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 March 31, 2005 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. (Exact name of registrant as specified in its charter) Maryland 04-3578653 (State or other jurisdiction (IRS Employer of incorporation or organization) Identification Number) 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 April 29, 2005 was 49,631,513.
Franklin Street Properties Corp. Form 10-Q Quarterly Report March 31, 2005 Table of Contents Page ---- Part I. Financial Information Item 1. Financial Statements Consolidated Balance Sheets as of March 31, 2005 and December 31, 2004....................................... 3 Consolidated Statements of Income for the three months ended March 31, 2005 and 2004........................... 4 Consolidated Statements of Stockholders' Equity as of March 31, 2005 and December 31, 2004.................... 5 Consolidated Statements of Cash Flows for the three months ended March 31, 2005 and 2004.............. 6 Notes to Consolidated Financial Statements.............. 7-15 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations..................... 16-26 Item 3. Quantitative and Qualitative Disclosures about Market Risk............................................. 27 Item 4. Controls and Procedures................................. 28 Part II. Other Information Item 1. Legal Proceedings....................................... 29 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds................................................ 29 Item 3. Defaults upon Senior Securities......................... 29 Item 4. Submission of Matters to a Vote of Security Holders..... 29 Item 5. Other Information....................................... 29 Item 6. Exhibits................................................ 30 Signatures ........................................................ 31
PART I - FINANCIAL INFORMATION Item 1. Financial Statements Franklin Street Properties Corp. Consolidated Balance Sheets (Unaudited) <TABLE> <CAPTION> March 31, December 31, (in thousands, except shares and par value amounts) 2005 2004 =========================================================================================================== <S> <C> <C> Assets: Real estate investments, at cost: Land $ 71,267 $ 71,267 Buildings and improvements 405,157 404,830 Fixtures and equipment 885 885 - ---------------------------------------------------------------------------------------------------------- 477,309 476,982 Less accumulated depreciation 40,046 37,227 - ---------------------------------------------------------------------------------------------------------- Real estate investments, net 437,263 439,755 Acquired real estate leases, net of accumulated amortization of $3,501 and $3,020, respectively 6,002 6,483 Investment in non-consolidated REITs 4,243 4,270 Assets held for syndication 74,300 59,246 Cash and cash equivalents 47,271 52,752 Restricted cash 1,076 1,033 Tenant rent receivables, less allowance for doubtful accounts of $350 and $350, respectively 769 769 Straight-line rent receivables, less allowance for doubtful accounts of $460 and $460, respectively 5,177 4,947 Prepaid expenses 1,305 901 Other assets 2,664 1,097 Office computers and furniture, net of accumulated depreciation of $631 and $597, respectively 340 374 Deferred leasing commissions, net of accumulated amortization of $972 and $873, respectively 1,480 1,484 - ---------------------------------------------------------------------------------------------------------- Total assets $ 581,890 $ 573,111 ========================================================================================================== Liabilities and Stockholders' Equity: Liabilities: Bank note payable $ 74,164 $ 59,439 Accounts payable and accrued expenses 7,893 8,846 Accrued compensation 600 705 Tenant security deposits 1,076 1,033 - ---------------------------------------------------------------------------------------------------------- Total liabilities 83,733 70,023 - ---------------------------------------------------------------------------------------------------------- Commitments and Contingencies Stockholders' Equity: Preferred Stock, $.0001 par value, 20,000,000 shares authorized, none issued or outstanding -- -- Common Stock, $.0001 par value, 180,000,000 shares authorized, 49,631,513 and 49,630,338 issued and outstanding 5 5 Additional paid-in capital 512,834 512,813 Treasury stock, 575 shares, at cost, issued March 2005 -- (10) Distributions in excess of earnings (14,682) (9,720) - ---------------------------------------------------------------------------------------------------------- Total Stockholders' Equity 498,157 503,088 - ---------------------------------------------------------------------------------------------------------- Total Liabilities and Stockholders' Equity $ 581,890 $ 573,111 ========================================================================================================== </TABLE> See accompanying notes to consolidated financial statements. 3
Franklin Street Properties Corp. Consolidated Statement of Stockholders' Equity (Unaudited) For the Three Months Ended March 31, -------------------- (in thousands, except per share amounts) 2005 2004 ================================================================================ Revenue: Rental $17,234 $18,875 Related party revenue: Syndication fees 2,519 3,041 Transaction fees 2,442 3,549 Management fees and interest income from loans 970 129 Other 13 5 - -------------------------------------------------------------------------------- Total revenue 23,178 25,599 - -------------------------------------------------------------------------------- Expenses: Real estate operating expenses 3,575 3,388 Real estate taxes and insurance 2,354 2,471 Depreciation and amortization 3,573 3,336 Selling, general and administrative 1,825 1,688 Commissions 1,324 1,520 Interest 955 264 - -------------------------------------------------------------------------------- Total expenses 13,606 12,667 - -------------------------------------------------------------------------------- Income before interest income, equity in earnings of non-consolidated REITs and taxes on income 9,572 12,932 Interest income 230 236 Equity in earnings of non-consolidated REITs 665 379 - -------------------------------------------------------------------------------- Income before taxes on income 10,467 13,547 Income tax expense 44 328 - -------------------------------------------------------------------------------- Net income $10,423 $13,219 ================================================================================ Weighted average number of shares outstanding, basic and diluted 49,630 49,624 ================================================================================ Net income per share, basic and diluted $ 0.21 $ 0.27 ================================================================================ See accompanying notes to consolidated financial statements. 4
Franklin Street Properties Corp. Consolidated Statement of Stockholders' Equity (Unaudited) <TABLE> <CAPTION> Common Stock Additional Distributions Total ------------------ Paid-In Treasury in excess of Stockholders' (in thousands) Shares Amount Capital Stock Earnings Equity =============================================================================================================== <S> <C> <C> <C> <C> <C> <C> Balance, December 31, 2004 49,630 $ 5 $512,813 $ (10) $ (9,720) $503,088 Shares issued 2 -- 21 -- -- 21 Treasury shares issued -- -- -- 10 -- 10 Net income -- -- -- -- 10,423 10,423 Distributions -- -- -- -- (15,385) (15,385) - --------------------------------------------------------------------------------------------------------------- Balance, March 31, 2005 49,632 $ 5 $512,834 $ -- $(14,682) $498,157 =============================================================================================================== </TABLE> See accompanying notes to consolidated financial statements. 5
Franklin Street Properties Corp. Consolidated Statements of Cash Flows (Unaudited) <TABLE> <CAPTION> For the Three Months Ended March 31, -------------------------- (in thousands) 2005 2004 ================================================================================================================================ <S> <C> <C> Cash flows from operating activities: Net income $ 10,423 $ 13,219 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization expense 3,374 3,200 Amortization of above market lease 59 59 Sponsored REIT income during consolidation -- (247) Equity in earnings from non-consolidated REITs (665) (379) Distributions from non-consolidated REITs 599 582 Shares issued as compensation 31 162 Changes in operating assets and liabilities: Restricted cash (43) 14 Tenant rent receivables, net -- (229) Straight-line rents, net (230) (340) Operations of assets held for syndication, net (236) -- Prepaid expenses and other assets, net (1,971) (164) Accounts payable and accrued expenses (953) 472 Accrued compensation (105) (1,134) Tenant security deposits 43 (14) Payment of deferred leasing commissions (95) (151) - ------------------------------------------------------------------------------------------------------------------------------- Net cash provided by operating activities 10,231 15,050 - ------------------------------------------------------------------------------------------------------------------------------- Cash flows from investing activities: Purchase of real estate assets, office computers and furniture, capitalized merger costs (327) (117) Investment in non-consolidated REITs -- (4,248) Investment in assets held for syndication, net (14,725) 4,117 - ------------------------------------------------------------------------------------------------------------------------------- Net cash used for investing activities (15,052) (248) - ------------------------------------------------------------------------------------------------------------------------------- Cash flows from financing activities: Distibutions to stockholders (15,385) (15,382) Purchase of treasury shares -- (146) Borrowings (repayments) under bank note payable, net 14,725 (4,117) - ------------------------------------------------------------------------------------------------------------------------------- Net cash used for financing activities (660) (19,645) - ------------------------------------------------------------------------------------------------------------------------------- Net decrease in cash and cash equivalents (5,481) (4,843) Cash and cash equivalents, beginning of period 52,752 58,793 - ------------------------------------------------------------------------------------------------------------------------------- Cash and cash equivalents, end of period $ 47,271 $ 53,950 - ------------------------------------------------------------------------------------------------------------------------------- Supplemental disclosure of cash flow information: Cash paid for: Interest $ 905 $ 264 Income taxes 401 100 </TABLE> See accompanying notes to consolidated financial statements. 6
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. ("FSP Corp." or the "Company", known as Franklin Street Partners Limited Partnership, or the "Partnership", prior to January 1, 2002) was formed as a Massachusetts limited partnership on February 4, 1997. FSP Corp. holds, directly and indirectly, 100% of the interest in three former subsidiaries of the Partnership: FSP Investments LLC, FSP Property Management LLC, and FSP Holdings LLC. The Company also has a non-controlling common stock interest in sixteen corporations organized to operate as real estate investment trusts ("REITs"). In December 2001, the limited partners of the Partnership approved the conversion of the Partnership from a partnership into a corporation (the "Conversion"). 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 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 was accounted for as a reorganization of affiliated entities, with assets and liabilities recorded at their historical costs. On May 30, 2003, the shareholders of the Company approved the Company's acquisition by merger of 13 REITs (the "2003 Target REITs"). The mergers were effective June 1, 2003 and, as a result, the Company issued 25,000,091 shares in a tax-free exchange for all the outstanding preferred shares of the 2003 Target REITs. The mergers were accounted for as a purchase and the acquired assets and liabilities were recorded at their fair value. On August 13, 2004, the Company entered into an agreement to acquire four real estate investment trusts (the "Target REITs"), by the merger of the four Target REITs with and into four of the Company's wholly-owned subsidiaries. The Company completed the mergers on April 30, 2005. Upon the consummation of these mergers, the Company issued 10,894,994 shares of common stock to holders of preferred stock in these Target REITs. The Company operates in two business segments: real estate operations and investment banking/investment services. FSP Investments provides real estate investment and broker/dealer services. FSP Investments' services include: (i) the organization of REIT entities (the "Sponsored REITs"), which are syndicated through private placements; (ii) sourcing of the acquisition of real estate on behalf of the Sponsored REITs; and (iii) the sale of preferred stock in Sponsored REITs. FSP Property Management provides asset management and property management services for the Sponsored REITs. Properties The following table summarizes the Company's investment in real estate assets, excluding assets held for syndication: As of March 31, 2005 2004 --------------- -------------- Residential real estate Number of properties 4 4 Number of apartments 837 837 Commercial real estate Number of properties 24 24 Square feet 3,051,748 3,049,357 7
Franklin Street Properties Corp. Notes to Consolidated Financial Statements (Unaudited) 1. Organization, Properties, Basis of Presentation and Recent Accounting Pronouncements (continued) Basis of Presentation The unaudited consolidated financial statements of the Company include all the accounts of the Company and its wholly and majority 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, 2004, as filed with the Securities and Exchange Commission. The accompanying interim financial statements are unaudited; however, the financial statements have been prepared in accordance with 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. Operating results for the three months ended March 31, 2005 are not necessarily indicative of the results that may be expected for the year ending December 31, 2005 or for any other period. Reclassifications Certain balances in the interim 2004 financial statements have been reclassified to conform to presentation contained in the Company's Annual Report on Form 10-K for its fiscal year ended December 31, 2004. The reclassifications primarily were related to Sponsored REIT income and expenses. Prior to December 31, 2004 the Company presented its proportionate share of Sponsored REIT's revenues and expenses and has since reclassified those amounts to consolidate the real estate operations activity from inception of the Sponsored REIT until the initiation of syndication upon which the equity method of accounting is applied. These reclassifications changed rental revenues, operating and maintenance expenses, depreciation and amortization, other income and equity in earnings of non-consolidated REITs. There was no change to income from continuing operations or net income for any period presented as a result of these reclassifications. Recent Accounting Standards In January 2003, the FASB issued FASB Interpretation No. 46 ("FIN 46"), Consolidation of Variable Interest Entities. In December 2003, the FASB revised FIN 46 with certain modifications and clarifications. The objective of this interpretation is to provide guidance on how to identify a variable interest entity ("VIE") and determine when the assets, liabilities, non-controlling interests, and results of operations of a VIE need to be included in a company's consolidated financial statements. A VIE exists when either the total equity investment at risk is not sufficient to permit the entity to finance its activities by itself, or the equity investors lack one of three characteristics associated with owning a controlling financial interest. Application of this guidance was effective for interests in certain VIEs commonly referred to as special-purpose entities (SPEs) as of December 31, 2003. The provisions of this interpretation became effective upon issuance. The adoption of this standard had no impact on the Company's financial position, operations or cash flow. In May 2003, the FASB issued SFAS No. 150 "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity". This statement was effective for financial instruments entered into or modified after May 31, 2003 and otherwise effective at the beginning of the first interim period beginning after June 15, 2003, except for mandatorily redeemable financial instruments of nonpublic entities which are subject to the provisions of this Statement for the first fiscal period beginning after December 15, 2003. SFAS No. 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. The adoption of this standard had no impact on our financial position, results of operations or cash flows. 8
Franklin Street Properties Corp. Notes to Consolidated Financial Statements (Unaudited) 2. Investment Banking/Investment Services Activity During the three months ended March 31, 2005, the Company sold on a best efforts basis, through private placements, preferred stock in the following Sponsored REITs: <TABLE> <CAPTION> Date Syndication Gross Proceeds Sponsored REIT Property Location Completed (in thousands)(1) ------------------------------------------------------------------------------------------------------- <S> <C> <C> <C> FSP 505 Waterford Corp. Plymouth, MN January 28, 2005 3,000 FSP Galleria North Corp. Dallas, TX 33,950(2) ------------------- Total $ 36,950 =================== </TABLE> 1. The syndication of FSP 505 Waterford Corp. and FSP Galleria North Corp. commenced in the fourth quarter of 2004. 2. The syndication of FSP Galleria North Corp. was not complete at March 31, 2005. This amount represents the gross proceeds syndicated during the three months ended March 31, 2005. 3. Related Party Transactions and Investments in Non-Consolidated Entities Investment in Sponsored REITs At March 31, 2005, the Company held an interest in sixteen Sponsored REITs. Fourteen were fully syndicated and the Company no longer derives economic benefits or risks from the common stock interest it has retained in them. The Company also holds a preferred stock investment in one of these Sponsored REITs, FSP Blue Lagoon Corp., from which it continues to derive economic benefit and risk. The remaining two entities were not fully syndicated and have a value of approximately $74.3 million on the accompanying consolidated balance sheets and are classified as assets held for syndication. The table below shows the Company's share of income and expenses from Sponsored REITs prior to consolidation. Management fees of $5,000 and $5,000 for the three months ended March 31, 2005 and 2004, respectively; and interest expenses are eliminated in consolidation. Three Months Ended March 31, (in thousands) 2005 2004 ---- ---- Operating Data: Rental revenues $ 694 $ 830 Operating and maintenance expenses 177 240 Depreciation and amortization 199 136 Interest expense 174 216 Interest income 2 9 ------- ------- $ 146 $ 247 ======= ======= 9
Franklin Street Properties Corp. Notes to Consolidated Financial Statements (Unaudited) 3. Related Party Transactions and Investments in Non-consolidated Entities, Continued Equity in earnings of investment in non-consolidated REITs: The following table includes equity in earnings of investments in non-consolidated REITs: Three Months Ended March 31, (in thousands) 2005 2004 ---- ---- Equity in earnings of Sponsored REITs $ 602 $ 335 Equity in earnings of Blue Lagoon 63 44 ------- ------- $ 665 $ 379 ======= ======= Equity in earnings of investments in Sponsored REITs is derived from the Company's share of income following the commencement of syndication of Sponsored REITs. Following the commencement of syndication the Company exercises influence over, but does not control these entities and investments are accounted for using the equity method. Equity in earnings of Blue Lagoon is derived from the Company's preferred stock investment in the entity, which was acquired in January 2004. The Company recorded distributions received or declared of $599,000 and $582,000 from Sponsored REITs during the three months ended March 31, 2005 and 2004, respectively. Non-consolidated REITs The Company has in the past acquired by merger entities similar to the Sponsored REITs. On August 13, 2004, the Company entered into an agreement to acquire by merger (the "2004 Merger Agreement") four Sponsored REITs (the Target REITs) and consummated the transactions on April 30, 2005. The Company's business model for growth includes the potential acquisition by merger in the future of Sponsored REITs. Following consummation of the transactions contemplated by the 2004 Merger Agreement, the Company has no legal or any other enforceable obligation to acquire or to offer to acquire any Sponsored REIT. In addition, any offer (and the related terms and conditions) that might be made in the future to acquire any Sponsored REIT would require the approval of the boards of directors of the Company and the Sponsored REIT and the approval of the shareholders of the Sponsored REIT. At March 31, 2005, December 31, 2004 and March 31, 2004, the Company had ownership interests in sixteen, fifteen and nine Sponsored REITs, respectively. Summarized financial information for these Sponsored REITs is as follows: March 31, December 31, ------------------------------- 2005 2004 ------------------------------- (in thousands) Balance Sheet Data (unaudited): Real estate, net $ 482,320 $ 293,722 Other assets 65,222 57,207 Total liabilities (44,729) (4,833) ---------- ---------- Shareholders equity $ 502,813 $ 346,096 ========== ========== 10
Franklin Street Properties Corp. Notes to Consolidated Financial Statements (Unaudited) 3. Related Party Transactions and Investments in Non-Consolidated Entities, Continued For the Three Months Ended March 31, 2005 2004 ------------------------- (in thousands) Operating Data (unaudited): Rental revenue $ 19,865 $ 13,006 Other revenue 281 120 Operating and maintenance expenses (7,188) (3,853) Depreciation and amortization (3,730) (3,050) Interest expense and commitment fees (2,316) (3,332) ---------- ---------- Net income (loss) $ 6,912 $ 2,891 ========== ========== Syndication fees and Transaction fees: The Company provides syndication and real estate acquisition advisory services for Sponsored REITs. Syndication and transaction fees from non-consolidated entities amounted to approximately $4,961,000 and $6,590,000 for the three months ended March 31, 2005 and 2004, respectively. Management fees and interest income from loans: Asset management fees range from 1% to 5% of collected rents and the applicable contracts are cancelable with 30 days notice. Asset management fee income from non-consolidated entities amounted to approximately $225,000 and $115,000, for the three months ended March 31, 2005 and 2004, respectively. The Company is typically entitled to interest on funds advanced to Sponsored REITs. The Company recognized interest income of approximately $745,000 and $14,000 for the three months ended March 31, 2005 and 2004, respectively, relating to these loans. 4. Bank Note Payable The Company has a revolving line of credit agreement (the "Loan Agreement") with a group of banks providing for borrowings at the Company's election of up to $125,000,000. Borrowings under the Loan Agreement bear interest at either the bank's base rate (5.75% at March 31, 2005) or at a LIBOR plus 125 basis points (4.1% at March 31, 2005), as defined. The balance outstanding was $74,164,000 and $59,439,000 at March 31, 2005 and December 31, 2004, respectively. The weighted average interest rate on amounts outstanding during the three months ended March 31, 2005 was 5.0% and for the year ended December 31, 2004 was approximately 3.62%. The Loan Agreement includes restrictions on property liens and requires compliance with various financial covenants. Financial covenants include the maintenance of at least $1,500,000 in operating cash accounts, a minimum tangible net worth and compliance with various debt and operating income ratios, as defined in the Loan Agreement. The Company was in compliance with the Loan Agreement's financial covenants as of March 31, 2005 and December 31, 2004. The Loan Agreement matures on August 18, 2005. 5. Net Income Per Share Basic net income per share is computed by dividing net income by the weighted average number of Company shares outstanding during the period. Diluted net income per share reflects the potential dilution that could occur if securities or other contracts to issue shares were exercised or converted into shares. There were no potential dilutive shares outstanding at March 31, 2005 and 2004. 11
Franklin Street Properties Corp. Notes to Consolidated Financial Statements (Unaudited) 6. Business Segments The Company operates in two business segments: real estate operations (including real estate leasing, interim acquisition financing and asset/property management) and investment banking/investment services (including real estate acquisition and broker/dealer services). The Company has identified these segments because this 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" " in Note 2 to the Company's consolidated financial statements included in its Annual Report on Form 10-K for the year ended December 31, 2004. The Company's operations 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"); excluding gains or losses on the sale of real estate and non-cash income from Sponsored REITs; 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 distributions received from Sponsored REITs; 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 (payments to) cash reserves established at the acquisition date of the property. Depreciation and amortization, gain or loss on the sale of real estate, 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 net income. The funded reserve represents funds that the Company has set aside in anticipation of future capital needs. These reserves are typically used for the payment of capital expenditures, deferred leasing commissions and certain tenant allowances; however, there are no legal restrictions on their use and they may be used for any Company purpose. 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. 12
Franklin Street Properties Corp. Notes to Consolidated Financial Statements (Unaudited) 6. Business Segments (continued) The calculation of CAD by business segment is shown in the following table : <TABLE> <CAPTION> Investment Real Banking/ Estate Investment (in thousands) Operations Services Total --------------------------------- <S> <C> <C> <C> Three Months Ended March 31, 2005 Net Income $ 10,346 $ 77 $ 10,423 Equity in income of non-consolidated REITs (665) -- (665) Distributions from non-consolidated REITs 599 -- 599 Depreciation and amortization 3,399 34 3,433 Straight line rent (230) -- (230) Non-cash compensation expense 4 27 31 Capital Expenditures (327) -- (327) Payment of deferred leasing costs (95) -- (95) Merger costs (87) -- (87) Proceeds from funded reserves 422 -- 422 -------- ----- -------- Cash Available for Distribution $ 13,366 $ 138 $ 13,504 ======== ===== ======== Three Months Ended March 31, 2004 Net Income $ 12,739 $ 480 $ 13,219 Sponsored REIT income during consolidation (247) -- (247) Equity in income of non-consolidated REITs (379) -- (379) Distributions from non-consolidated REITs 582 -- 582 Depreciation and amortization 3,235 24 3,259 Straight line rent (340) -- (340) Non-cash compensation expense -- 162 162 Capital Expenditures (100) (17) (117) Payment of deferred leasing costs (151) -- (151) Proceeds from funded reserves 251 -- 251 -------- ----- -------- Cash Available for Distribution $ 15,590 $ 649 $ 16,239 ======== ===== ======== </TABLE> 13
Franklin Street Properties Corp. Notes to Consolidated Financial Statements (Unaudited) 6. Business Segments (continued) The following table is a summary of other financial information by business segment: Investment Real Banking/ Estate Investment Operations Services Total ==================================================================== (in thousands) March 31, 2005: Revenue $ 20,342 $2,836 $ 23,178 Interest income 222 8 230 Interest expense 955 -- 955 Capital expenditures 327 -- 327 Identifiable assets 578,220 3,670 581,890 March 31, 2004: Revenue $ 21,837 $3,762 $ 25,599 Interest income 220 16 236 Interest expense 264 -- 264 Capital expenditures 100 17 117 Identifiable assets 518,255 3,334 521,589 7. Cash Dividends The Company declared and paid dividends as follows (in thousands, except per share amounts): Dividends Total Quarter Paid Per Share Dividends ------------------------------- --------- --------- First quarter of 2005 $ .31 $ 15,385 First quarter of 2004 $ .31 $ 15,382 8. Income Taxes The Company has elected to be taxed as a REIT under the Internal Revenue Code of 1986, as amended (the "Code"). As a REIT, the Company generally is entitled to a tax deduction for 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, FSP Investments operates as a taxable corporation under the Code and has accounted for income taxes in accordance with the provisions of Statement of Financial Accounting Standard ("SFAS") No. 109, Accounting for Income Taxes. Taxes are provided when FSP investments has net profits for both financial statement and income tax purposes. 14
Franklin Street Properties Corp. Notes to Consolidated Financial Statements (Unaudited) 8. Income Taxes (continued) 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 statements of income relates only to the TRS. The expense differs from the amounts computed by applying the Federal statutory rate of 34% to income before income taxes as follows: For the Three Months Ended March 31, --------------------- (in thousands) 2005 2004 --------------------- Federal income tax expense at statutory rate $ 37 $ 283 Increase in taxes resulting from: State income taxes, net of federal impact 7 45 --------------------- $ 44 $ 328 ===================== No deferred income taxes were provided as there were no material temporary differences between the financial reporting basis and the tax basis of the taxable REIT subsidiary. 10. Subsequent Events The Company declared a cash distribution of $0.41 per share on April 19, 2005 to stockholders of record on April 29, 2005 payable on May 16, 2005. The cash dividend represents four months of operations. On April 30, 2005 the Company acquired by merger four Target REITs and issued 10,894,994 of common stock, $0.0001 par value per share in connection with the mergers. On April 29, 2005 the Company's Board of Directors authorized the Company to explore the possibility of the acquisition (by merger or otherwise) of any or all of five Sponsored REITs: FSP Willow Bend Office Corp., FSP Innsbrook Corp., FSP 380 Interlocken Corp., FSP Blue Lagoon Drive Corp. and FSP Eldridge Green Corp. The Company has no obligation to acquire any or all of these Sponsored REITs. 15
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations The following discussion should be read in conjunction with the financial statements and notes thereto appearing elsewhere in this report and in our Annual Report on Form 10-K for the year ended December 31, 2004. Historical results and percentage relationships set forth in the 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 changes in economic conditions in the markets in which we own properties, changes in the demand by investors for investment in Sponsored REITs, risks of a lessening of demand for the types of real estate owned by us, 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 the factors set forth below under the caption, "Certain Factors That May Affect Future Results". 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 of 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. operates in two business segments: real estate operations and investment banking/investment services. The real estate operations segment involves real estate rental operations, leasing, interim acquisition financing and asset/property management services. The investment banking/investment services segment involves providing real estate investment and broker/dealer services that include the organization of Sponsored REITs, the acquisition of real estate on behalf of Sponsored REITs and the syndication of Sponsored REITs through the sale of preferred stock in private placements. 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 the national market conditions. We look to acquire quality properties in good locations in order to lessen the impact of downturns in the local markets and to take advantage of upturns in these same local markets when they occur. Our investment banking/investment services customers are primarily institutions and high net-worth individuals. To the extent that the broad capital markets affect these investors, our business is also affected. These investors have many investment choices. We must continually search for real estate at a price and at a competitive risk/reward rate of return that meets our customer's risk/reward profile for providing a stream of income and as a long-term hedge against inflation. 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 Conditions and Results of Operations in our Annual Report on Form 10-K for the year ended December 31, 2004. 16
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) Critical Accounting Policies (continued) 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 our Annual Report on Form 10-K for the year ended December 31, 2004. Trends and Uncertainties Real Estate Operations The trends in our office markets have remained consistent across the last few quarters with slow employment growth leading to slow improvement in occupancy and an almost imperceptible improvement in market rents. While market rents for new leases may be increasing in some areas, the new market rents are generally lower than expiring rents in most of our markets, particularly for those leases that were made at the height of the market four to five years ago. We expect to continue to see a decrease in rents to market rents for leases at our properties that expire during the rest of the year unless there is dramatic improvement in market fundamentals. Our apartment properties are beginning to see improving market conditions, despite recent competition from condominiums in addition to the usual competition from other apartments and new homes. If the improvement continues, we expect it will first manifest itself in higher occupancy and lower rent concessions, before there is any significant increase in rental rates. The uncertainty surrounding utility prices in the larger economy creates uncertainty about our future utility costs. Although many of our leases pass through the cost of utilities to the tenants, higher utility prices would increase our overall operating costs. The following table summarizes property wholly owned by us as of the dates indicated: March 31, --------------------------- 2005 2004 Residential: Number of properties 4 4 Number of apartment units 837 837 Commercial: Number of properties 24 24 Square footage 3,051,748 3,049,357 17
Investment Banking/Investment Services Unlike our real estate operations business, which provides a rental revenue stream which is ongoing and recurring in nature, our investment banking/investment services business is transactional in nature. Both the number of Sponsored REIT syndications and the amount of equity anticipated to be raised in 2005 are likely to be below our 2004 levels. Future business in this area is unpredictable. Our property acquisition executives are concerned about continued high valuation levels for prime commercial investment real estate in 2005. It appears that a combination of factors, including low interest rates, a recovering general economy and increased capital allocation to real estate assets is increasing prices on many properties we would have an interest in acquiring. This upward pressure on prices is causing capitalization rates to fall and prices per square foot to rise. Consequently, our acquisition executives are having a difficult time identifying enough property during 2005 at a price acceptable under our investment criteria to grow our overall investment banking/investment services business. Lower revenues from this business reduce the cash available for distribution to stockholders as dividends. As the second quarter of 2005 begins, valuation levels for many top quality investment properties remain at historically high levels, with significant competition from a variety of capital sources to acquire them. Lower capitalization rates on properties acquired for investment syndication mean lower initial cash flow yields for potential equity investors in our Sponsored REITs. Consequently we expect slower sales of these investments to our clients and prospective clients. We continue to rely solely on our in-house investment executives to access interested investors who have capital they can afford to place in an illiquid position for an indefinite period of time (i.e., invest in a Sponsored REIT). We also continue to evaluate our in-house sales force, as to whether we are capable, either through our existing client base or through new clients, of raising sufficient investment capital in Sponsored REITs to achieve future performance objectives. 18
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) Results of Operations The following table shows each segment for the three months ended March 31, 2005 and 2004. <TABLE> <CAPTION> (in thousands) Three months ended March 31, ------------------------------------- Real Estate Operations 2005 2004 Change ---- ---- ------ <S> <C> <C> <C> Revenues: Rental income $ 17,234 $ 18,875 $(1,641) Transaction fees 2,125 2,828 (703) Management fees and interest income from loans 970 129 841 Other 13 5 8 -------------------------------------- 20,342 21,837 (1,495) -------------------------------------- Expenses: Real estate operating expenses 3,575 3,388 187 Real estate taxes and insurance 2,354 2,471 (117) Depreciation and amortization 3,539 3,312 227 Selling, general and administrative 460 262 198 Interest 955 264 691 -------------------------------------- 10,883 9,697 1,186 -------------------------------------- Other items: Interest income 222 220 2 Equity in earnings of non-consolidated REIT's 665 379 286 -------------------------------------- 887 599 288 -------------------------------------- Contribution from real estate operations 10,346 12,739 (2,393) -------------------------------------- Investment Banking/Investment Services Revenues: Syndication fees 2,519 3,041 (522) Transaction fees 317 721 (404) -------------------------------------- 2,836 3,762 (926) -------------------------------------- Expenses: Commissions 1,324 1,520 (196) Depreciation and amortization 34 24 10 Selling, general and administrative 1,365 1,426 (61) -------------------------------------- 2,723 2,970 (247) -------------------------------------- Other items: Interest income 8 16 (8) Taxes on income (44) (328) 284 -------------------------------------- (36) (312) 276 -------------------------------------- Contribution from investment banking/investment services 77 480 (403) -------------------------------------- Net income $ 10,423 $ 13,219 $(2,796) ====================================== </TABLE> 19
Comparison of the three months ended March 31, 2005 to the three months ended March 31, 2004 Total revenues decreased $2.4 million, or 9.5%, to $23.2 million for the three months ended March 31, 2005, as compared to $25.6 million for the three months ended March 31, 2004. Total expenses were $13.6 million for the three months ended March 31, 2005; an increase of $0.9 million, or 7.4%, compared to the three months ended March 31, 2004. The real estate segment included 28 owned properties for each three month period. During the three months ended March 31, 2005 our investment banking/investment services segment had total gross proceeds of $37.0 million, which included completion of the syndication for FSP 505 Waterford Corp. and a continuing syndication of FSP Galleria North Corp., which had been started in the fourth quarter of 2004. During the three months ended March 31, 2004, our investment banking/investment services segment had total gross proceeds of $49.2 million, which included completion of the syndication of FSP Blue Lagoon Drive Corp., which had been started in the fourth quarter of 2003; and of FSP Eldridge Green Corp. As a result, total gross proceeds decreased $12.2 million or 24.8% for the three months ended March 31, 2005 compared to three months ended March 31, 2004. This decrease was attributable to a slower pace of closings in 2005 compared to 2004. Revenues and expenses for investment banking/investment services are directly related to the gross proceeds of these syndications. Each segment is discussed below. Real Estate Operations Contribution from the real estate segment was $10.3 million for the three months ended March 31, 2005; a decrease of $2.4 million, or 18.8%, compared to the three months ended March 31, 2004. The decrease is primarily attributable to: o A decrease to revenues of $1.5 million, of which $1.2 million resulted from a lease termination payment made by a tenant during the three months ended March 31, 2004 that did not recur during the three months ended March 31, 2005, $0.4 million resulted from decreases in occupancy and lower rental rates in the portfolio; and $0.7 million resulted from a decrease in transaction (loan commitment) fees, which was principally caused by the decrease in gross syndication proceeds in the quarter compared to the same period in 2004. These decreases were partially offset by increases in management fees and interest income of $0.8 million. o An increase in selling, general and administrative costs of $0.2 million related primarily to costs of monitoring and managing a larger portfolio of REITs, and an increase to franchise taxes. o An increase in interest expense of $0.7 million resulting from larger loan balances outstanding for syndications in process during the three months ended March 31, 2005 compared to the three months ended March 31, 2004. o An increase in equity in income from non-consolidated REITs of $0.3 million as a result of Sponsored REITs in syndication with greater net operating income during the three months ended March 31, 2005 compared to the three months ended March 31, 2004. o There were insignificant changes to real estate operating expenses, real estate taxes, insurance, depreciation and interest income during the three months ended March 31, 2005 compared to the three months ended March 31, 2004. Investment Banking/Investment Services Contribution of the investment banking and services segment was $0.1 million for the three months ended March 31, 2005; a decrease of $0.4 million, compared to the three months ended March 31, 2004. The decrease was primarily attributable to: o A decrease in syndication fee revenues of $0.9 million, which was primarily attributable to a lower level of gross syndication proceeds during the three months ended March 31, 2005 compared to the three months ended March 31, 2004. o A decrease in commission expense of $0.2 million, which relates to the decrease in gross syndication proceeds. o These decreases were offset by a decrease in taxes on income of $0.3 million as a result of the lower taxable income during the three months ended March 31, 2005 compared to the three months ended March 31, 2004. o There were insignificant changes to selling, general and administrative costs, depreciation and interest income during the three months ended March 31, 2005 compared to the three months ended March 31, 2004. Net Income Net income from contribution of both segments for the three months ended March 31, 2005 decreased $2.8 million to $10.4 million compared to $13.2 million for the reasons discussed above. 20
Liquidity and Capital Resources Cash and cash equivalents were $47.3 million and $52.8 million at March 31, 2005 and December 31, 2004, respectively. This decrease of $5.5 million is attributable to $10.2 million provided by operating activities, less $15.0 million used for investing activities, less $0.7 million used for financing activities. Management believes that existing cash, cash anticipated to be generated internally by operations, cash anticipated to be generated by the sale of preferred stock in future Sponsored REITs and our line of credit will be sufficient to meet working capital requirements and anticipated capital expenditures for at least the next 12 months. Operating Activities The cash provided by our operating activities of $10.2 million is primarily attributable to net income of $10.4 million, plus the add-back of $3.2 million of non-cash activity and was partially offset by increases in prepaid and other assets of $2.0 million, decreases in accounts payable and accrued expenses and compensation of $1.1 million and increases in other operating assets of $0.3 million. Investing Activities Our cash used by investing activities of $15.0 million is primarily attributable to an additional $14.7 million invested in assets held for syndication and $0.3 million to acquire or improve real estate assets. Financing Activities Our cash used by financing activities of $0.7 million is attributable to $15.4 million of distributions to shareholders and net borrowings of $14.7 million made during the three months ended March 31, 2005, which related to assets held for syndication. Line of Credit We have a revolving line of credit agreement with a group of banks providing for borrowings of up to $125 million. Borrowings under the line of credit bear interest at either the bank's base rate (5.75% at March 31, 2005) or at LIBOR plus 125 basis points (4.1% at March 31, 2005), as defined. Borrowings outstanding under the line of credit at March 31, 2005 were $74.2 million. We are in compliance with all bank covenants required by this line of credit. The maturity date of the line of credit is August 18, 2005, and we intend to evaluate extension, renewal or replacement of the facility. Contingencies We are subject to various legal proceedings and claims that arise in the ordinary course of its business. Although occasional adverse decisions (or settlements) may occur, we believe that the final disposition of such matters will not have a material adverse effect on our financial position or results of operations. Assets Held for Syndication As of March 31, 2005 there are two assets held for syndication. As of December 31, 2004 we also had two assets held for syndication. One syndication was completed in January 2005, and the second asset was purchased during the three months ended March 31, 2005, but the syndication has not commenced. Related Party Transactions In the three months ended March 31, 2005, we completed the syndication of FSP 505 Waterford Corp., and continued the syndication of FSP Galleria North Corp. We did not enter into any other significant transactions with related parties during the quarter ended March 31, 2005. For a discussion of transactions between us and related parties during 2004, see Footnote No. 5 "Related Party Transactions" to the Consolidated Financial Statements of the Company's Annual Report on Form 10-K for the year ended December 31, 2004. Other Considerations We generally pay the ordinary annual operating expenses of our properties from the rental revenue generated by the properties. For the three months ended March 31, 2005 and 2004 the rental income exceeded the expenses for each individual property, with the exception of Blue Ravine and Lyberty Way. The single tenant lease at the Blue Ravine property located in Folsom, California, expired June 30, 2003. The single tenant lease at the Lyberty Way property located in Westford, Massachusetts expired October 31, 2004. We have not re-let either property and expect that these properties will not produce revenue to cover their expenses in the second quarter. 21
Management believes that cash and cash equivalents, as of March 31, 2005, are in excess of our known needs for extraordinary expenses or capital improvements within the next twelve months. 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. We believe that we have adequate funds to cover unusual expenses and capital improvements, in addition to normal operating expenses. Our ability to maintain or increase our level of dividends to stockholders, however, depends in part upon the level of interest on the part of investors in purchasing shares of Sponsored REITs and the level of rental income from our real properties. CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS The following important factors, among others, could cause actual results to differ materially from those indicated by forward-looking statements made in this Quarterly Report on Form 10-Q and presented elsewhere by management from time to time. If we are not able to collect sufficient rents from each of our owned real properties, we may suffer significant operating losses or a reduction in cash available for future dividends. A substantial portion of our revenues are generated by the rental income of our real properties. If our properties do not provide us with a steady rental income, our revenues will decrease and may cause us to incur operating losses in the future. We face risks in continuing to attract investors for Sponsored REITs. Our investment banking/investment services business continues to depend upon its ability to attract purchasers of equity interests in Sponsored REITs. Our success in this area will depend on the propensity and ability of investors who have previously invested in Sponsored REITs to continue to invest in future Sponsored REITs and on our ability to expand the investor pool for the Sponsored REITs by identifying new potential investors. Moreover, our investment banking/investment services business may be affected to the extent existing Sponsored REITs incur losses or have operating results that fail to meet investors' expectations. If we are unable to fully syndicate a Sponsored REIT, we may be required to keep a balance outstanding on our line of credit or use our cash balance to repay our line of credit, which may reduce cash available for distribution to our stockholders. We typically draw on our line of credit to make an interim mortgage loan to a Sponsored REIT, so that it can acquire real property prior to the consummation of the offering of its equity interests; this interim loan is secured by a first mortgage of the real property acquired by the Sponsored REIT. Once the offering has been completed, the Sponsored REIT repays the loan out of the offering proceeds. If we are unable to fully syndicate a Sponsored REIT, the Sponsored REIT could be unable to fully repay the loan, and we would have to satisfy our obligation under our line of credit through other means. If we are required to use cash for this purpose, we would have less cash available for distribution to our stockholders. Failure to renew, replace or extend our line of credit could have a material adverse effect on the cash available for distribution to our stockholders and would limit our growth. Our line of credit matures in August 2005. We typically draw on our line of credit to make an interim mortgage loan to a sponsored REIT, so that the sponsored REIT can acquire real property prior to the consummation of the offering of such sponsored REIT's equity interests. Once the offering has been completed, the sponsored REIT repays the loan out of the offering proceeds. An inability to renew, replace or extend our line of credit could result in difficulty financing growth in the investment banking/investment services segment of our business. It could also result in a reduction in the cash available for distribution to our stockholders because revenue for our investment banking/investment services segment is directly related to the amount of equity raised by sponsored REITs which we syndicate. In addition, a significant part of our growth strategy is to acquire additional real properties by cash purchase or by acquisition of sponsored REITs, and the loss of the line of credit would make it substantially more difficult to pursue acquisitions by either method. To the extent we have a balance outstanding on the line of credit on the date of its maturity, we would have to satisfy our obligation through other means. If we are required to use cash for this purpose, we would have less cash available for distribution to its stockholders. We may not be able to find properties that meet our criteria for purchase. Growth in our investment banking/investment services business and our portfolio of real estate is dependent on the ability of our acquisition executives to find properties for sale which meet our investment criteria. To the extent they fail to find such properties, we will be unable to syndicate offerings of Sponsored REITs to investors, and this segment of our business could have lower revenue, which would reduce the cash available for distribution to our stockholders, and we would be unable to increase the size of our portfolio of real estate. 22
We are dependent on key personnel. We depend on the efforts of George Carter, our Chief Executive Officer, and our other executive officers. If they were to resign, our operations could be adversely affected. We do not have employment agreements with Mr. Carter or any other of our executive officers. Our level of dividends may fluctuate. Because our investment banking/investment services business is transactional in nature and real estate occupancy levels and rental rates can fluctuate, there is no predictable recurring level of revenue from such activities. As a result of this, the amount of cash available for distribution may fluctuate, which may result in us not being able to maintain or grow dividend levels in the future. The real properties held by us may significantly decrease in value. As of March 31, 2005, we owned 28 properties. We acquired an additional four properties on April 30, 2005. Some or all of these properties may decline in value. To the extent our real properties decline in value, our stockholders could lose some or all the value of their investments. Although currently there is no public market for the shares of our common stock, the value of our common stock may still be adversely affected if the real properties held by us decline in value since these real properties represent the majority of the tangible assets held by us. Moreover, if either we are forced to sell or lease the real property held by us below its initial purchase price or its carrying costs or if we are forced to lease real property at below market rates because of the condition of the property, our results of operations would be adversely affected and such negative results of operations may result in lower dividends being paid to holders of our common stock. New acquisitions may fail to perform as expected. We may acquire new properties, whether by direct FSP Corp. cash purchase, by acquisition of Sponsored REITs or other properties by cash or through the issuance of shares of our stock or by investment in a Sponsored REIT. We acquired four Sponsored REITs and the properties they own on April 30, 2005. Newly acquired properties may fail to perform as expected, in which case, our results of operations could be adversely affected. We face risks in owning and operating real property. An investment in us is subject to the risks incident to the ownership and operation of real estate-related assets. These risks include the fact that real estate investments are generally illiquid, which may impact our ability to vary our portfolio in response to changes in economic and other conditions, as well as the risks normally associated with: o changes in general and local economic conditions; o the supply or demand for particular types of properties in particular markets; o changes in market rental rates; o the impact of environmental protection laws; and o changes in tax, real estate and zoning laws. Certain significant costs, such as real estate taxes, utilities, insurance and maintenance costs, generally are not reduced even when a property's rental income is reduced. In addition, environmental and tax laws, interest rate levels, the availability of financing and other factors may affect real estate values and property income. Furthermore, the supply of commercial and multi-family residential space fluctuates with market conditions. We face risks from tenant defaults or bankruptcies. 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. We may encounter significant delays in reletting vacant space, resulting in losses of income. When leases expire, we will incur expenses and may not be able to re-lease the space on the same terms. Certain leases provide tenants the right to terminate early if they pay a fee. If we are unable to re-lease space promptly, if the terms are significantly less favorable than anticipated or if the costs are higher, we may have to reduce distributions to our stockholders. For example, approximately $10,393,000, or 17.6%, of our annualized rental revenue from commercial and residential apartment properties derives from leases which expire during 2005. Some of these leases have been renewed during the first quarter and some have not. 23
We face risks from geographic concentration. The properties in our portfolio as of March 31, 2005, by aggregate square footage, are distributed geographically as follows: Southwest - 26%, Northeast - 31%, Midwest - 19%, West - 16% and Southeast 8%. However, within certain of those regions, we hold a larger concentration of our properties in Houston, Texas - 18% and Washington, DC - 13%. We are likely to face risks to the extent that any of these areas in which we hold a larger concentration of our properties suffer deteriorating economic conditions. We compete with national, regional and local real estate operators and developers, which could adversely affect our cash flow. Competition exists in every market in which our properties are currently located and in every market in which our properties will be located. We compete with, among others, national, regional and numerous local real estate operators and developers. Such competition may adversely affect the percentage of leased space and the rental revenues of our properties, which could adversely affect our cash flow from operations and our ability to make expected distributions to our stockholders. Some of our competitors may have more resources than we do or other competitive advantages. Competition may be accelerated by any increase in availability of funds for investment in real estate. For example, decreases in interest rates tend to increase the availability of funds and therefore can increase competition. To the extent that our properties continue to operate profitably, this will likely stimulate new development of competing properties. The extent to which we are affected by competition will depend in significant part on local market conditions. There is limited potential for an increase in leased space gains in our properties. We anticipate that future increases in revenue from our properties will be primarily the result of scheduled rental rate increases or rental rate increases as leases expire. Properties with higher rates of vacancy are generally located in soft economic markets so that it may be difficult to realize increases in revenue when vacant space is re-leased. We are subject to possible liability relating to environmental matters, and we cannot assure you that we have identified all possible liabilities. Under various federal, state and local laws, ordinances and regulations, an owner or operator of real property may become liable for the costs of removal or remediation of certain hazardous substances released on or in its property. Such laws may impose liability without regard to whether the owner or operator knew of, or caused, the release of such hazardous substances. The presence of hazardous substances on a property may adversely affect the owner's ability to sell such property or to borrow using such property as collateral, and it may cause the owner of the property to incur substantial remediation costs. In addition to claims for cleanup costs, the presence of hazardous substances on a property could result in the owner incurring substantial liabilities as a result of a claim by a private party for personal injury or a claim by an adjacent property owner for property damage. In addition, we cannot assure you that: o future laws, ordinances or regulations will not impose any material environmental liability; o the current environmental conditions of our properties will not be affected by the condition of properties in the vicinity of such properties (such as the presence of leaking underground storage tanks) or by third parties unrelated to us; o tenants will not violate their leases by introducing hazardous or toxic substances into our properties that could expose us to liability under federal or state environmental laws; or o environmental conditions, such as the growth of bacteria and toxic mold in heating and ventilation systems or on walls, will not occur at our properties and pose a threat to human health. We are subject to compliance with the Americans With Disabilities Act and fire and safety regulations which could require us to make significant capital expenditures. All of our properties are required to comply with the Americans With Disabilities Act (ADA), and the regulations, rules and orders that may be issued thereunder. The ADA has separate compliance requirements for "public accommodations" and "commercial facilities," but generally requires that buildings be made accessible to persons with disabilities. Compliance with ADA requirements might require, among other things, removal of access barriers and noncompliance could result in the imposition of fines by the U.S. government, or an award of damages to private litigants. In addition, we are required to operate our properties in compliance with fire and safety regulations, building codes and other land use regulations, as they may be adopted by governmental agencies and bodies and become applicable to our properties. Compliance with such requirements may require us to make substantial capital expenditures, which expenditures would reduce cash otherwise available for distribution to its stockholders. 24
There are significant conditions to our obligation to redeem shares of our common stock, and any such redemption will result in the stockholders tendering shares receiving less than their estimated fair market value. Under our redemption plan, we are only obligated to use our best efforts to redeem shares of our common stock from stockholders wishing to have them redeemed. Stockholders wishing to have their shares redeemed must so request on or before the July 1 which precedes the January 1 date on which the redemption will be effective, and any such request will be irrevocable. There are significant conditions to our obligation to redeem shares of our common stock including: o we cannot be insolvent or be rendered insolvent by the redemption; o the redemption cannot impair our capital or operations; o the redemption cannot contravene any provision of federal or state securities laws; o the redemption cannot result in our failing to qualify as a REIT; and o our management must determine that the redemption is in our best interests. Any redemption effected by us under this plan would result in those stockholders tendering shares of our common stock receiving 90% of the estimated fair market value of such shares, as determined by our board of directors in its sole and absolute discretion, and not their full estimated fair market value. If our common stock becomes listed for trading on AMEX or any other national securities exchange or the NASDAQ National Market, we will no longer be obligated to, and do not intend to, effect any redemption. We did not receive any requests for redemption from the time of the mailing of the Consent Solicitation/Prospectus related to the mergers, which occurred on March 1, 2005, until the effective date of the mergers, which was April 30, 2005. We may lose capital investment or anticipated profits if an uninsured event occurs. We carry or our tenants carry comprehensive liability, fire and extended coverage with respect to each of our properties, with policy specification and insured limits customarily carried for similar properties. There are, however, certain types of losses, such as from wars, pollution or earthquakes, that may be either uninsurable or not economically insurable (although most properties located in California have earthquake insurance). Should an uninsured material loss occur, we could lose both capital invested in the property and anticipated profits. Contingent or unknown liabilities acquired in mergers or similar transactions could require us to make substantial payments. The properties which we acquired in mergers were acquired subject to liabilities and without any recourse with respect to liabilities, whether known or unknown. As a result, if liabilities were asserted against us based upon any of these properties, we might have to pay substantial sums to settle them, which could adversely affect our results of operations and financial condition and our cash flow and ability to make distributions to our stockholders. Unknown liabilities with respect to properties acquired might include: o liabilities for clean-up or remediation of environmental conditions; o claims of tenants, vendors or other persons dealing with the former owners of the properties; and o liabilities incurred in the ordinary course of business. We would incur adverse tax consequences if we failed to qualify as a REIT. The provisions of the tax code governing the taxation of real estate investment trusts are very technical and complex, and although we expect that we will be organized and will operate in a manner that will enable us to meet such requirements, no assurance can be given that we will always succeed in doing so. In addition, as a result of our acquisition of the target REITs pursuant to the mergers, we might no longer qualify as a real estate investment trust. We could lose our ability to so qualify for a variety of reasons relating to the nature of the assets acquired from the target REITs, the identity of the shareholders of the target REITs who become our shareholders or the failure of one or more of the target REITs to have previously qualified as a real estate investment trust. Moreover, you should note that if one or more of the REITs that we acquired in June 2003 or April 2005 did not qualify as a real estate investment trust immediately prior to the consummation of its acquisition, we could be disqualified as a REIT as a result of such acquisition. If in any taxable year we do not qualify as a real estate investment trust, we would be taxed as a corporation and distributions to our stockholders would not be deductible by us in computing our taxable income. In addition, if we were to fail to qualify as a real estate investment trust, we could be disqualified from treatment as a real estate investment trust in the year in which such failure occurred and for the next four taxable years and, consequently, we would be taxed as a regular corporation during such years. Failure to qualify for even one taxable year could result in a significant reduction of our cash available for distribution to our stockholders or could require us to incur indebtedness or liquidate investments in order to generate sufficient funds to pay the resulting federal income tax liabilities. 25
Provisions in our organizational documents may prevent changes in control. Our Articles of Incorporation and Bylaws contain provisions, described below, which may have the effect of discouraging a third party from making an acquisition proposal for us and may thereby inhibit a change of control under circumstances that could otherwise give the holders of our common stock the opportunity to realize a premium over the then-prevailing market prices. Ownership Limits. In order for us to maintain our qualification as a real estate investment trust, the holders of our common stock may be limited to owning, either directly or under applicable attribution rules of the Internal Revenue Code, no more than 9.8% of the lesser of the value or the number of equity shares of us, and no holder of common stock may acquire or transfer shares that would result in our shares of common stock being beneficially owned by fewer than 100 persons. Such ownership limit may have the effect of preventing an acquisition of control of us without the approval of our board of directors. Our Articles of Incorporation give our board of directors the right to refuse to give effect to the acquisition or transfer of shares by a stockholder in violation of these provisions. Staggered Board. Our board of directors is divided into three classes. The terms of these classes will expire in 2006, 2007 and 2008, respectively. Directors of each class are elected for a three-year term upon the expiration of the initial term of each class. The staggered terms for directors may affect our stockholders' ability to effect a change in control even if a change in control were in the stockholders' best interests. Preferred Stock. Our Articles of Incorporation authorize our board of directors to issue up to 20,000,000 shares of preferred stock, par value $.0001 per share, and to establish the preferences and rights of any such shares issued. The issuance of preferred stock could have the effect of delaying or preventing a change in control even if a change in control were in our stockholders' best interest. Increase of Authorized Stock. Our board of directors, without any vote or consent of the stockholders, may increase the number of authorized shares of any class or series of stock or the aggregate number of authorized shares we have authority to issue. The ability to increase the number of authorized shares and issue such shares could have the effect of delaying or preventing a change in control even if a change in control were in our stockholders' best interest. Amendment of Bylaws. Our board of directors has the sole power to amend our Bylaws. This power could have the effect of delaying or preventing a change in control even if a change in control were in our stockholders' best interests. Stockholder Meetings. Our Bylaws require advance notice for stockholder proposals to be considered at annual meetings of stockholders and for stockholder nominations for election of directors at special meetings of stockholders. Our Bylaws also provide that stockholders entitled to cast more than 50% of all the votes entitled to be cast at a meeting must join in a request by stockholders to call a special meeting of stockholders. These provisions could have the effect of delaying or preventing a change in control even if a change in control were in the best interests of our stockholders. Supermajority Votes Required. Our Articles of Incorporation require the affirmative vote of the holders of no less than 80% of the shares of capital stock outstanding and entitled to vote in order (i) to amend the provisions of our Articles of Incorporation relating to the classification of directors, removal of directors, limitation of liability of officers and directors or indemnification of officers and directors or (ii) to amend our Articles of Incorporation to impose cumulative voting in the election of directors. These provisions could have the effect of delaying or preventing a change in control even if a change in control were in our stockholders' best interest. The listing of our common stock on the American Stock Exchange or another national securities exchange and the trading price of our common stock following such listing are uncertain. Our common stock could trade at a lower price than anticipated. Although we have filed an application to list our common stock on the AMEX, and the AMEX has approved the application, there can be no assurances that our common stock will be listed for trading. Therefore, a trading market may not develop at all, or if one does, it may not be meaningful. If a trading market does develop, the market prices for our common stock may fluctuate with changes in market and economic conditions, including the market perception of REITs in general, and changes in the financial condition of our securities. Such fluctuations may depress the market price of our common stock independent of the financial performance of FSP Corp. The market conditions for REIT stocks generally could affect the market price of our common stock. 26
Item 3. Quantitative and Qualitative Disclosures about Market Risk We were not a party to any derivative financial instruments at or during the three months ended March 31, 2005. We borrow from time-to-time on our line of credit. These borrowings bear interest at the bank's base rate (5.75% at March 31, 2005) or at LIBOR plus 125 basis points (4.1% at March 31, 2005), as elected by us when requesting funds as defined. As of March 31, 2005, $74,164,000 was outstanding under the line of credit consisting of one borrowing of $30,164,000 at the bank's base rate and a borrowing of $44,000,000 at the LIBOR plus 125 basis point rate. We have used the funds drawn on our line of credit only for the purpose of making interim mortgage loans to Sponsored REITs. These mortgage loans bear interest at the same variable rate payable by us under our line of credit. We therefore believe that we have mitigated our interest rate risk with respect to our borrowings. 27
Item 4. Controls and Procedures. Our management, with the participation of FSP Corp.'s President and Chief Executive Officer and FSP Corp.'s Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(d) under the Exchange Act) as of March 31, 2005. Based on this evaluation, FSP Corp.'s President and Chief Executive Officer and FSP Corp.'s Chief Financial Officer concluded that, as of March 31, 2005, our disclosure controls and procedures were (1) designed to ensure that material information relating to us, including our consolidated subsidiaries, is made known to FSP Corp.'s President and Chief Executive Officer and FSP Corp.'s Chief Financial Officer by others within these entities as appropriate to allow timely decisions regarding required disclosure, particularly during the period in which this report was being prepared and (2) effective, in that they provide reasonable assurance that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms. No change to our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the quarter ended March 31, 2005 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. 28
PART II - OTHER INFORMATION Item 1. Legal Proceedings: Not applicable. Item 2. Unregistered Sales of Equity Securities and Use of Proceeds: (c) The following table provides information about purchases by Franklin Street Properties Corp. during the quarter ended March 31, 2005 of equity securities that are registered by the Company pursuant to Section 12 of the Exchange Act: ISSUER PURCHASES OF EQUITY SECURITIES <TABLE> <CAPTION> - ----------------------------------------------------------------------------------------------------------------------- (a) (b) (c) (d) Total Number of Maximum Number (or Shares (or Units) Approximate Dollar Value) Purchased as Part of Shares (or Units) that Total Number of of Publicly May Yet Be Purchased Shares (or Units) Average Price Paid Announced Plans or Under the Plans or Period Purchased (1) per Share (or Unit) Programs (1) Programs (1) - ----------------------------------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> 01/01/05-01/31/05 0 N/A 0 0 - ----------------------------------------------------------------------------------------------------------------------- 02/01/05-02/28/05 0 N/A 0 0 - ----------------------------------------------------------------------------------------------------------------------- 03/01/05-03/30/05 0 N/A 0 0 - ----------------------------------------------------------------------------------------------------------------------- Total: 0 N/A 0 0 - ----------------------------------------------------------------------------------------------------------------------- </TABLE> FSP Corp. does not have any publicly announced repurchase plans or programs. However, FSP Corp.'s Articles of Incorporation provide that FSP Corp. will use its best efforts to redeem shares of its common stock from stockholders who request such redemption. Any FSP Corp. stockholder wishing to have shares redeemed must make such a request no later than July 1 of any year for a redemption that would be effective the following January 1. This obligation is subject to significant conditions, including that (i) FSP Corp. cannot be insolvent or rendered insolvent by the redemption, (ii) the redemption cannot impair the capital or operations of FSP Corp., (iii) the redemption cannot contravene any provision of federal or state securities law, (iv) the redemption cannot result in FSP Corp.'s failing to qualify as a REIT, and (v) the management of FSP Corp. must determine that the redemption is in the best interest of FSP Corp. Redemptions pursuant to these provisions result in redeeming stockholders receiving cash in an amount of 90% of the fair market value of the stock redeemed, as determined by FSP Corp.'s Board of Directors. If our common stock becomes listed for trading on AMEX or any other national securities exchange or the NASDAQ National Market, we will no longer be obligated to, and do not intend to, effect any redemption. We did not receive any requests for redemption from the time of the mailing of the Consent Solicitation/Prospectus related to the mergers, which occurred on March 1, 2005, until the effective date of the mergers, which was April 30, 2005. 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: For purposes of Regulation FD the Company has attached a table regarding the investors in Sponsored REITs attached as Exhibit 99.1 hereto. 29
PART II - OTHER INFORMATION (Continued) Item 6. Exhibits: 2.2 Amendment No. 1 to Agreement and Plan of Merger, dated as of August 13, 2004, by and among the Registrant and the parties thereto (incorporated by reference to Exhibit 2.2 to the Registrant's Current Report on Form 8-K dated April 29, 2005). 3.2 Restated Bylaws of FSP Corp. 31.1 Certification of the President and Chief Executive Officer of the Registrant pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 Certification of the Chief Financial Officer of the Registrant pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.1 Certification of the President and Chief Executive Officer of the Registrant pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2 Certification of the Chief Financial Officer of the Registrant pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 99.1 Table regarding investors in Sponsored REITs. 30
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 ---- --------- ----- May 6, 2005 /s/ George J. Carter Chief Executive Officer and -------------------- Director (Principal Executive Officer) George J. Carter May 6, 2005 /s/ John G. Demeritt Senior Vice President and Chief Financial -------------------- Officer (Principal Financial Officer) John G. Demeritt 31