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FSP > SEC Filings for FSP > Form 10-Q on 29-Oct-2013All Recent SEC Filings

Show all filings for FRANKLIN STREET PROPERTIES CORP /MA/

Form 10-Q for FRANKLIN STREET PROPERTIES CORP /MA/


29-Oct-2013

Quarterly Report


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 current strategy is to invest in select urban infill and central business district office properties, with primary emphasis on our top five markets of Atlanta, Dallas, Denver, Houston and Minneapolis. We will also monitor San Diego, Silicon Valley, Greater Boston, Raleigh-Durham, and Greater Washington, DC, as well as other markets, for opportunistic investments. FSP Corp. seeks value-oriented investments with an eye towards long-term growth and appreciation, as well as current income.

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.


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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 93.8% leased as of September 30, 2013, a decrease from 94.4% as of June 30, 2013. The drop in leased percentage for the third quarter was primarily attributable to the acquisition of a 655,420 square foot office building in Denver, Colorado that was 88.5% leased at the time of acquisition. We believe this property offers an excellent opportunity to increase occupancy and rental income stream within a vibrant and growing Denver central business district office market, creating incremental value for the Company. During the nine months ended September 30, 2013, we leased approximately 645,000 square feet of office space, of which approximately 457,000 square feet were with existing tenants, at a weighted average term of 7.75 years. On average, tenant improvements for such leases were $22.14 per square foot, lease commissions were $9.14 per square foot and rent concessions were approximately four months of free rent. Average GAAP base rents under such leases were $23.13 per square foot, or 10.4% higher than average rents in the respective properties as applicable compared to the year ended December 31, 2012.

As of September 30, 2013, approximately 0.6% of the square footage in our portfolio is scheduled to expire during the remainder of 2013, and approximately 4.9% is scheduled to expire during 2014. As the fourth quarter of 2013 begins, our property portfolio is well stabilized, with a balanced lease expiration schedule. We believe that most of our largest property markets are now experiencing positive trends in both occupancies and rental rates.

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 August 28, we acquired an office property with approximately 655,565 rentable square feet of space for $217.0 million located in the central business district of Denver, Colorado; and

funded advances on Sponsored REIT Loans for revolving lines of credit of an aggregate of approximately $5.0 million.

Additional potential real estate investment opportunities are actively being explored and we would anticipate further real estate investments in the future.


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During 2012, we:

acquired two properties directly into our portfolio with a total of approximately 1,016,000 rentable square feet at an aggregate purchase price of approximately $207.6 million. On July 31, 2012, we acquired an office property with approximately 387,000 square feet for approximately $52.8 million in Atlanta, Georgia and on November 1, 2012 we acquired an office property with approximately 629,000 square feet for approximately $154.8 million in Houston, Texas;

funded advances on Sponsored REIT Loans for revolving lines of credit of an aggregate of approximately $41.6 million including $30 million during March 2012 to FSP 50 South Tenth Street Corp., and $11.6 million for revolving lines of credit made during the year ended December 31, 2012;

received repayments on Sponsored REIT Loans of $121.2 million, including $106.2 million on July 27, 2012 from a first mortgage loan on a property owned by FSP 50 South Tenth Street Corp., and $15.0 million on December 20, 2012 from a secured revolving line of credit with FSP Phoenix Tower Corp.; and

made and funded a Sponsored REIT Loan on July 5, 2012, in the form of a first mortgage loan in the principal amount of $33 million to a wholly-owned subsidiary of a Sponsored REIT, FSP Energy Tower I Corp., which owns a property in Houston, Texas.

Property Dispositions

We include properties sold or held for sale as discontinued operations in our consolidated financial statements for all periods presented. During the three months ended September 30, 2013, we reached an agreement to sell an office property located in Richardson, Texas. The property was classified as an asset held for sale at September 30, 2013 and is expected to be sold within one year in excess of its net book value. The Company sold an office property located in Southfield, Michigan, on December 21, 2012. Accordingly, both properties were classified as discontinued for all periods presented.

We will continue to evaluate our portfolio, and in the future may decide to dispose of additional properties from time-to-time in the ordinary course of business. We believe that the current property sales environment remains challenged in many markets relative to both liquidity and pricing. However, we also believe that we are witnessing improving pricing and liquidity in certain markets. We believe that both improving office property fundamentals as well as plentiful and attractive financing availability will likely be required to broadly improve the marketplace for potential property dispositions. As an important part of our total return strategy, we intend to be active in property dispositions when we believe that market conditions warrant such activity and, as a consequence, we continuously review and evaluate our portfolio of properties for potentially advantageous dispositions.

Results of Operations

Impact of Real Estate Acquisitions and Investment Activity:

The results of operations for each of the acquired properties are included in our operating results as of their respective purchase dates and the funding and repayment dates for mortgage investments. Increases or decreases in interest income and increases in rental revenues and expenses for the three and nine months ended September 30, 2013 compared to the three and nine months ended September 30, 2012, are primarily a result of the timing of these acquisitions and subsequent contribution of these acquired properties as well as the effect on interest income from the dates of funding and repayment on our mortgage investments.


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The following table shows results for the three months ended September 30, 2013 and 2012:

                                                  Three months ended September 30,
(in thousands)                                   2013            2012          Change
Revenue:
Rental                                       $     56,760    $     37,944    $    18,816
Related party revenue:
Management fees and interest income from
loans                                               1,665           3,485         (1,820 )
Other                                                  21              39            (18 )
Total revenue                                      58,446          41,468         16,978

Expenses:
Real estate operating expenses                     13,991           9,642          4,349
Real estate taxes and insurance                     8,801           5,761          3,040
Depreciation and amortization                      22,163          13,367          8,796
Selling, general and administrative                 3,477           3,141            336
Interest                                            5,474           4,187          1,287
Total expenses                                     53,906          36,098         17,808

Income before interest income, equity in
earnings (losses) of non-consolidated
REITs and taxes                                     4,540           5,370           (830 )
Interest income                                         5               5              -
Equity in earnings (losses) of
non-consolidated REITs                               (431 )           176           (607 )

Income before taxes on income                       4,114           5,551         (1,437 )
Taxes on income                                       118              80             38

Income from continuing operations                   3,996           5,471         (1,475 )

Discontinued operations:
Income (loss) from discontinued
operations, net of income tax                          98            (169 )          267
Provision for loss on property held for
sale of $14,300 less applicable income
tax                                                     -         (14,300 )       14,300
Total discontinued operations                          98         (14,469 )       14,567

Net income                                   $      4,094    $     (8,998 )  $    13,092

Comparison of the three months ended September 30, 2013 to the three months ended September 30, 2012:

Revenues

Total revenues increased by $17.0 million to $58.4 million for the quarter ended September 30, 2013, as compared to the quarter ended September 30, 2012. The increase was primarily a result of:

An increase in rental revenue of approximately $18.8 million arising primarily from property acquisitions in July 2012, November 2012, May 2013, July 2013 and August 2013, which were included in the quarter ended September 30, 2013; and to a lesser extent, leasing, which raised occupancy approximately 2.5% in the continuing real estate portfolio at September 30, 2013 compared to September 30, 2012.

The increase was partially offset by a $1.8 million decrease in interest income from loans to Sponsored REITs, which was primarily a result of repayment of two loans that were outstanding during the three months ended September 30, 2012 and that were repaid in July and December 2012. These repayments resulted in lower average loan receivable balances from which interest income is derived, during the three months ended September 30, 2013, as compared to the three months ended September 30, 2012.


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Expenses

Total expenses increased by $17.8 million to $53.9 million for the quarter ended September 30, 2013, as compared to the quarter ended September 30, 2012. The increase was primarily a result of:

An increase in real estate operating expenses and real estate taxes and insurance of approximately $7.4 million, and depreciation and amortization of $8.8 million, which were primarily from property acquisitions in July 2012, November 2012, May 2013, July 2013 and August 2013, which were included in the quarter ended September 30, 2013.

An increase to interest expense of approximately $1.3 million to $5.5 million during the three months ended September 30, 2013 compared to the same period in 2012. The increase was attributable to a higher amount of debt outstanding, which was partially offset by lower average interest rates during the third quarter of 2013 compared to the third quarter of 2012.

An increase in selling, general and administrative expenses of approximately $0.3 million, which was primarily the result of increased personnel related expenses, acquisition costs and professional fees. We had 35 and 35 employees as of September 30, 2013 and 2012, respectively, at our headquarters in Wakefield, Massachusetts.

Equity in earnings (losses) of non-consolidated REITs

Equity in earnings (losses) from non-consolidated REITs decreased approximately $0.6 million to a loss of $0.4 million during the three months ended September 30, 2013 compared to income of $0.2 million for the same period in 2012. The decrease was primarily because equity in income from our preferred stock investment in a Sponsored REIT, FSP 303 East Wacker Drive Corp., which we refer to as East Wacker, decreased $0.6 million during the three months ended September 30, 2013 compared to the same period in 2012.

Taxes on income

Included in income taxes is the Revised Texas Franchise Tax, which is a tax on revenues from Texas properties that increased $25,000 and federal income taxes of $13,000 for the three months ended September 30, 2013, compared to the three months ended September 30, 2012.

Income from continuing operations

Income from continuing operations for the three months ended September 30, 2013 was $4.0 million compared to $5.5 million for the three months ended September 30, 2012, for the reasons described above.

Discontinued operations and provision for sale of property

Income from discontinued operations increased $14.6 million for the three months ended September 30, 2013 compared to the three months ended September 30, 2012. During September 2013, we reached an agreement to sell an office property located in Richardson, Texas in excess of its net book value. In September 2012, we reached a decision to classify an office property in Southfield Michigan and recorded a provision for loss on the property of $14.3 million. The property was sold in December 2012. These assets are classified as held for sale on our balance sheet and resulted in a reclassification of real estate income and expenses of these properties to discontinued operations for all periods presented.

Net income

Net income for the three months ended September 30, 2013 was $4.1 million compared to a net loss of $9.0 million for the three months ended September 30, 2012, for the reasons described above.


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The following table shows results for the nine months ended September 30, 2013 and 2012:

                                                   Nine months ended September 30,
(in thousands)                                   2013            2012          Change
Revenue:
Rental                                       $    145,618    $    109,207    $    36,411
Related party revenue:
Management fees and interest income from
loans                                               4,929           9,146         (4,217 )
Other                                                  64             112            (48 )
Total revenue                                     150,611         118,465         32,146

Expenses:
Real estate operating expenses                     35,877          26,938          8,939
Real estate taxes and insurance                    22,704          16,946          5,758
Depreciation and amortization                      54,863          39,031         15,832
Selling, general and administrative                 9,213           7,454          1,759
Interest                                           13,856          11,901          1,955
Total expenses                                    136,513         102,270         34,243

Income before interest income, equity in
earnings (losses) of non-consolidated
REITs and taxes                                    14,098          16,195         (2,097 )
Interest income                                        10              17             (7 )
Equity in earnings (losses) of
non-consolidated REITs                               (814 )         1,061         (1,875 )

Income before taxes on income                      13,294          17,273         (3,979 )
Taxes on income                                       352             236            116

Income from continuing operations                  12,942          17,037         (4,095 )

Discontinued operations:
Income (loss) from discontinued
operations, net of income tax                         294            (563 )          857
Provision for loss on property held for
sale of $14,300 less applicable income
tax                                                     -         (14,300 )       14,300
Total discontinued operations                         294         (14,863 )       15,157

Net income                                   $     13,236    $      2,174    $    11,062

Comparison of the nine months ended September 30, 2013 to the nine months ended September 30, 2012:

Revenues

Total revenues increased by $32.1 million to $150.6 million for the nine months ended September 30, 2013, as compared to the nine months ended September 30, 2012. The increase was primarily a result of:

An increase in rental revenue of approximately $36.4 million arising primarily from property acquisitions in July 2012, November 2012, May 2013, July 2013 and August 2013, which were included in the nine months ended September 30, 2013; and to a lesser extent, leasing, which raised occupancy approximately 2.5% in the continuing real estate portfolio at September 30, 2013 compared to September 30, 2012.

The increase was partially offset by a $4.2 million decrease in interest income from loans to Sponsored REITs, which was primarily a result of repayment of two loans that were outstanding during the nine months ended September 30, 2012 and that were repaid in July and December 2012. These repayments resulted in lower average loan receivable balances from which interest income is derived, during the nine months ended September 30, 2013, as compared to the nine months ended September 30, 2012.


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Expenses

Total expenses increased by $34.2 million to $136.5 million for the nine months ended September 30, 2013, as compared to the nine months ended September 30, 2012. The increase was primarily a result of:

An increase in real estate operating expenses and real estate taxes and insurance of approximately $14.7 million, and depreciation and amortization of $15.8 million, which were primarily from property acquisitions in July 2012, November 2012, May 2013, July 2013 and August 2013, which were included in the nine months ended September 30, 2013.

An increase to interest expense of approximately $2.0 million to $13.9 million during the nine months ended September 30, 2013 compared to the same period in 2012. The increase was attributable to a higher amount of debt outstanding, which was partially offset by lower average interest rates during the nine months ended September 30, 2013 compared to the same period in 2012.

An increase in selling, general and administrative expenses of approximately $1.7 million, which was primarily the result of increased personnel related expenses, acquisition costs and professional fees. We had 35 and 35 employees as of September 30, 2013 and 2012, respectively, at our headquarters in Wakefield, Massachusetts.

Equity in earnings (losses) of non-consolidated REITs

Equity in earnings (losses) from non-consolidated REITs decreased approximately $1.9 million to a loss of $0.8 million during the nine months ended September 30, 2013 compared to income of $1.1 million for the same period in 2012. The decrease was primarily because equity in income from our preferred stock investment in a Sponsored REIT, FSP 303 East Wacker Drive Corp., which we refer to as East Wacker, decreased $1.8 million during the nine months ended September 30, 2013 compared to the same period in 2012.

Taxes on income

Included in income taxes is the Revised Texas Franchise Tax, which is a tax on revenues from Texas properties that increased $103,000 and federal income taxes of $13,000 for the nine months ended September 30, 2013, compared to the nine months ended September 30, 2012.

Income from continuing operations

Income from continuing operations for the nine months ended September 30, 2013 was $12.9 million compared to $17.0 million for the nine months ended September 30, 2012, for the reasons described above.

Discontinued operations and provision for sale of property

Income from discontinued operations increased $15.2 million for the nine months ended September 30, 2013 compared to the nine months ended September 30, 2012. During September 2013, we reached an agreement to sell an office property located in Richardson, Texas in excess of its net book value. In September 30, 2012, we reached a decision to classify an office property in Southfield Michigan and recorded a provision for loss on the property of $14.3 million. The property was sold in December 2012. These assets are classified as held for . . .

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