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FSP > SEC Filings for FSP > Form 10-Q on 29-Jul-2014All Recent SEC Filings

Show all filings for FRANKLIN STREET PROPERTIES CORP /MA/

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


29-Jul-2014

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, 2013. 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 properties, with primary emphasis on our top five markets of Atlanta, Dallas, Denver, Houston and Minneapolis. We believe that our top five markets have macro-economic drivers that have the potential to increase occupancies and rents. 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, 2013.

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, 2013.

Recent Accounting Standards

In April 2014, the Financial Accounting Standards Board, or FASB, issued Accounting Standards Update No. 2014-08, Reporting Discontinued Operations and Disclosures of Disposals of Components of and Entity. This ASU standard establishes criteria to evaluate whether transactions should be classified as discontinued operations and requires additional disclosure for discontinued operations and new disclosures for individually material disposal transactions that do not meet the definition of a discontinued operation. This standard is applied prospectively and is effective for annual periods beginning after December 15, 2014. Early adoption is permitted but only for disposals or classifications as held for sale that have not been reported in financial statements previously issued. The adoption of this ASU is not expected to have a material impact on the disclosures in, or presentation of, our condensed consolidated financial statements.

In May 2014, the FASB issued Accounting Standard Update No. 2014-09, Revenue from Contracts with Customers, which provides guidance for revenue recognition. The standard's core principle is a company will recognize revenue when promised goods or services are transferred to customers in an amount that reflects the consideration to which a company expects to be entitled in exchange for those goods or services. This update is effective for interim and annual reporting periods beginning after December 15, 2016. The Company is currently in the process of evaluating the impact the adoption of this ASU will have on the 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 slow economic growth, with slowly declining unemployment from recent high levels, 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 credit and interest rates. However, unemployment rates have been trending lower. We also believe that the Federal Reserve Bank's current tapering program has been generally received as a harbinger of real improvement in the economy, which could bode well for our real estate operations. We could benefit from any further improved economic fundamentals and increasing levels of employment. We believe that the economy is in the early stages of a cyclically-slower but prolonged broad-based upswing. However, future economic factors may negatively affect real estate values, occupancy levels and property income.

Real Estate Operations

Leasing

Our real estate portfolio was approximately 94.1% leased as of June 30, 2014, unchanged from December 31, 2013. During the six months ended June 30, 2014, we leased approximately 425,000 square feet of office space, of which approximately 380,000 square feet were with existing tenants, at a weighted average term of 7.1 years. On average, tenant improvements for such leases were $15.49 per square foot, lease commissions were $8.33 per square foot and rent concessions were approximately three months of free rent. Average GAAP base rents under such leases were $25.41 per square foot, or 12.5% higher than average rents in the respective properties as applicable compared to the year ended December 31, 2013.

As of June 30, 2014, leases for approximately 3.7% and 7.8% of the square footage in our portfolio are scheduled to expire during 2014 and 2015, respectively. As the third quarter of 2014 begins, we believe that 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. Our property portfolio has improved in occupancy levels and should allow overall tenant improvement expenditures and leasing costs to moderate in relation to the level of rental revenues being achieved as we look ahead.

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 above or 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 Acquisition and Investment Activity

During 2014:

We funded advances on Sponsored REIT Loans for revolving lines of credit in the aggregate amount of approximately $2.6 million; and

on June 19, we received approximately $13.9 million from FSP Galleria North Corp. as repayment in full of a Sponsored REIT Loan.

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

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;


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on December 6, we received approximately $2.35 million from FSP 505 Waterford Corp. as repayment in full of a Sponsored REIT Loan; and

we funded advances on Sponsored REIT Loans for revolving lines of credit in the aggregate amount of approximately $8.2 million.

Discontinued Operations and Dispositions

We include properties sold or held for sale prior to 2014 as discontinued operations.

Property Dispositions

We sold an office property located in Richardson, Texas on October 29, 2013 for $12.3 million and recognized a $2.2 million gain.

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 is improving in many markets relative to both liquidity and pricing. We believe that both improving office property fundamentals as well as attractive financing availability will likely be required to continue to be an improvement in 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 properties we acquired in 2013 are included in our operating results as of their respective purchase dates. The income earned from mortgage investments is included as of the respective funding date and is reduced upon repayment dates. Increases in rental revenues, interest income from loans and expenses for the three and six months ended June 30, 2014 compared to the three and six months ended June 30, 2013 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.

Sales of Real Estate:

We sold an office property located in Richardson, Texas on October 29, 2013 for $12.3 million and recognized a $2.2 million gain. The operating results of the properties sold are classified as discontinued operations in our consolidated financial statements for all periods presented.


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The following table shows results for the three months ended June 30, 2014 and 2013:

                                                   Three months ended June 30,
(in thousands)                                2014             2013           Change
Revenue:
Rental                                    $      60,994    $     46,017    $     14,977
Related party revenue:
Management fees and interest income
from loans                                        1,671           1,643              28
Other                                                76              12              64
Total revenue                                    62,741          47,672          15,069

Expenses:
Real estate operating expenses                   14,995          11,116           3,879
Real estate taxes and insurance                   9,763           7,308           2,455
Depreciation and amortization                    23,563          16,921           6,642
Selling, general and administrative               3,148           3,204             (56 )
Interest                                          6,891           4,174           2,717
Total expenses                                   58,360          42,723          15,637

Income before interest income, equity
in losses of non-consolidated REITs
and taxes                                         4,381           4,949            (568 )
Interest income                                       1               4              (3 )
Equity in losses of non-consolidated
REITs                                              (552 )          (195 )          (357 )

Income before taxes on income                     3,830           4,758            (928 )
Taxes on income                                     117             115               2

Income from continuing operations                 3,713           4,643            (930 )

Discontinued operations:
Income from discontinued operations,
net of income tax                                     -              98             (98 )
Total discontinued operations                         -              98             (98 )

Net income                                $       3,713    $      4,741    $     (1,028 )

Comparison of the three months ended June 30, 2014 to the three months ended June 30, 2013:

Revenues

Total revenues increased by $15.1 million to $62.7 million for the quarter ended June 30, 2014, as compared to the quarter ended June 30, 2013. The increase was primarily a result of:

An increase in rental revenue of approximately $15.0 million arising primarily from property acquisitions in May 2013, July 2013 and August 2013, which were included in the quarter ended June 30, 2014; and was partially offset by lower occupancy of approximately 0.3% in the real estate portfolio at June 30, 2014 compared to June 30, 2013.

Expenses

Total expenses increased by $15.6 million to $58.4 million for the quarter ended June 30, 2014, as compared to the quarter ended June 30, 2013. The increase was primarily a result of:

An increase in real estate operating expenses and real estate taxes and insurance of approximately $6.3 million, and depreciation and amortization of $6.6 million, which were primarily from property acquisitions in May 2013, July 2013 and August 2013, which were included in the quarter ended June 30, 2014.

An increase to interest expense of approximately $2.7 million to $6.9 million during the three months ended June 30, 2014 compared to the same period in 2013. The increase was attributable to a higher amount of debt outstanding


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during the three months ended June 30, 2014 compared to the same period in 2013. The second quarter of 2014 includes interest from the 2013 Term Loan that we entered into in August of 2013, and is at a higher rate than the 2012 Credit Facility.

Equity in losses of non-consolidated REITs

Equity in losses from non-consolidated REITs increased approximately $0.4 million to a loss of $0.6 million during the three months ended June 30, 2014 compared to the same period in 2013. The increase was primarily because equity in loss from our preferred stock investment in a Sponsored REIT, FSP 303 East Wacker Drive Corp., which we refer to as East Wacker, increased $0.4 million during the three months ended June 30, 2014 compared to the same period in 2013.

Taxes on income

Included in income taxes is the Revised Texas Franchise Tax, which is a tax on revenues from Texas properties that increased $11,000 and was partially offset by a decrease in federal income taxes of $9,000 for the three months ended June 30, 2014, compared to the three months ended June 30, 2013.

Income from continuing operations

Income from continuing operations for the three months ended June 30, 2014 was $3.7 million compared to $4.6 million for the three months ended June 30, 2013, for the reasons described above.

Discontinued operations and provision for sale of property

Income from discontinued operations decreased $0.1 million for the three months ended June 30, 2014 compared to the three months ended June 30, 2013. On October 29, 2013 we sold an office property located in Richardson, Texas at a gain of approximately $2.2 million, which resulted in a reclassification of real estate income and expenses of this property to discontinued operations for all periods presented.

Net income

Net income for the three months ended June 30, 2014 was $3.7 million compared to $4.7 million for the three months ended June 30, 2013, for the reasons described above.


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The following table shows results for the six months ended June 30, 2014 and 2013:

                                                    Six months ended June 30,
(in thousands)                                  2014           2013          Change
Revenue:
Rental                                      $    122,591    $    88,859    $    33,732
Related party revenue:
Management fees and interest income from
loans                                              3,314          3,265             49
Other                                                 99             43             56
Total revenue                                    126,004         92,167         33,837

Expenses:
Real estate operating expenses                    30,066         21,886          8,180
Real estate taxes and insurance                   19,014         13,903          5,111
Depreciation and amortization                     47,863         32,702         15,161
Selling, general and administrative                6,420          5,736            684
Interest                                          14,067          8,382          5,685
Total expenses                                   117,430         82,609         34,821

Income before interest income, equity in
losses of non-consolidated REITs and
taxes                                              8,574          9,558           (984 )
Interest income                                        2              5             (3 )
Equity in losses of non-consolidated
REITs                                             (1,036 )         (383 )         (653 )

Income before taxes on income                      7,540          9,180         (1,640 )
Taxes on income                                      254            234             20

Income from continuing operations                  7,286          8,946         (1,660 )

Discontinued operations:
Income from discontinued operations, net
of income tax                                          -            196           (196 )
Total discontinued operations                          -            196           (196 )

Net income                                  $      7,286    $     9,142    $    (1,856 )

Comparison of the six months ended June 30, 2014 to the six months ended June 30, 2013:

Revenues

Total revenues increased by $33.8 million to $126.0 million for the six months ended June 30, 2014, as compared to the six months ended June 30, 2013. The increase was primarily a result of:

An increase in rental revenue of approximately $33.7 million arising primarily from property acquisitions in May 2013, July 2013 and August 2013, which were included in the six months ended June 30, 2014; and was partially offset by lower occupancy of approximately 0.3% in the real estate portfolio at June 30, 2014 compared to June 30, 2013.

Expenses

Total expenses increased by $34.8 million to $117.4 million for the six months ended June 30, 2014, as compared to the six months ended June 30, 2013. The increase was primarily a result of:


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An increase in real estate operating expenses and real estate taxes and insurance of approximately $13.2 million, and depreciation and amortization of $15.2 million, which were primarily from property acquisitions in May 2013, July 2013 and August 2013, which were included in the six months ended June 30, 2014.

An increase to interest expense of approximately $5.7 million to $14.1 million during the six months ended June 30, 2014 compared to the same period in 2013. The increase was attributable to a higher amount of debt outstanding during the six months ended June 30, 2014 compared to the same period in 2013. The first six months of 2014 includes interest from the 2013 Term Loan that we entered into in August of 2013, and is at a higher rate than the 2012 Credit Facility.

An increase in selling, general and administrative expenses of approximately $0.7 million, which was primarily the result of increased personnel related expenses and professional fees. We had 38 and 35 employees as of June 30, 2014 and 2013, respectively, at our headquarters in Wakefield, Massachusetts.

Equity in losses of non-consolidated REITs

Equity in losses from non-consolidated REITs increased approximately $0.7 million to a loss of $1.0 million during the six months ended June 30, 2014 compared to the same period in 2013. The increase was primarily because equity in loss from our preferred stock investment in a Sponsored REIT, FSP 303 East Wacker Drive Corp., which we refer to as East Wacker, increased $0.8 million during the six months ended June 30, 2014 compared to the same period in 2013.

Taxes on income

Included in income taxes is the Revised Texas Franchise Tax, which is a tax on revenues from Texas properties that increased $21,000 and was partially offset by a decrease in federal income taxes of $1,000 for the six months ended June 30, 2014, compared to the six months ended June 30, 2013.

Income from continuing operations

Income from continuing operations for the six months ended June 30, 2014 was $7.3 million compared to $8.9 million for the six months ended June 30, 2013, for the reasons described above.

Discontinued operations and provision for sale of property

Income from discontinued operations decreased $0.2 million for the six months ended June 30, 2014 compared to the six months ended June 30, 2013. On October 29, 2013 we sold an office property located in Richardson, Texas at a gain of approximately $2.2 million, which resulted in a reclassification of real estate income and expenses of this property to discontinued operations for all periods presented.

Net income

Net income for the six months ended June 30, 2014 was $7.3 million compared to $9.1 million for the six months ended June 30, 2013, for the reasons described above.


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Non-GAAP Financial Measures

Funds From Operations

The Company evaluates performance based on Funds From Operations, which we refer to as FFO, as management believes that FFO represents the most accurate measure of activity and is the basis for distributions paid to equity holders. The Company defines FFO as net income (computed in accordance with GAAP), excluding gains (or losses) from sales of property and acquisition costs of newly acquired properties that are not capitalized, plus depreciation and amortization, including amortization of acquired above and below market lease intangibles and impairment charges on properties or investments in non-consolidated REITs, and after adjustments to exclude equity in income or losses from, and, to include the proportionate share of FFO from, non-consolidated REITs.

FFO should not be considered as an alternative to net income (determined in accordance with GAAP), nor as an indicator of the Company's financial performance, nor as an alternative to cash flows from operating activities (determined in accordance with GAAP), nor as a measure of the Company's liquidity, nor is it necessarily indicative of sufficient cash flow to fund all of the Company's needs.

Other real estate companies and the National Association of Real Estate Investment Trusts, or NAREIT may define this term in a different manner. We have included the NAREIT FFO definition in our table and note that other REITs may not define FFO in accordance with the current NAREIT definition or may interpret the current NAREIT definition differently than we do.

We believe that in order to facilitate a clear understanding of the results of the Company, FFO should be examined in connection with net income and cash flows from operating, investing and financing activities in the consolidated financial statements.

The calculations of FFO are shown in the following table:

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