Assuming the Company completes a satisfactory due diligence inspection of the property and certain other conditions are satisfied, the closing of the purchase of the property will take place on August 28, 2013. The pro forma operating results from this acquisition are not available at this time as the acquisition is not considered probable and the books and records are not fully available.

 

On July 18, 2013, the Company made a $0.4 million advance pursuant to a Sponsored REIT loan to wholly-owned subsidiary of FSP Galleria North Corp.

 

15

 

Item 2.         Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

The following discussion should be read in conjunction with the financial statements and notes thereto appearing elsewhere in this report and in our Annual Report on Form 10-K for the year ended December 31, 2012.  Historical results and percentage relationships set forth in the condensed consolidated financial statements, including trends which might appear, should not be taken as necessarily indicative of future operations.  The following discussion and other parts of this Quarterly Report on Form 10-Q may also contain forward-looking statements based on current judgments and current knowledge of management, which are subject to certain risks, trends and uncertainties that could cause actual results to differ materially from those indicated in such forward-looking statements.  Accordingly, readers are cautioned not to place undue reliance on forward-looking statements.  Investors are cautioned that our forward-looking statements involve risks and uncertainty, including without limitation, economic conditions in the United States, disruptions in the debt markets, economic conditions in the markets in which we own properties, risks of a lessening of demand for the types of real estate owned by us, uncertainties relating to fiscal policy, changes in government regulations and regulatory uncertainty, geopolitical events, and expenditures that cannot be anticipated such as utility rate and usage increases, unanticipated repairs, additional staffing, insurance increases and real estate tax valuation reassessments.  See Item 1A. “Risk Factors” below.  Although we believe the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements.  We may not update any of the forward-looking statements after the date this Quarterly Report on Form 10-Q is filed to conform them to actual results or to changes in our expectations that occur after such date, other than as required by law.

 

Overview

 

FSP Corp., or we, operate in the real estate operations segment. The real estate operations segment involves real estate rental operations, leasing, secured financing of real estate and services provided for asset management, property management, property acquisitions, dispositions and development.  Our investment strategy is to make direct investments in real estate assets. Institutional-quality urban infill and central business district office properties within our core markets of Atlanta, Dallas, Denver, and Houston will be our primary target for investment. We will also monitor San Diego, Silicon Valley, Greater Boston, Raleigh-Durham, and Greater Washington, DC, as well as other markets, for opportunistic investments.

 

The main factor that affects our real estate operations is the broad economic market conditions in the United States.  These market conditions affect the occupancy levels and the rent levels on both a national and local level.  We have no influence on broader economic/market conditions.  We look to acquire and/or develop quality properties in good locations in order to lessen the impact of downturns in the market and to take advantage of upturns when they occur.

 

Critical Accounting Policies

 

We have certain critical accounting policies that are subject to judgments and estimates by our management and uncertainties of outcome that affect the application of these policies.  We base our estimates on historical experience and on various other assumptions we believe to be reasonable under the circumstances.  On an on-going basis, we evaluate our estimates.  In the event estimates or assumptions prove to be different from actual results, adjustments are made in subsequent periods to reflect more current information.  The accounting policies that we believe are most critical to the understanding of our financial position and results of operations, and that require significant management estimates and judgments, are discussed in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended December 31, 2012.

 

Critical accounting policies are those that have the most impact on the reporting of our financial condition and results of operations and those requiring significant judgments and estimates.  We believe that our judgments and assessments are consistently applied and produce financial information that fairly presents our results of operations.  No changes to our critical accounting policies have occurred since the filing of our Annual Report on Form 10-K for the year ended December 31, 2012.

 

Recent Accounting Standards

 

In February 2013, the Financial Accounting Standards Board, or FASB, issued Accounting Standards Update No. 2013-02, Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income. This update  requires entities to report  the  effect  of  significant reclassifications   out   of   accumulated   other   comprehensive   income   on   the respective  line  items  in  net  income  if  the  amount  being  reclassified  is  required under U.S. generally accepted accounting principles (GAAP) to be reclassified in its  entirety  to  net  income. This update was effective for interim and annual reporting periods beginning after December 15, 2012. The adoption of this update did not have a material impact on the disclosures in, or presentation of, our condensed consolidated financial statements.

 

16

 

Trends and Uncertainties

 

Economic Conditions

 

The economy in the United States is continuing to experience a period of limited economic growth, including high levels of unemployment, which directly affects the demand for office space, our primary income producing asset.  The broad economic market conditions in the United States are affected by numerous factors, including but not limited to, inflation and employment levels, energy prices, slow economic growth and/or recessionary concerns, uncertainty about government fiscal and tax policy, changes in currency exchange rates, geopolitical events, the regulatory environment, the availability of debt and interest rate fluctuations.  Future economic factors may negatively affect real estate values, occupancy levels and property income.  At this time, we cannot predict the extent or duration of any negative impact that the current state of the United States economy could have on our business.

 

Real Estate Operations

 

Leasing

 

Our real estate portfolio was approximately 94.4% leased as of June 30, 2013.  During the six months ended June 30, 2013, we leased approximately 468,000 square feet of office space, of which approximately 292,000 square feet were with existing tenants, at a weighted average term of 7.13 years.  On average, tenant improvements for such leases were $17.11 per square foot, lease commissions were $8.84 per square foot and rent concessions were approximately three months of free rent.  Average GAAP base rents under such leases were $24.40 per square foot, or 12.7% higher than average rents in the respective properties as applicable compared to the year ended December 31, 2012.

 

As of June 30, 2013, approximately 1.2% of the square footage in our portfolio is scheduled to expire during the remainder of 2013, and approximately 4.5% is scheduled to expire during 2014.  We anticipate growth in rental revenue from our existing portfolio of properties during the second half of 2013, as we begin to realize the benefits of leases entered into over the past few quarters.  Our property portfolio is comprised of office assets.  We believe that most of the rental/leasing markets where our properties are located remained stable during the second quarter both in terms of occupancy and rental rate levels.  Our property portfolio has relatively modest lease expirations over the next year and a half and, along with our improving occupancy levels, should allow overall tenant improvement expenditures and leasing costs to continue to moderate in relation to the level of rental revenues being achieved.  We are optimistic that we can maintain or increase our occupancy levels during the remainder of 2013.

 

While we cannot generally predict when existing vacancy in our real estate portfolio will be leased or if existing tenants with expiring leases will renew their leases or what the terms and conditions of the lease renewals will be, we expect to renew or sign new leases at then-current market rates for locations in which the buildings are located, which could be below the expiring rates.  Also, even as the economy recovers, we believe the potential for any of our tenants to default on its lease or to seek the protection of bankruptcy still exists.  If any of our tenants defaults on its lease, we may experience delays in enforcing our rights as a landlord and may incur substantial costs in protecting our investment.  In addition, at any time, a tenant of one of our properties may seek the protection of bankruptcy laws, which could result in the rejection and termination of such tenant’s lease and thereby cause a reduction in cash available for distribution to our stockholders.

 

Real Estate Acquisitions and Investments

 

During 2013:

·         on May 22, we acquired an office property with approximately 680,277 rentable square feet of space for $183.0 million located in the central business district of Denver, Colorado;

·                  on July 1, we acquired an office property with approximately 621,007 rentable square feet for $157.9 million located in the midtown submarket of Atlanta, Georgia;

·                  on July 15, we entered into an agreement to acquire an office property that consists of a 20-story office building and a retail plaza containing an aggregate of approximately 655,565 rentable square feet of space located in the central business district of Denver, Colorado for $217 million. The purchase of the property is subject to customary conditions and termination rights for transactions of this type, including a due diligence inspection period for us.  Assuming we complete a satisfactory due diligence inspection of the property and certain other conditions are satisfied, the closing of the purchase of the property will take place on August 28, 2013; and

·         funded advances on Sponsored REIT Loans for revolving lines of credit of an aggregate of approximately $4.0 million.

 

Additional potential real estate investment opportunities are actively being explored and we would anticipate further real estate investments during the remainder of 2013 and/or 2014.

 

17