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 September 30, 2002 OR |_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period _________ to __________. Commission File Number: 0-32615 Franklin Street Properties Corp. (formerly known as Franklin Street Partners Limited Partnership) (Exact name of registrant as specified in its charter) Maryland 04-3578653 (State or other jurisdiction of (IRS Employer Identification Number) incorporation or organization) 401 Edgewater Place, Suite 200 Wakefield, MA 01880-6210 (Address of principal executive offices) Registrant's telephone number: (781) 557-1300 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 ninety days. YES |X| NO |_| Indicate by check mark whether the registrant is an accelerated filer as defined in Rule 12b-2 of the Exchange Act. YES |X| NO |_| The number of shares of common stock outstanding as of December 18, 2002 was 24,630,247.
Franklin Street Properties Corp. Form 10-Q Quarterly Report September 30, 2002 Table of Contents Part I. Financial Information Page ---- Item 1. Financial Statements Consolidated Balance Sheets as of September 30, 2002 and December 31, 2001.................................... 3 Consolidated Statements of Income for the nine months ended September 30, 2002 and 2001........................ 4 Consolidated Statements of Cash Flows for the nine months ended September 30, 2002 and 2001................. 5 Notes to the Consolidated Financial Statements........... 6-16 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations...................... 17-22 Item 3. Quantitative and Qualitative Disclosures about Market Risk.............................................. 23 Item 4. Controls and Procedures.................................. 23 Part II. Other Information Item 1. Legal Proceedings........................................ 24 Item 2. Changes in Securities and Use of Proceeds................ 24 Item 3. Defaults upon Senior Securities.......................... 24 Item 4. Submission of Matters to a Vote of Security Holders...... 24 Item 5. Other Information........................................ 24 Item 6. Exhibits and Reports on Form 8-K......................... 24 Signatures ......................................................... 26 Certifications ......................................................... 27-30
PART I - FINANCIAL INFORMATION Item 1. Financial Statements Franklin Street Properties Corp. Consolidated Balance Sheets (unaudited) <TABLE> <CAPTION> September 30, December 31, (in thousands, except share, unit and par value amounts) 2002 2001 ====================================================================================================== (REIT) (Limited Partnership) <S> <C> <C> Assets: Real estate investments, at cost: Land $ 39,560 $ 39,560 Buildings and improvements 154,689 153,632 Fixtures and equipment 930 920 - ------------------------------------------------------------------------------------------------------ 195,179 194,112 Less accumulated depreciation 20,648 17,419 - ------------------------------------------------------------------------------------------------------ Real estate investments, net 174,531 176,693 Real estate assets held for syndication 51,500 -- Cash and cash equivalents 21,841 24,357 Restricted cash 486 495 Tenant rent receivables, net of allowance for doubtful accounts of $357 and $210, respectively 2,416 1,434 Prepaid expenses and other assets, net 1,678 741 Office computers and furniture, net of accumulated depreciation of $358 and $215, respectively 265 397 - ------------------------------------------------------------------------------------------------------ Total Assets $252,717 $ 204,117 ====================================================================================================== Liabilities and Stockholders' Equity/Partners' Capital: Liabilities: Bank note payable $ 50,000 $ -- Accounts payable and accrued expenses 4,618 2,112 Accrued compensation 1,432 1,747 Tenant security deposits 486 495 - ------------------------------------------------------------------------------------------------------ Total Liabilities 56,536 4,354 - ------------------------------------------------------------------------------------------------------ Commitments and Contingencies: Stockholders' Equity/Partners' Capital: Preferred Stock, $.0001 par value, 20,000,000 shares authorized, none issued or outstanding $ -- $ -- Common Stock, $.0001 par value, 180,000,000 shares authorized, 24,630,247 shares issued and outstanding 2 -- Additional paid-in capital 192,743 -- Limited partnership units, 23,637,750 units issued and outstanding -- 203,348 General partnership units, 948,499 units issued and outstanding -- (3,585) Retained earnings 3,436 -- - ------------------------------------------------------------------------------------------------------ Total Stockholders' Equity/Partners' Capital 196,181 199,763 - ------------------------------------------------------------------------------------------------------ Total Liabilities and Stockholders' Equity/Partners' Capital $252,717 $ 204,117 ====================================================================================================== </TABLE> See accompanying notes to consolidated financial statements. 3
Franklin Street Properties Corp. Consolidated Statements of Income (Unaudited) <TABLE> <CAPTION> For the For the Three Months Nine Months Ended Ended September 30, September 30, ----------------------- ----------------------- (in thousands, except per share/unit amounts) 2002 2001 2002 2001 ==================================================================================================================== (REIT) (Limited Partnership) (REIT) (Limited Partnership) <S> <C> <C> <C> <C> Revenue: Rental $ 6,676 $ 6,915 $20,035 $20,234 Syndication fees 4,153 2,765 9,890 8,996 Transaction fees 3,865 1,305 9,203 7,176 Interest and other 473 317 915 1,179 - -------------------------------------------------------------------------------------------------------------------- Total revenue 15,167 11,302 40,043 37,585 - -------------------------------------------------------------------------------------------------------------------- Expenses: Selling, general and administrative 1,190 1,396 4,093 3,380 Commissions 2,075 1,382 4,910 4,498 Stock/units issued as compensation 604 186 604 1,744 Rental operating expenses 1,660 1,941 4,857 5,374 Depreciation and amortization 1,202 1,148 3,515 3,572 Real estate taxes and insurance 796 919 2,307 2,335 Interest 297 247 647 641 Total expenses 7,824 7,219 20,933 21,544 - -------------------------------------------------------------------------------------------------------------------- Income before minority interests 7,343 4,083 19,110 16,041 Income applicable to minority interests -- -- -- 40 Income before taxes 7,343 4,083 19,110 16,001 Taxes on income 216 -- 417 -- - -------------------------------------------------------------------------------------------------------------------- Net income $ 7,127 $ 4,083 $18,693 $16,001 ==================================================================================================================== Allocation of net income to: Common Shareholders $ 7,127 $ -- $18,693 $ -- Limited Partners -- 3,925 -- 15,380 General Partner -- 158 -- 621 - -------------------------------------------------------------------------------------------------------------------- $ 7,127 $ 4,083 $18,693 $16,001 ==================================================================================================================== Weighted average number of shares/units outstanding, respectively, basic and diluted 24,623 24,586 24,598 24,487 ==================================================================================================================== Net income per share and per limited and general partnership unit, respectively, basic and diluted $ 0.29 $ 0.17 $ 0.76 $ 0.65 ==================================================================================================================== </TABLE> See accompanying notes to consolidated financial statements. 4
Franklin Street Properties Corp. Consolidated Statements of Cash Flows (Unaudited) <TABLE> <CAPTION> For the Nine months Ended September 30, ----------------------- (in thousands) 2002 2001 =========================================================================================================== (REIT) (Limited Partnership) <S> <C> <C> Cash flows from operating activities: Net income $ 18,693 $ 16,001 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 3,515 3,572 Stock/units issued as compensation 604 1,744 Gain on sale of land -- (11) Minority interests -- 40 Changes in operating assets and liabilities: Decrease (increase) in restricted cash 9 (8) (Increase) decrease in tenant rent receivables (982) 300 Increase in prepaid expenses and other assets, net (1,080) (204) Increase in accounts payable and accrued expenses 962 2,083 (Decrease) increase in accrued compensation (315) 626 (Decrease) increase in tenant security deposits (9) 8 - ----------------------------------------------------------------------------------------------------------- Net cash provided by operating activities 21,397 24,151 - ----------------------------------------------------------------------------------------------------------- Cash flows from investing activities: Purchase of real estate assets, office computers and furniture (1,078) (257) Change in real estate assets held for syndication (49,956) 935 Proceeds received on sale of land -- 449 Proceeds from marketable securities -- 4,227 - ----------------------------------------------------------------------------------------------------------- Net cash (used for) provided by investing activities (51,034) 5,354 - ----------------------------------------------------------------------------------------------------------- Cash flows from financing activities: Distributions to stockholders/partners (22,879) (20,527) Distributions to minority interest holders -- (103) Proceeds from bank note payable 50,000 15,682 Repayments of bank note payable -- (16,500) - ----------------------------------------------------------------------------------------------------------- Net cash provided by (used for) financing activities 27,121 (21,448) - ----------------------------------------------------------------------------------------------------------- Net (decrease) increase in cash and cash equivalents (2,516) 8,057 Cash and cash equivalents, beginning of period 24,357 13,718 - ----------------------------------------------------------------------------------------------------------- Cash and cash equivalents, end of period $ 21,841 $ 21,775 =========================================================================================================== Supplemental disclosure of non-cash investing activity: Capital expenditures included in accounts payable and accrued expenses $ 1,544 $ -- Supplemental disclosure of cash flow information: Cash paid for: Interest $ 647 $ 641 Income taxes $ 390 $ -- </TABLE> See accompanying notes to consolidated financial statements. 5
Franklin Street Properties Corp. Notes to Consolidated Financial Statements (Unaudited) 1. Organization, Properties, Basis of Presentation and Recent Accounting Pronouncements Organization Franklin Street Properties Corp. (the "Company") was formed as a Massachusetts limited partnership (the "Partnership") on February 4, 1997. Through June 30, 2001 the Partnership owned a 99% interest in FSP Investments LLC ("FSP Investments") and a 99% interest in FSP Property Management LLC ("FSP Property Management"). Effective July 1, 2001, a wholly-owned subsidiary of the Partnership purchased the remaining 1% ownership interest in FSP Investments and 1% ownership interest in FSP Property Management for an aggregate purchase price of approximately $32,000. In December 2001, the limited partners of the Partnership approved the conversion of the Partnership from a partnership into a corporation. The conversion was effective January 1, 2002, and was accomplished as a tax-free reorganization by merging the Partnership with and into a wholly owned subsidiary, Franklin Street Properties Corp., with the subsidiary as the surviving entity. In 2002, the Company elected to be taxed as a real estate investment trust ("REIT"). As a part of the conversion, all of the Partnership's outstanding units were converted on a one-for-one basis into 24,586,249 shares of common stock of the Company. The conversion is being accounted for as a reorganization of affiliated entities, with assets and liabilities recorded at their historical costs. The Company operates in two business segments: rental operations and investment services. FSP Investments provides real estate investment and broker/dealer services. FSP Investments' services include: (i) the organization of REITs (the "Sponsored REITs") which are syndicated through private placements; (ii) the acquisition of real estate on behalf of the Sponsored REITs; and (iii) the sale through best efforts of private placements of preferred stock in Sponsored REITs. Properties As of September 30, 2002, December 31, 2001 and September 30, 2001, excluding assets held for syndication, the Company owned a portfolio of four residential real estate properties (consisting of approximately 642 apartment units) and 13 commercial properties (consisting of approximately 1,433,300 square feet of rentable space). Basis of Presentation The 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 financial statements and notes thereto contained in the Company's annual report on Form 10-K for its fiscal year ended December 31, 2001. The accompanying interim financial statements are unaudited; however, the financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America 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 accounting principles generally accepted in the United States of America 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. The results of operations for the interim periods are not necessarily indicative of the results to be obtained for other interim periods or for the full fiscal year. Certain prior-year balances have been reclassified in order to conform to the current-year presentation. Recent Accounting Pronouncements In August 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 143, "Accounting for Asset Retirement Obligations," which addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. This Statement requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of the fair value can be made. The associated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset. This Statement will be effective at the beginning of 2003. The Company has reviewed the provisions of SFAS 143 and believes that the impact of adoption will not be material to its financial position, results of operations and cash flows. 6
Franklin Street Properties Corp. Notes to Consolidated Financial Statements (Unaudited) 1. Organization, Properties, Basis of Presentation and Recent Accounting Pronouncements (continued) Recent Accounting Pronouncements (continued) In October 2001, the FASB issued SFAS No. 144 "Accounting for the Impairment or Disposal of Long-Lived Assets". This Statement supersedes SFAS No. 121 and requires that long-lived assets that are to be disposed of by sale be measured at the lower of book value or fair value less costs to sell. SFAS No. 144 retains the fundamental provisions of SFAS 121 for (a) recognition and measurement of the impairment of long-lived assets to be held and used, and (b) measurement of long-lived assets to be disposed of by sale, but broadens the definition of what constitutes a discontinued operation and how the results of a discontinued operation are to be measured and presented. This Statement was effective at the beginning of 2002. With the exception of reclassifying the operations of certain real estate assets considered "held for syndication" (and for which no significant continuing involvement exists) to "Discontinued operations, net of tax" in the consolidated statement of income, the impact of adoption is not expected to have a material impact on the Company's financial position, results of operations and cash flows. The Company has one real estate asset that it considers "held for syndication" at September 30, 2002. In April 2002, the FASB issued SFAS No. 145 "Rescission of FAS Nos. 4, 44, and 64, Amendment of FAS 13, and Technical Corrections". This Statement rescinds FASB No. 4, "Reporting Gains and Losses from Extinguishment of Debt", and an amendment of that Statement, FASB No. 64, "Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements". This Statement amends FASB No. 13, "Accounting for Leases". This Statement also amends other existing authoritative pronouncements to make various technical corrections, clarify meanings or describe their applicability under changed conditions. This statement will be effective for the Company's fiscal year ending December 31, 2003. The Company has reviewed the provisions of FASB 145 and believes that the impact of adoption will not be material to its financial position, results of operations and cash flow. In July 2002, the FASB issued SFAS No. 146 "Accounting for Costs Associated with Exit or Disposal Activities". This statement will be effective January 1, 2003. SFAS No. 146 replaces current accounting literature and requires the recognition of costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal plan. The Company does not anticipate that the adoption of this statement will have a material effect on the Company's financial statements. On November 25, 2002, the FASB issued FASB Interpretation No. 45 ("FIN 45") "Guarantors Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, an Interpretation of FASB Statements No. 5, 57 and 107 and Rescission of FASB Interpretation No. 34". FIN 45 clarifies the requirements of SFAS No. 5 "Accounting for Contingencies", relating to a guarantors accounting for, and disclosure of, the issuance of certain types of guarantees. The Company does not anticipate that the adoption of this statement will have a material effect on the Company's financial statement. 2. Investment Services Activity During the three months ended September 30, 2002, two Sponsored REITs, FSP Park Ten Corp. and FSP Montague Business Center Corp., acquired office buildings in Houston, Texas and San Jose, California, respectively. The Company sold on a best efforts basis, through private placements, approximately $60.9 million in preferred stock in these Sponsored REITs. The Company recorded approximately $4.2 million and $3.9 million of syndication fee and transaction fee revenues, respectively, as a result of these transactions. 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 in the future of Sponsored REITs. However, the Company has no 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; and likely would require the approval of the shareholders of the Company. 7
Franklin Street Properties Corp. Notes to Consolidated Financial Statements (Unaudited) 3. Real Estate Assets Held For Syndication Real estate assets held for syndication represents the assets of a Sponsored REIT which was owned 99% by the Company and 1% by an officer of the Company at September 30, 2002. The Company intends to syndicate, on a best efforts basis, through a private placement approximately $63.6 million in preferred stock in the Sponsored REIT. Following the anticipated syndication of the preferred stock in the fourth quarter of 2002, the Company will own 99% of the common stock in the sponsored REIT, which represents less than a 1% ownership interest in the Sponsored REIT. Additionally, the Company anticipates earning a fee of approximately 1% of gross rental revenue, as defined, for services rendered in connection with the ongoing asset management of the property. Accordingly, as the Company anticipates having significant continuing involvement following the syndication, as defined in FAS 144, syndication and transaction fees and related expenses from the syndication will be recorded in continuing operations. The assets owned by the Sponsored REIT, FSP Addison Circle Corp., were purchased on September 30, 2002, are located in Addison, Texas and are comprised principally of land and an office building totaling $51,500,000. The purchase was primarily funded by a bank note payable of $50 million. The results of operations for FSP Addison Circle Corp. for the three months ended September 30, 2002 were not material. 8
Franklin Street Properties Corp. Notes to Consolidated Financial Statements (Unaudited) 4. Related Party Transactions and Investments in Non-consolidated Entities The Company has arranged for Citizens Bank to provide a line of credit for the Company's senior officers in the maximum aggregate amount of $3 million. The borrowings under this line of credit are for the purpose of paying income taxes on equity interests in the Company issued to such senior officers as compensation. Loans under this line of credit have a term of one year and bear interest at the bank's prime rate plus 50 basis points. Each borrower has secured the loan by pledging shares of the Company's Common Stock having an aggregate fair market value at the time of the loan of no less than twice the principal amount of the loan. In the three months ended September 30, 2002 a senior officer of the Company repaid $275,000 of outstanding borrowings. Borrowings of $1,803,000, which are not reflected in the consolidated balance sheets, were outstanding to senior officers of the Company at September 30, 2002 and $1,625,000 at December 31, 2001. The Company has agreed to purchase from Citizens Bank any such loan on which the borrower defaults. Following the purchase of the loan, the Company would have the same rights as Citizens Bank, including the right to foreclose on the pledged stock or to recover the outstanding amount of the loan from the officer/borrower. In order to comply with the Sarbanes-Oxley Act of 2002, the Company has informed Citizens Bank and its senior officers that it will no longer agree to guarantee any such loans made in the future. The existing repurchase agreements will terminate on February 23, 2003. The Company typically retains a non-controlling common stock ownership interest in Sponsored REITs that it has organized. These ownership interests have virtually no economic benefit or risk. At September 30, 2002, December 31, 2001, and September 30, 2001 the Company had ownership interests in sixteen, ten and five Sponsored REITs, respectively. During 1999 and 2000, the Company acquired 100% of the non-owned interests of 17 limited partnerships (through a series of mergers) that it had previously organized. Summarized financial information for the Sponsored REITs is as follows (unaudited): September 30, December 31, 2002 2001 ------------- ------------ (in thousands) Balance Sheet Data: Real estate, net $337,439 $222,232 Other assets 35,270 19,048 Total liabilities 6,514 6,755 Shareholders' equity 366,195 234,525 <TABLE> <CAPTION> For the three months ended For the nine months ended September 30, September 30, 2002 2001 2002 2001 ------- ------- ------- ------- (in thousands) <S> <C> <C> <C> <C> Operating Data: Rental revenue $12,838 $ 5,204 $31,542 $11,713 Other revenue 334 78 551 250 Operating and maintenance expenses 2,540 1,498 9,326 3,577 Depreciation and amortization 2,200 1,378 4,802 2,058 Interest expense and commitment fees 4,893 3,240 8,937 4,479 ------- ------- ------- ------- Net income (loss) $ 3,539 $ (834) $ 9,028 $ 1,849 ======= ======= ======= ======= </TABLE> The Company provided syndication and real estate acquisition advisory services for the Sponsored REITs in 2002 and 2001. For the three months ended September 30, 2002 and 2001, respectively, syndication fees were approximately $4.2 million and $2.8 million, and transaction fees were approximately $3.9 million and $1.3 million. For the nine months ended September 30, 2002 and 2001, respectively, syndication fees were approximately $9.9 million and $9.0 million, and transaction fees were approximately $9.2 million and $7.2 million. 9
Franklin Street Properties Corp. Notes to Consolidated Financial Statements (Unaudited) 4. Related Party Transactions and Investments in Non-consolidated Entities (continued) Asset management fee income charged by the Company to the Sponsored REITs amounted to approximately $172,000 and $72,000 for the three months ended September 30, 2002 and 2001, respectively, and $389,000 and $109,000 for the nine months ended September 30, 2002 and 2001, respectively, and is included in "Interest and other" in the Consolidated Statements of Income. Management fees range from 1% to 5% of collected rents and the applicable contracts are cancelable with 30 days notice. 5. Bank note payable On September 30, 2002, $50 million was outstanding under the Company's $50 million unsecured line of credit (the "Loan Agreement"). Borrowings under the Loan Agreement bear interest at a rate of either the bank's base rate or a variable LIBOR rate, as defined, which was 4.75% per annum at September 30, 2002. There were no borrowings outstanding under the Loan Agreement at December 31, 2001. The Loan Agreement matures on February 23, 2003. 6. Net Income Per Share/Partnership Unit The Company follows SFAS No. 128, "Earnings per Share," which specifies the computation, presentation and disclosure requirements for the Company's net income per share/unit. Basic net income per share/unit is computed by dividing net income by the weighted average number of Company shares/units outstanding during the period. Diluted net income per share/unit reflects the potential dilution that could occur if securities or other contracts to issue shares/units were exercised or converted into shares/units. There were no potential dilutive shares/units outstanding at September 30, 2002 and 2001. The denominator used for calculating basic and diluted net income per share/unit is as follows: <TABLE> <CAPTION> Three Months Nine Months Ended Ended September 30, September 30, -------------------------- -------------------------- 2002 2001 2002 2001 ---- ---- ---- ---- <S> <C> <C> <C> <C> Weighted average number of shares outstanding: Common shares 24,622,914 -- 24,598,470 -- Limited partnership units -- 23,637,748 -- 23,538,745 General partnership units -- 948,499 -- 948,499 -------------------------- -------------------------- 24,622,914 24,586,247 24,598,470 24,487,244 ========================== ========================== </TABLE> 10
Franklin Street Properties Corp. Notes to Consolidated Financial Statements (Unaudited) 7. Business Segments The Company operates in two business segments: rental operations and investment services (including real estate acquisition, financing and broker/dealer services). The Company has identified these segments because this discrete information is the basis upon which management makes decisions regarding resource allocation and performance assessment. The accounting policies of the reportable segments are the same as those described in the "Significant Accounting Policies" set forth in Note 2 to the Company's audited financial statements included in the Company's Annual Report on Form 10-K for the year ended December 31, 2001. The Company's segments are located in the United States of America. The Company evaluates the performance of its reportable segments based on Cash Available for Distribution ("CAD") as management believes that CAD represents the most accurate measure of the reportable segment's activity and is the basis for distributions paid to equity holders. The Company defines CAD as: net income as computed in accordance with accounting principles generally accepted in the United States of America ("GAAP"); plus certain non-cash items included in the computation of net income (depreciation and amortization, certain non-cash compensation expenses and straight line rent adjustments); plus investment services proceeds received from controlled partnerships; plus the net proceeds from the sale of land; less purchases of property and equipment ("Capital Expenditures") and payments for deferred leasing commissions, plus proceeds from cash reserves established at the acquisition date of the property. Depreciation and amortization, non-cash compensation and straight line rents are an adjustment to CAD, as these are non-cash items included in net income. Capital Expenditures, payments of deferred leasing commissions and the proceeds from (payments to) the funded reserve are an adjustment to CAD, as they represent cash items not reflected in income. CAD should not be considered as an alternative to net income (determined in accordance with GAAP), 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 may define CAD in a different manner. It is at the Company's discretion to retain a portion of CAD for operational needs. We believe that in order to facilitate a clear understanding of the results of the Company, CAD should be examined in connection with net income and cash flows from operating, investing and financing activities in the consolidated financial statements. CAD by business segment is as follows (in thousands): <TABLE> <CAPTION> Rental Investment Intercompany Operations Services Total Eliminations Consolidated ---------- -------- ----- ------------ ------------ Three Months Ended March 31, 2001 <S> <C> <C> <C> <C> <C> Net Income $ 4,059 $ 1,900 $ 5,959 $ 43 $ 6,002 Depreciation and amortization 1,306 10 1,316 (43) 1,273 Non-cash compensation expense -- 29 29 -- 29 Straight line rent (66) -- (66) -- (66) Capital expenditures (21) (55) (76) -- (76) Payment of deferred leasing commission (25) -- (25) -- (25) Proceeds of funded reserves 25 -- 25 -- 25 ------- ------- ------- ---- ------- Cash Available for Distribution $ 5,278 $ 1,884 $ 7,162 $ -- $ 7,162 ======= ======= ======= ==== ======= Three Months Ended June 30, 2001 Net Income $ 3,915 $ 1,958 $ 5,873 $ 43 $ 5,916 Depreciation and amortization 1,184 10 1,194 (43) 1,151 Straight line rent (161) -- (161) -- (161) Capital expenditures (60) (25) (85) -- (85) ------- ------- ------- ---- ------- Cash Available for Distribution $ 4,878 $ 1,943 $ 6,821 $ -- $ 6,821 ======= ======= ======= ==== ======= </TABLE> 11
Franklin Street Properties Corp. Notes to Consolidated Financial Statements (Unaudited) 7. Business Segments (continued) CAD by business segment is as follows (in thousands): <TABLE> <CAPTION> Rental Investment Intercompany Operations Services Total Eliminations Consolidated ---------- -------- ----- ------------ ------------ <S> <C> <C> <C> <C> <C> Three Months Ended September 30, 2001 Net Income $ 5,024 $ (985) $ 4,039 $ 44 $ 4,083 Depreciation 1,181 11 1,192 (44) 1,148 Straight line rent (144) -- (144) -- (144) Non-cash compensation -- 1,715 1,715 -- 1,715 Capital expenditures (24) (72) (96) -- (96) Proceeds from sale of land 449 -- 449 -- 449 Proceeds from funded reserves 105 -- 105 -- 105 -------- ------- -------- ----- -------- Cash Available for Distribution $ 6,591 $ 669 $ 7,260 $ -- $ 7,260 ======== ======= ======== ===== ======== Nine Months Ended September 30, 2001 Net Income $ 12,998 $ 2,873 $ 15,871 $ 130 $ 16,001 Depreciation 3,671 31 3,702 (130) 3,572 Straight line rent (371) -- (371) -- (371) Non-cash compensation -- 1,744 1,744 -- 1,744 Capital expenditures (105) (152) (257) -- (257) Proceeds from funded reserves 105 -- 105 -- 105 Proceeds from sale of surplus land (net) 449 -- 449 -- 449 -------- ------- -------- ----- -------- Cash Available for Distribution $ 16,747 $ 4,496 $ 21,243 $ -- $ 21,243 ======== ======= ======== ===== ======== Three Months Ended March 31, 2002 Net Income $ 4,432 $ (378) $ 4,054 $ 43 $ 4,097 Depreciation and amortization 1,118 71 1,189 (43) 1,146 Straight line rent (54) -- (54) -- (54) Capital expenditures (546) (2) (548) -- (548) Proceeds from funded reserves 538 -- 538 -- 538 -------- ------- -------- ----- -------- Cash Available for Distribution $ 5,488 $ (309) $ 5,179 $ -- $ 5,179 ======== ======= ======== ===== ======== Three Months Ended June 30, 2002 Net Income $ 6,443 $ 982 $ 7,425 $ 44 $ 7,469 Depreciation and amortization 1,174 37 1,211 (44) 1,167 Straight line rent (961) -- (961) -- (961) Capital expenditures (187) (8) (195) -- (195) Payment of deferred leasing commissions (531) -- (531) -- (531) Proceeds from funded reserves 1,460 -- 1,460 -- 1,460 -------- ------- -------- ----- -------- Cash Available for Distribution $ 7,398 $ 1,011 $ 8,409 $ -- $ 8,409 ======== ======= ======== ===== ======== </TABLE> 12
Franklin Street Properties Corp. Notes to Consolidated Financial Statements (Unaudited) 7. Business Segments (continued) Three Months Ended September 30, 2002 <TABLE> <S> <C> <C> <C> <C> <C> Net Income $ 6,497 $ 586 $ 7,083 $ 44 $ 7,127 Depreciation and amortization 1,215 31 1,246 (44) 1,202 Straight line rent (20) -- (20) -- (20) Non-cash compensation -- 604 604 -- 604 Capital expenditures (335) -- (335) -- (335) Payment of deferred leasing commissions (77) -- (77) -- (77) Proceeds from funded reserves 810 -- 810 -- 810 -------- ------- -------- ----- -------- Cash Available for Distribution $ 8,090 $ 1,221 $ 9,311 $ -- $ 9,311 ======== ======= ======== ===== ======== Nine Months Ended September 30, 2002 Net Income $ 17,372 $ 1,190 $ 18,562 $ 131 $ 18,693 Depreciation and amortization 3,507 139 3,646 (131) 3,515 Straight line rent (1,035) -- (1,035) -- (1,035) Non-cash compensation -- 604 604 -- 604 Capital expenditures (1,068) (10) (1,078) -- (1,078) Payment of deferred leasing commissions (608) -- (608) -- (608) Proceeds from funded reserves 2,808 -- 2,808 -- 2,808 -------- ------- -------- ----- -------- Cash Available for Distribution $ 20,976 $ 1,923 $ 22,899 $ -- $ 22,899 ======== ======= ======== ===== ======== </TABLE> 13
Franklin Street Properties Corp. Notes to Consolidated Financial Statements (Unaudited) 7. Business Segments (continued) The following table is a summary of other financial information by business segment (in thousands): <TABLE> <CAPTION> Rental Investment Operations Services Total ---------- -------- ----- <S> <C> <C> <C> Three Months Ended September 30, 2002: Revenue $ 10,475 $ 4,518 $ 14,993 Interest Income 158 16 174 Interest Expense 297 -- 297 Capital Expenditures 335 -- 335 Total assets at September 30, 2002 247,153 5,564 252,717 Three Months Ended September 30, 2001: Revenue $ 8,159 $ 2,920 $ 11,079 Interest Income 198 25 223 Interest Expense 247 -- 247 Capital Expenditures 26 11 37 Total assets at September 30, 2001 201,496 6,685 208,181 Nine Months Ended September 30, 2002: Revenue $ 28,997 $10,672 $ 39,669 Interest Income 324 50 374 Interest Expense 647 -- 647 Capital Expenditures 1,068 10 1,078 Total assets at September 30, 2002 247,153 5,564 252,717 Nine Months Ended September 30, 2001: Revenue $ 25,072 $11,456 $ 36,528 Interest Income 970 87 1,057 Interest Expense 641 -- 641 Capital Expenditures 105 152 257 Total assets at September 30, 2001 201,496 6,685 208,181 </TABLE> 14
Franklin Street Properties Corp. Notes to Consolidated Financial Statements (Unaudited) 8. Cash Dividends The Company declared and paid dividends as follows (in thousands, except per share amounts): Dividends Per Total Quarter Paid Share Dividends ------------ ------------- --------- First Quarter of 2002 $ .31 $ 7,622 Second Quarter of 2002 .31 7,622 Third Quarter of 2002 .31 7,635 ------- $22,879 ======= 9. 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 dividends 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 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 20% 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. Effective January 1, 2001, a subsidiary of the Company has elected to be treated as a TRS. As a result, it will be required to pay taxes on its net income like any other taxable corporation. 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 income tax expense reflected in the consolidated statement of income relates only to the taxable REIT subsidiary. The expense differs from the amounts computed by applying the Federal statutory rate of 35% to income before income taxes as follows: For the Nine Months Ended September 30, 2002 ------------------ (in thousands) Federal income tax expense at statutory rate $ 562 Increase (decrease) in taxes resulting from: State income taxes, net of federal impact 89 Other (234) ------- $ 417 ======= 15
Franklin Street Properties Corp. Notes to Consolidated Financial Statements (Unaudited) 9. Income Taxes (continued) Other consists primarily of the tax benefit on cash bonuses accrued in 2001 but paid in 2002. Due to the conversion from a partnership into a corporation the bonus is treated as a permanent tax difference. No deferred income taxes were provided as there were no temporary differences between the financial reporting basis and the tax basis of the taxable REIT subsidiary. Prior to the REIT conversion on January 1, 2002, no provision or benefit was made for federal or state income taxes in the consolidated financial statements of the Partnership. Partners were required to report on their individual tax returns their allocable share of income, gains, losses, deductions and credits of the Partnership. 10. Employee Benefit Plan On May 20, 2002, the stockholders of the Company approved the 2002 Stock Incentive Plan (the "Plan"). The Plan is an equity-based incentive compensation plan, and provides for the grants of up to a maximum of 2,000,000 shares of the Company's common stock ("Awards"). All of the Company's employees, officers, directors, consultants and advisors are eligible to be granted awards. Awards under the Plan are made at the discretion of the Company's Board of Directors, and have no vesting requirements. The Company has granted 43,998 shares under the Plan as of September 30, 2002 to Mr. R. Scott MacPhee, an officer of the Company. The shares were valued at $13.73 per share. Upon granting an Award, the Company will recognize compensation cost equal to the fair market value of the Company's common stock, as determined by the Company's Board of Directors, on the date of the grant. 11. Subsequent Events The Company declared a dividend of $0.31 per share on October 18, 2002 to shareholders of record as of October 18, 2002. 16
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 the Company's Annual Report on Form 10-K for the year ended December 31, 2001. Historical results and percentage relationships set forth in the Consolidated Statements of Operations contained in the financial statements, including trends which might appear, should not be taken as necessarily indicative of future operations. This discussion 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 the Company's forward-looking statements involve risks and uncertainty, including without limitation, changes in economic conditions in the markets in which the Company owns properties, changes in the demand by investors for investment in Sponsored REITS, the impact of the events of September 11, 2001, risks of a lessening of demand for the types of real estate owned by the Company, changes in government regulations, 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 "Risk Factors" in Item 1A of the Company's Annual Report on Form 10-K for the year ended December 31, 2001. 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 will not update any of the forward-looking statements after the date this quarterly report 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. Critical Accounting Policies Basis of Presentation The consolidated financial statements of the Company include the accounts of the Company and wholly and majority-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. Prior to the mergers by which the Company acquired 17 limited partnerships ("the Acquired Partnerships"), FSP Holdings LLC was the general partner and owned a 5% interest in each of the Acquired Partnerships. As the general partner, FSP Holdings LLC, a wholly owned subsidiary of the Company, had the exclusive rights and powers to manage and control the business of each Acquired Partnership without the consent or approval of the limited partners. The limited partners in the Acquired Partnerships could not elect to replace the general partner, except for cause. Accordingly, prior to the mergers, the accounts of the Acquired Partnerships have been consolidated into the Company's financial statements under the principles of accounting applicable to investments in subsidiaries in accordance with SOP 78-9. Real Estate and Depreciation Real estate assets are stated at the lower of cost or fair value, as appropriate, less accumulated depreciation. Costs related to property acquisition and improvements are capitalized. Typical capital items include new roofs, site improvements, various exterior building improvements and major interior renovations. Funding for capital improvements typically is provided by cash set aside at the time the property was purchased. Routine replacements and ordinary maintenance and repairs that do not extend the life of the asset are expensed as incurred. Typical expense items include interior painting, landscaping, minor carpet replacements and residential appliances. Funding for repairs and maintenance items typically is provided by cash flows from operating activities. Depreciation is computed using the straight line method over the assets' estimated useful lives as follows: Category Years -------- ----- Buildings: Residential 27 Commercial 39 Building Improvements 15-39 Furniture and equipment 5-7 The Company evaluates its assets used in operations by identifying indicators of impairment and by comparing the sum of the estimated undiscounted future cash flows for each asset to the asset's carrying value. When indicators of impairment are present and the sum of the undiscounted future cash flows is less than the carrying value of such asset, an impairment loss is recorded equal to the difference between the asset's current carrying value and its fair value based on discounting its estimated future cash flows. No such indicators of impairment have been identified. 17
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) Revenue Recognition Rental income for Commercial Properties -- The Company has retained substantially all of the risks and benefits of ownership of the Company's commercial properties and accounts for its leases as operating leases. Rental income from leases, which include scheduled increases in rental rates during the lease term, is recognized on a straight-line basis. The Company does not have any percentage rent arrangements with its commercial property tenants. Reimbursable common area maintenance charges are included in rental income in the period earned. Rental income for Residential Apartments -- The Company's residential property leases are generally for terms of one year or less. Rental income from tenants of residential apartment properties is recognized in the period earned. Rent concessions, including free rent and leasing commissions are charged as a reduction of rental revenue. Investment Banking Services -- Syndication fees ranging from 6% to 8% of the gross offering proceeds from the sale of securities in Sponsored Entities are generally recognized upon an investor closing; at that time the Company has provided all required services, the fee is fixed and collected, and no further contingencies exist. Commission expense ranging from 3% to 4% of the gross offering proceeds is recorded in the period the related syndication fee is earned. Investment Banking Services -- Transaction fees are generally recognized upon the final investor closing of a Sponsored REIT. The final investor closing is the last admission of investors into a Sponsored REIT; at that time, required funds have been received from the investors, charges relating to the syndication have been paid or accrued, continuing investment and continuing involvement criteria have been met, and legal and economic rights have been transferred. Third party transaction-related costs are deferred and later expensed to match revenue recognition. Internal expenses are expensed as incurred. The Company follows the requirements as set forth by Statement of Financial Accounting Standards No. 66 "Accounting for Sales of Real Estate" and Statement of Position 92-1 "Accounting for Real Estate Syndication Income" and revenue is recognized provided the criteria for sale accounting in SFAS 66 are met. Trends and Uncertainties Rental Operations Historically, real estate has been subject to a wide range of cyclical economic conditions, which affect various real estate sectors and geographic regions with differing intensities at different times. In 2002, many regions of the United States experienced varying degrees of economic recession. The bankruptcies of Enron, WorldCom, and others, the concerns about accounting practices and corporate governance at other major companies, and the decline in the stock market are likely to have a negative impact on vacancy and absorption rates, but the extent of the effect will vary by industry segment and geography. The Company believes that it has been affected, and will likely continue to be affected, by the combination of these events but is unable to predict the extent to which it will be affected. As discussed in the Company's Annual Report on Form 10-K for the year ended December 31, 2001, XO California, Inc., a subsidiary of XO Communications, is a tenant at the Company's property in San Diego, California. During the three months ended June 30, 2002, XO Communications filed for bankruptcy protection under Chapter 11. The Company has not been notified by the bankruptcy court as to whether the lease will be accepted or rejected. However, at the time of the bankruptcy filing and as of September 30, 2002, XO California, Inc. was current on its rent. There were no major lease expirations, terminations, renewals or new leases during the three months ended September 30, 2002. The lease at the Bollman property in Savage, Maryland expires November 30, 2002 and the tenant will not renew. The Company has been actively marketing the space, but there is no signed lease with a new tenant. The monthly rental income was $53,000. Operating costs are projected at $26,000 per month. 18
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) A purchase and sale agreement has been signed to sell the Weslayan Oaks property in Houston, Texas at a price in excess of book value. The transaction, which is subject to the due diligence process of the buyer, is not expected to take place until the first quarter of 2003. The following table summarizes property wholly owned by the Company as of the dates indicated: September 30, ------------------------ 2002 2001 ---- ---- (unaudited) Residential: Number of properties 4 4 Number of apartment units 642 642 Commercial: Number of properties 13 13 Square footage 1,433,300 1,433,300 Investment Services Unlike the Company's real estate business, which provides a rental revenue stream which is ongoing and recurring in nature, the Company's investment banking business is transactional in nature. During the three months ended September 30, 2002, the Company's acquisition executives continued to report large spreads between bid and ask prices for properties. Differing views of the strength and timing of a national economic recovery as well as low interest rate carrying costs on debt-financed properties are contributing to this situation. Without the ability to acquire properties at attractive prices on behalf of the Sponsored REITs, the Company's investment banking activities may suffer. Further, the Company continues to rely solely on its in-house investment executives to access interested investors who have capital they can afford to place in an illiquid investment in Sponsored REITs for an indefinite period of time. Further setbacks in the stock market or the general economy could have negative effects, and while the tragic events of September 11, 2001 did not disrupt the Company's transactional business unit significantly, further terrorist attacks, if they occur, may have an adverse effect on the willingness of investors to purchase interests in future Sponsored REITs. 19
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) Results of Operations The following table shows the variance in dollars for the Company's operations: Variance For the three For the nine months ended months ended September 30, September 30, 2002 and 2001 2002 and 2001 ------------- ------------- (in thousands) Revenue: Rental operations Rental income $ (239) $ (199) Transaction income 4,656 3,707 Interest income 163 (229) ------- ------- Total rental operations revenue 4,580 3,279 ------- ------- Investment services Syndication income 1,388 894 Transaction income (2,096) (1,680) Interest income (7) (35) ------- ------- Total investment services revenue (715) (821) ------- ------- Total revenue 3,865 2,458 ------- ------- Expenses: Rental operations Selling, general and administrative (488) (352) Rental operating expenses (281) (517) Depreciation and amortization 34 (165) Real estate taxes and insurance (123) (28) Interest Expense 50 6 ------- ------- Total rental operations expenses (808) (1,056) ------- ------- Investment Services Expenses Selling, general and administrative 311 1,065 Commission expense 693 412 Stock/units issued as compensation 389 (1,140) Depreciation and amortization 20 108 ------- ------- Total investment services expenses 1,413 445 ------- ------- Total Expenses 605 (611) ------- ------- Income applicable to minority interest -- (40) Taxes on income 216 417 ------- ------- Net Income $ 3,044 $ 2,692 ======= ======= 20
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) Comparison of the three and nine months ended September 30, 2002 to the three and nine months ended September 30, 2001 Net Income The Company's net income for the three months ended September 30, 2002 was $7.1 million, compared to $4.1 million during the comparable period in 2001, an increase of $3.0 million which relates primarily to rental operations. The Company's net income for the nine months ended September 30, 2002 was $18.7 million, compared to $16.0 million during the comparable period in 2001, an increase of $2.7 million, of which an increase of $4.3 million relates to rental operations and a decrease of $1.6 million relates to investment services. The increase in net income was comprised of increased revenue of $2.5 million and decreased expenses of $0.6 million offset by increased taxes of $0.4 million. Revenue Total revenues during the three months ended September 30, 2002 increased $3.9 million to $15.2 million compared to $11.3 million for the three months ended September 30, 2001. This is primarily attributable to the syndication of two Sponsored REITs (with aggregate proceeds of $60.9 million) in 2002 as compared to one Sponsored REIT (with aggregate proceeds of $20 million) in the comparable period in 2001. The increase of $3.9 million is comprised of an increase of $4.6 million in rental operations revenue offset by a decrease of $0.7 million in investment services revenue. Total revenues during the nine months ended September 30, 2002 increased $2.4 million to $40.0 million compared to $37.6 million for the nine months ended September 30, 2001. This increase is primarily attributable to the syndication of five Sponsored REITs (with aggregate proceeds of $146.5 million) in 2002 as compared to four Sponsored REITs (with aggregate proceeds of $117.9 million) for the comparable period in 2001. For the nine months ended September 30, 2002 revenues from rental operations increased by $3.3 million. This increase is primarily attributable to increased transaction income of $3.7 million due to transaction fees earned on the increase in gross syndication proceeds and an increase in the rate charged for loan fees, offset by a decrease in rental income of $0.3 million, and decreased interest income of $0.2 million. Investment services revenues decreased $0.8 million primarily attributable to a decrease in transaction fees of $1.7 million due to a decrease in the rate charged for acquisition fees on syndication proceeds, offset by an increase of $0.9 million of syndication fees charged on the syndication proceeds. Expenses Total expenses during the three months ended September 30, 2002 increased $0.6 million to $7.8 million compared to $7.2 million for the three months ended September 30, 2001. This increase is primarily attributable to a increase in Investment services expenses of $1.4 million offset by a decrease in rental operations expenses of $0.8 million. The decrease in rental operations expenses by $0.8 million was due to increased vacancies which resulted in a lowering of rental costs in all major categories. The primary factors in the increase in Investment services expenses of $1.4 million were increased costs of $1.0 million relating to syndication of the two Sponsored REITs in the period and the increase in the expense relating to stock issued as compensation of $0.4 million. Total expenses during the nine months ended September 30, 2002 decreased $0.6 million to $20.9 million compared to $21.5 million for the three months ended September 30, 2001. This is primarily attributable to an increase in Investment services expenses of $0.4 million which was more than offset by a decrease in rental expenses of $1.0 million. The primary factors in the increase in Investment services expenses were the increased costs of $1.5 million relating to syndication of the Sponsored REITs in the period less the decrease in the expense relating to stock issued as compensation of $1.1 million. The decrease in Rental expenses by $1.0 million was due to increased vacancies which resulted in a lowering of rental costs in all major categories. There was no income related to minority interest in 2002. There were no taxes on income in 2001. 21
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) Liquidity and Capital Resources Cash and cash equivalents were $21.8 million and $24.3 million at September 30, 2002 and December 31, 2001, respectively. This decrease of $2.5 million is attributable to $51.0 million used for investing activities offset by $21.4 million provided by operating activities and $27.1 million provided by financing activities. Operating Activities The Company's cash provided by operating activities of $21.4 million is primarily attributable to net income of $18.7 million plus the add-back of $4.1 million from non-cash activity less a $1.4 million net change in operating assets and liabilities. Investing Activities The Company's cash used for investing activities of $51.0 million is primarily attributable to the $50.0 million increase in assets held for syndication and $1.0 million for the purchase of real estate assets, office computers and furniture. Financing Activities The Company's cash provided by financing activities of $27.1 million is attributable to $50.0 million of proceeds from a bank note payable offset by $22.9 million of distributions to shareholders. Sources and uses of funds Our principal demands for liquidity are cash for operations, dividends to equity holders, debt repayments and expense associated with indebtedness. As of September 30, 2002 we had approximately $56.5 million in liabilities of which $50.0 million is a bank note payable. The Company has no permanent, long-term debt. In the near term, liquidity is generated from funds from ongoing real estate operations and transaction fees and commissions received in connection with the sale of shares in Sponsored REITs. The Company maintains an unsecured line of credit through Citizens Bank. The Company has entered into a Master Promissory Note and Loan Agreement which provides for a revolving line of credit of up to $50 million. Borrowings under the loan bear interest at either the bank's base rate or a variable LIBOR rate. The Company typically uses the unsecured line of credit to provide each newly-formed Sponsored REIT with the funds to purchase a property. The Company's loan agreement with the bank includes customary restrictions on property liens and requires compliance with various financial covenants. Financial covenants include maintaining minimum cash balances in operating accounts, tangible net worth of at least $140 million and compliance with other various debt and income ratios. The Company was in compliance with all covenants as of September 30, 2002. The Company had $50.0 million of borrowings under its revolving credit facility as of September 30, 2002. Contingencies The Company is subject to various legal proceedings and claims that arise in the ordinary course of its business. Although occasional adverse decisions (or settlements) may occur, the Company believes that the final disposition of such matters will not have a material adverse effect on the financial position or results of operations of the Company. Assets Held for Syndication If all of the shares of preferred stock of the Sponsored REIT are sold, the Company anticipates recording approximately $4.1 million and $3.6 million of syndication fee and transaction fee revenue, respectively. The Company expects to record approximately $2.4 million in expenses. Related Party Transactions As discussed in Note 2, during the third quarter of 2002, the Company syndicated two Sponsored REITs and retained a non-controlling common stock interest in those Sponsored REITs with virtually no economic benefit. The Company did not enter into any other transactions with related parties during the three months ended September 30, 2002. For a discussion of transactions between the Company and related parties during 2001, see "Related Party Transactions" under Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations - of the Company's Annual Report on Form 10-K for the year ended December 31, 2001. The Company has arranged for Citizens Bank to provide a line of credit for the Company's senior officers in the maximum aggregate amount of $3M. The borrowings under this line of credit are for the purpose of paying income taxes on equity interests in the Company issued to such senior officers as compensation. Loans under this line of credit have a term of one. 22
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) Related Party Transactions (continued) year and bear interest at the bank's prime rate plus 50 basis points. Each borrower has secured the loan by pledging shares of the Company's Common Stock having an aggregate fair market value at the time of the loan of no less than twice the principal amount of the loan. Borrowings of $1,803,000 and $1,625,000 were outstanding to senior officers of the Company at September 30, 2002 and December 31, 2001, respectively. The Company has agreed to purchase from Citizens Bank any such loan on which the borrower defaults. Following the purchase of the loan, the Company would have the same rights as Citizens Bank, including the right to foreclose on the pledged stock or recover the outstanding amount of the loan from the officer/borrower. In order to comply with the Sarbanes-Oxley Act of 2002, the Company has informed Citizens Bank and its senior officers that it will no longer agree to purchase and service loans made in the future and the existing repurchase agreements will terminate on February 23, 2003. Economic Conditions The Company generally pays the ordinary annual operating expenses of the properties from the rental revenue generated by the properties. In addition to rental income, the Company maintains cash reserves, which are replenished from property operations as necessary and may be used to fund unusual expenses or major capital improvements. The cash reserves included in cash and cash equivalents, which as of September 30, 2002 were approximately $2.9 million, are in excess of the known needs for extraordinary expenses or capital improvements for the real properties within the next few years. There are no external restrictions on these reserves, and they may be used for any Company purpose. Although there is no guarantee that we will be able to obtain the funds necessary for our future growth, we anticipate generating funds from continuing real estate operations and from fees and commissions from the sale of shares in newly-formed Sponsored REITs. The Company believes that it has adequate funds to cover unusual expenses and capital improvements, in addition to normal operating expenses. The Company's ability to maintain or increase its level of dividends to stockholders, however, depends upon the level of interest on the part of investors in purchasing shares of Sponsored REITs and the level of rental income from the Company's real properties. 23
Item 3. Quantitative and Qualitative Disclosures about Market Risk The Company was not a party to any derivative financial instruments at or during the year ended December 31, 2001 or during the nine months ended September 30, 2002. The Company borrows from time to time upon its line of credit. These borrowings bear interest at a variable rate. The Company uses the funds it draws on its line of credit for the purpose of making interim mortgage loans to Sponsored REITs. These mortgage loans bear interest at the same variable rate payable by the Company under its line of credit. Therefore, the Company believes that it has mitigated its interest rate risk with respect to its borrowings. Item 4. Controls and Procedures Evaluation of disclosure controls and procedures. Based on their evaluation of the Company's disclosure controls and procedures (as defined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934) as of a date within 90 days of the filing date of this Quarterly Report on Form 10-Q, the Company's chief executive officer and chief operating officer (equivalent of chief financial officer) have concluded that he Company's disclosure controls and procedures are designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SECs rules and forms and are operating in an effective manner. Changes in internal controls. There were no significant changes in the Company's internal controls or in other factors that could significantly affect these controls subsequent to the date of their most recent evaluation. 24
PART II - OTHER INFORMATION Item 1. Legal Proceedings: Not applicable. Item 2. Changes in Securities and Use of Proceeds: Not applicable. Item 3. Defaults Upon Senior Securities: Not applicable. Item 4. Submission of Matters to a Vote of Security Holders: Not applicable. Item 5. Other Information: Not applicable. Item 6. Exhibits and Reports on Form 8 - K: 99.1 Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 filed herewith. 25
SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Franklin Street Properties Corp. Date Signature Title ---- --------- ----- December 23, 2002 By: /s/ George J. Carter Chief Executive Officer and -------------------- Director (Principal Executive George J. Carter Officer) December 23, 2002 By: /s/ Lloyd S. Dow Controller -------------------- (Principal Accounting Officer) Lloyd S. Dow 26
CERTIFCATIONS I, Barbara Corinha, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Franklin Street Properties Corp.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date")' and c) presented in the quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Dated: December 23, 2002 /s/ Barbara J. Corinha --------------------------- Vice President, Chief Operating Officer (equivalent of Chief Financial Officer), Treasurer and Secretary 27
CERTIFICATIONS ------------- I, George Carter, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Franklin Street Properties Corp.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date")' and c) presented in the quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): d) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and e) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Dated: December 23, 2002 /s/ George J. Carter ------------------------------------- President and Chief Executive Officer 28
Exhibit Index Page Exhibit 99.1................................................................. 29 29