UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10 - Q (Mark One) |X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 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 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 July 29, 2005 was 60,525,608.
Franklin Street Properties Corp. Form 10-Q Quarterly Report June 30, 2005 Table of Contents Part I. Financial Information Page Item 1. Financial Statements Consolidated Balance Sheets as of June 30, 2005 and December 31, 2004 ............................................. 3 Consolidated Statements of Income for the three and six months ended June 30, 2005 and 2004................................... 4 Consolidated Statements of Cash Flows for the six months ended June 30, 2005 and 2004......................................... 5 Notes to Consolidated Financial Statements................... 6-16 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations................................... 17-30 Item 3. Quantitative and Qualitative Disclosures about Market Risk ... 31 Item 4. Controls and Procedures ...................................... 32 Part II. Other Information Item 1. Legal Proceedings ............................................ 33 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds .. 33 Item 3. Defaults upon Senior Securities .............................. 33 Item 4. Submission of Matters to a Vote of Security Holders .......... 34 Item 5. Other Information ............................................ 34 Item 6. Exhibits ..................................................... 35 Signatures .............................................................. 36
PART I - FINANCIAL INFORMATION Item 1. Financial Statements Franklin Street Properties Corp. Consolidated Balance Sheets (Unaudited) <TABLE> <CAPTION> June 30, December 31, (in thousands, except shares and par value amounts) 2005 2004 ===================================================================================================================== <S> <C> <C> Assets: Real estate investments, at cost: Land $ 90,997 $ 71,267 Buildings and improvements 518,956 404,830 Fixtures and equipment 885 885 - --------------------------------------------------------------------------------------------------------------------- 610,838 476,982 Less accumulated depreciation 42,583 37,227 - --------------------------------------------------------------------------------------------------------------------- Real estate investments, net 568,255 439,755 Acquired real estate leases, net of accumulated amortization of $4,919 and $3,020, respectively 23,549 6,483 Investment in non-consolidated REITs 4,215 4,270 Assets held for syndication 53,646 59,246 Asset held for sale 4,766 -- Cash and cash equivalents 51,475 52,752 Restricted cash 1,326 1,033 Tenant rent receivables, less allowance for doubtful accounts of $350 and $350, respectively 679 769 Straight-line rent receivables, less allowance for doubtful accounts of $460 and $460, respectively 5,506 4,947 Prepaid expenses 1,264 901 Other assets 1,359 1,097 Office computers and furniture, net of accumulated depreciation of $668 and $597, respectively 304 374 Deferred leasing commissions, net of accumulated amortization of $1,084 and $873, respectively 1,584 1,484 - --------------------------------------------------------------------------------------------------------------------- Total assets $ 717,928 $ 573,111 ===================================================================================================================== Liabilities and Stockholders' Equity: Liabilities: Bank note payable $ 53,213 $ 59,439 Accounts payable and accrued expenses 10,640 8,846 Accrued compensation 940 705 Tenant security deposits 1,326 1,033 - --------------------------------------------------------------------------------------------------------------------- Total liabilities 66,119 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, 60,525,608 and 49,630,338 issued and outstanding 6 5 Additional paid-in capital 677,397 512,813 Treasury stock, 898 and 575 shares, respectively (16) (10) Distributions in excess of earnings (25,578) (9,720) - --------------------------------------------------------------------------------------------------------------------- Total Stockholders' Equity 651,809 503,088 - --------------------------------------------------------------------------------------------------------------------- Total Liabilities and Stockholders' Equity $ 717,928 $ 573,111 ===================================================================================================================== </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 Ended Six Months Ended June 30, June 30, - ----------------------------------------------------------------------------------------------------------------- (in thousands, except per share amounts) 2005 2004 2005 2004 ================================================================================================================= <S> <C> <C> <C> <C> Revenue: Rental $ 21,748 $ 17,564 $ 38,982 $ 36,439 Related party revenue: Syndication fees 1,603 5,407 4,122 8,448 Transaction fees 1,595 5,193 4,038 8,742 Management fees and interest income from loans 481 124 1,451 253 Other -- 11 13 16 - ----------------------------------------------------------------------------------------------------------------- Total revenue 25,427 28,299 48,606 53,898 - ----------------------------------------------------------------------------------------------------------------- Expenses: Real estate operating expenses 4,528 3,576 8,067 6,942 Real estate taxes and insurance 2,902 2,279 5,239 4,729 Depreciation and amortization 4,621 3,544 8,160 6,843 Selling, general and administrative 1,741 1,606 3,567 3,294 Commissions 867 2,767 2,191 4,287 Interest 788 253 1,743 517 - ----------------------------------------------------------------------------------------------------------------- Total expenses 15,447 14,025 28,967 26,612 - ----------------------------------------------------------------------------------------------------------------- Income before interest income, equity in earnings of non-consolidated REITs and taxes on income 9,980 14,274 19,639 27,286 Interest income 367 127 597 363 Equity in earnings of non-consolidated REITs 302 6 968 385 - ----------------------------------------------------------------------------------------------------------------- Income before taxes on income 10,649 14,407 21,204 28,034 Income tax expense 70 648 114 976 - ----------------------------------------------------------------------------------------------------------------- Income from continuing operations 10,579 13,759 21,090 27,058 Loss from discontinued operations (70) (83) (158) (163) Estimated loss on asset held for sale (1,055) -- (1,055) -- - ----------------------------------------------------------------------------------------------------------------- Net income $ 9,454 $ 13,676 $ 19,877 $ 26,895 ================================================================================================================= Weighted average number of shares outstanding, basic and diluted 56,815 49,630 53,242 49,627 ================================================================================================================= Net income from continuing operations $ 0.19 $ 0.28 $ 0.39 $ 0.54 Loss from discontinued operations -- -- -- -- Estimated loss on asset held for sale (0.02) -- (0.02) -- - ----------------------------------------------------------------------------------------------------------------- Net income per share, basic and diluted $ 0.17 $ 0.28 $ 0.37 $ 0.54 ================================================================================================================= </TABLE> See accompanying notes to consolidated financial statements. 4
Franklin Street Properties Corp. Consolidated Statements of Cash Flows (Unaudited) <TABLE> <CAPTION> For the Six Months Ended June 30, -------------------------------- (in thousands) 2005 2004 ==================================================================================================================================== <S> <C> <C> Cash flows from operating activities: Net income $ 19,877 $ 26,895 Adjustments to reconcile net income to net cash provided by operating activities: Estimated loss on asset held for sale 1,055 -- Depreciation and amortization expense 8,230 6,697 Amortization of above market lease 887 118 Sponsored REIT income during consolidation -- (441) Equity in earnings from non-consolidated REITs (968) (385) Distributions from non-consolidated REITs 980 773 Shares issued as compensation 31 162 Changes in operating assets and liabilities: Restricted cash (293) (46) Tenant rent receivables, net 90 251 Straight-line rents, net (724) (854) Operations of assets held for syndication, net (1,295) -- Prepaid expenses and other assets, net (843) (201) Accounts payable and accrued expenses (1,144) 2,952 Accrued compensation 235 272 Tenant security deposits 293 46 Payment of deferred leasing commissions (311) (252) - ------------------------------------------------------------------------------------------------------------------------------------ Net cash provided by operating activities 26,100 35,987 - ------------------------------------------------------------------------------------------------------------------------------------ Cash flows from investing activities: Cash acquired through issuance of common stock in merger transaction 10,621 -- Purchase of real estate assets, office computers and furniture (1,928) (619) Merger costs paid (402) -- Investment in non-consolidated REITs 43 (4,248) Investment in assets held for syndication, net 6,265 4,117 - ------------------------------------------------------------------------------------------------------------------------------------ Net cash provided by (used) for investing activities 14,599 (750) - ------------------------------------------------------------------------------------------------------------------------------------ Cash flows from financing activities: Distibutions to stockholders (35,734) (30,767) Purchase of treasury shares (16) (146) Repayments under bank note payable, net (6,226) (4,117) - ------------------------------------------------------------------------------------------------------------------------------------ Net cash used for financing activities (41,976) (35,030) - ------------------------------------------------------------------------------------------------------------------------------------ Net increase (decrease) in cash and cash equivalents (1,277) 207 Cash and cash equivalents, beginning of period 52,752 58,793 - ------------------------------------------------------------------------------------------------------------------------------------ Cash and cash equivalents, end of period $ 51,475 $ 59,000 ==================================================================================================================================== Supplemental disclosure of cash flow information: Cash paid for: Interest $ 1,795 $ 517 Income taxes $ 406 $ 1,020 Non-cash investing and financing activities: Assets acquired through issuance of common stock in merger transaction, net $ 153,943 $ -- </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. ("FSP Corp." or the "Company") holds, directly and indirectly, 100% of the interest in FSP Investments LLC, FSP Property Management LLC, and FSP Holdings LLC. The Company also has a non-controlling common stock interest in twelve corporations organized to operate as real estate investment trusts ("REITs"). 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 April 30, 2005, the Company acquired 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. 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 June 30, 2005 2004 --------- --------- Residential real estate Number of properties 4 4 Number of apartments 837 837 Commercial real estate Number of properties 28 24 Square feet 3,952,011 3,049,357 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 and six months ended June 30, 2005 are not necessarily indicative of the results that may be expected for the year ending December 31, 2005 or for any other period. 6
Franklin Street Properties Corp. Notes to Consolidated Financial Statements (Unaudited) 1. Organization, Properties, Basis of Presentation and Recent Accounting Pronouncements (continued) 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. 2. Investment Banking/Investment Services Activity During the six months ended June 30, 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 58,250(2) ------------- Total $ 61,250 ============= </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 June 30, 2005. This amount represents the gross proceeds syndicated during the six months ended June 30, 2005. 3. Related Party Transactions and Investments in Non-Consolidated Entities Investment in Sponsored REITs At June 30, 2005, the Company held a common stock interest in twelve Sponsored REITs. Ten were fully syndicated and the Company no longer derives economic benefits or risks from the common stock interest that is 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 Sponsored REITs were not fully syndicated and have a value of approximately $53.6 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 $24,000 and $13,000 for the six months ended June 30, 2005 and 2004, respectively; and interest expenses are eliminated in consolidation. 7
Franklin Street Properties Corp. Notes to Consolidated Financial Statements (Unaudited) 3. Related Party Transactions and Investments in Non-Consolidated Entities (continued) Six Months Ended (unaudited) June 30, (in thousands) 2005 2004 ---- ---- Operating Data: Rental revenues $ 2,469 $ 1,372 Operating and maintenance expenses (720) (422) Depreciation and amortization (795) (220) Interest expense (605) (290) Interest income 6 14 -------- -------- $ 355 $ 454 ======== ======== Equity in earnings of investment in non-consolidated REITs: The following table includes equity in earnings of investments in non-consolidated REITs: Six Months Ended (unaudited) June 30, (in thousands) 2005 2004 ---- ---- Equity in earnings of Sponsored REITs $ 841 $ 292 Equity in earnings of Blue Lagoon 127 93 ------- ------- $ 968 $ 385 ======= ======= 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 declared or received of $980,000 and $773,000 from non-consolidated Sponsored REITs during the six months ended June 30, 2005 and 2004, respectively. The Company has in the past acquired by merger entities similar to the Sponsored REITs. On April 30, 2005, the Company acquired four Sponsored REITs (the Target REITs) by merger. The Company's business model for growth may include the potential acquisition by merger in the future of Sponsored REITs. The Company has no legal or any other enforceable obligation to acquire or to offer to acquire any Sponsored REIT. In addition, any offer (and the related terms and conditions) that might be made in the future to acquire any Sponsored REIT would require the approval of the boards of directors of the Company and the Sponsored REIT and the approval of the shareholders of the Sponsored REIT. 8
Franklin Street Properties Corp. Notes to Consolidated Financial Statements (Unaudited) 3. Related Party Transactions and Investments in Non-Consolidated Entities (continued) At June 30, 2005, December 31, 2004 and June 30, 2004, the Company had ownership interests in twelve, fifteen and nine Sponsored REITs, respectively. Summarized financial information for these non-consolidated Sponsored REITs is as follows: June 30, December 31, ------------------------------ 2005 2004 ------------------------------ (in thousands) Balance Sheet Data (unaudited): Real estate, net $ 345,009 $ 350,030 Other assets 47,754 47,001 Total liabilities (41,577) (75,372) ---------- ---------- Shareholders equity $ 351,186 $ 321,659 ========== ========== For the Six Months Ended June 30, 2005 2004 -------------------------- (in thousands) Operating Data (unaudited): Rental revenue $ 27,721 $ 13,043 Other revenue 559 170 Operating and maintenance expenses (10,657) (4,558) Depreciation and amortization (5,240) (2,585) Interest expense and commitment fees (2,730) (8,250) ----------- ---------- Net income (loss) $ 9,653 $ (2,180) ========== ========== 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 $8,160,000 and $17,190,000 for the six months ended June 30, 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 $396,000 and $242,000 for the six months ended June 30, 2005 and 2004, respectively. The Company is typically entitled to interest on funds advanced to Sponsored REITs. The Company recognized interest income of approximately $1,056,000 and $12,000 for the six months ended June 30, 2005 and 2004, respectively, relating to these loans. 9
Franklin Street Properties Corp. Notes to Consolidated Financial Statements (Unaudited) 4. Merger Transactions On April 30, 2005, the Company issued 10,894,994 shares of common stock, $0.0001 par value per share, in exchange for all of the outstanding preferred stock of the Target REITs. The results of operations for each of Target REIT have been included in the Company's consolidated financial statements since May 1, 2005. The aggregate purchase price was approximately $164,564,000. On the acquisition date, for each Sponsored REIT, the increase between the appraised value of the property and the historical cost of the property was allocated to real estate investments and leases, including lease origination costs. Lease origination costs represent the value associated with acquiring an in-place lease (i.e. the market cost to execute a similar lease, including leasing commission, legal, vacancy, and other related costs). The value assigned to buildings approximates their replacement cost; the value assigned to land approximates its appraised value; and the value assigned to leases approximates their fair value. Other assets and liabilities are recorded at their historical costs, which approximates fair value. The following table summarizes the estimated fair value of the assets acquired at the date of acquisition: Value of Assets Acquired ------------------------ (in thousands) Real estate assets $ 137,687 Value of acquired real estate leases 18,965 Cash 10,621 Other assets 229 Liabilities assumed (2,938) ----------- Total $ 164,564 =========== Pro forma operating results for the Company and the Target REITs are shown in the following table. The results assume that the mergers occurred and the shares of the Company's stock were issued on January 1, 2004 and are not necessarily indicative of what the Company's actual results of operations would have been for the period indicated, nor do they purport to represent the results of operations of any future period. <TABLE> <CAPTION> For Three Months Ended For Six Months Ended (unaudited) June 30, June 30, (in thousands except per share amounts) 2005 2004 2005 2004 -------------------------- -------------------------- <S> <C> <C> <C> <C> Revenue $ 27,003 $ 33,207 $ 54,894 $ 64,252 -------------------------- -------------------------- Net income $ 9,995 $ 15,276 $ 22,523 $ 30,978 ========================== ========================== Weighted average shares outstanding 60,527 60,525 60,526 60,522 ========================== ========================== Net income per share $ 0.17 $ 0.25 $ 0.37 $ 0.51 ========================== ========================== </TABLE> 10
Franklin Street Properties Corp. Notes to the Consolidated Financial Statements (Unaudited) 5. 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 (6.25% at June 30, 2005) or at a LIBOR plus 125 basis points (4.55% at June 30, 2005), as defined. The balance outstanding was $53,213,000 and $59,439,000 at June 30, 2005 and December 31, 2004, respectively. The weighted average interest rate on amounts outstanding during the six months ended June 30, 2005 was 4.91% 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 June 30, 2005 and December 31, 2004. The Loan Agreement matures on August 18, 2005, however, the Company has received a commitment letter from the bank for a three year agreement maturing in August 2008 with substantially the same terms. 6. Net Income Per Share Basic net income per share is computed by dividing net income by the weighted average number of Company shares outstanding during the period. Diluted net income per share reflects the potential dilution that could occur if securities or other contracts to issue shares were exercised or converted into shares. There were no potential dilutive shares outstanding at June 30, 2005 and 2004. 7. 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 several measures including Cash Available for Distribution ("CAD") as management believes that CAD represents an important measure of the reportable segment's activity and is an important consideration in determining 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 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 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. 11
Franklin Street Properties Corp. Notes to Consolidated Financial Statements (Unaudited) 7. Business Segments (continued) The calculation of CAD by business segment is shown in the following table: <TABLE> <CAPTION> Investment Banking/ (in thousands) Real Estate Investment 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 3,598 34 3,632 Straight line rent (307) -- (307) Capital Expenditures (327) -- (327) Payment of deferred leasing costs (95) -- (95) Proceeds from funded reserves 422 -- 422 -------- ------ -------- Cash Available for Distribution $ 13,571 $ 111 $ 13,682 ======== ====== ======== Three Months Ended June 30, 2005 Net Income $ 9,362 $ 92 $ 9,454 Estimated loss on sale of property 1,055 -- 1,055 Equity in income of non-consolidated REITs (303) -- (303) Distributions from non-consolidated REITs 381 -- 381 Depreciation and amortization 5,448 37 5,485 Straight line rent (417) -- (417) Capital Expenditures (1,601) -- (1,601) Payment of deferred leasing costs (216) -- (216) Proceeds from funded reserves 1,817 -- 1,817 -------- ------ -------- Cash Available for Distribution $ 15,526 $ 129 $ 15,655 ======== ====== ======== Six Months Ended June 30, 2005 Net Income $ 19,708 $ 169 $ 19,877 Estimated loss on sale of property 1,055 -- 1,055 Equity in income of non-consolidated REITs (968) -- (968) Distributions from non-consolidated REITs 980 -- 980 Depreciation and amortization 9,046 71 9,117 Straight line rent (724) -- (724) Capital Expenditures (1,928) -- (1,928) Payment of deferred leasing costs (311) -- (311) Proceeds from funded reserves 2,239 -- 2,239 -------- ------ -------- Cash Available for Distribution $ 29,097 $ 240 $ 29,337 ======== ====== ======== </TABLE> 12
Franklin Street Properties Corp. Notes to Consolidated Financial Statements (Unaudited) 7. Business Segments (continued) The calculation of CAD by business segment is shown in the following table: <TABLE> <CAPTION> Investment Banking/ (in thousands) Real Estate Investment Operations Services Total ----------- ---------- ----------- <S> <C> <C> <C> 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) Capital Expenditures (100) (17) (117) Payment of deferred leasing costs (151) -- (151) Proceeds from funded reserves 251 -- 251 -------- ------- -------- Cash Available for Distribution $ 15,590 $ 487 $ 16,077 ======== ======= ======== Three Months Ended June 30, 2004 Net Income $ 12,780 $ 896 $ 13,676 Sponsored REIT income during consolidation -- -- -- Equity in income of non-consolidated REITs (182) -- (182) Distributions from non-consolidated REITs 173 -- 173 Depreciation and amortization 3,501 55 3,556 Straight line rent revenue (514) -- (514) Capital expenditures (430) (72) (502) Payment of deferred leasing costs (101) -- (101) Payments to (proceeds from) funded reserve 531 -- 531 -------- ------- -------- Cash Available for Distribution $ 15,758 $ 879 $ 16,637 ======== ======= ======== Six Months Ended June 30, 2004 Net Income $ 25,519 $ 1,376 $ 26,895 Sponsored REIT income during consolidation (247) -- (247) Equity in income of non-consolidated REITs (561) -- (561) Distributions from non-consolidated REITs 755 -- 755 Depreciation and amortization 6,736 79 6,815 Straight line rent revenue (854) -- (854) Capital expenditures (530) (89) (619) Payment of deferred leasing costs (252) -- (252) Payments to (proceeds from) funded reserve 782 -- 782 -------- ------- -------- Cash Available for Distribution $ 31,348 $ 1,366 $ 32,714 ======== ======= ======== </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: <TABLE> <CAPTION> Investment Real Banking/ Estate Investment Operations Services Total ------------------------------------------------------------------------------------ (in thousands) <S> <C> <C> <C> Three Months Ended June 30, 2005: Revenue $ 23,626 $1,801 $ 25,427 Interest income 360 7 367 Interest expense 788 -- 788 Loss from discontinued operations 70 -- 70 Capital expenditures 1,601 -- 1,601 Six Months Ended June 30, 2005: Revenue $ 43,968 $4,638 $ 48,606 Interest income 582 15 597 Interest expense 1,743 -- 1,743 Loss from discontinued operations 158 -- 158 Capital expenditures 1,928 -- 1,928 Identifiable Assets at June 30, 2005: $714,065 $3,863 $717,928 Three Months Ended June 30, 2004: Revenue $ 22,478 $5,822 $ 28,300 Interest income 122 5 127 Interest expense 253 -- 253 Loss from discontinued operations 83 -- 83 Capital expenditures 431 71 502 Six Months Ended June 30, 2004: Revenue $ 44,314 $9,584 $ 53,898 Interest income 342 21 363 Interest expense 517 -- 517 Loss from discontinued operations 163 -- 163 Capital expenditures 530 89 619 Identifiable Assets at June 30, 2004: Identifiable assets $518,313 $5,513 $523,826 </TABLE> 14
Franklin Street Properties Corp. Notes to Consolidated Financial Statements (Unaudited) 8. Cash Distributions The Company declared and paid distributions as follows (in thousands, except per share amounts): Distribution Total Quarter Paid Per Share Dividends ------------------------------ --------------- -------------- First quarter of 2005 $ 0.31 $ 15,385 Second quarter of 2005 $ 0.41 $ 20,349 First quarter of 2004 $ 0.31 $ 15,382 Second quarter of 2004 $ 0.31 $ 15,385 The second quarter distribution was paid on April 29, 2005 to shareholders of record on April 19, 2005, in anticipation of the consummation of the acquisition of four REITs by merger on April 30, 2005, and was in respect of the first four months of operations in 2005. 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, 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. 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 Six Months Ended June 30, ------------------ (in thousands) 2005 2004 ------------------ Federal income tax expense at statutory rate $ 96 $ 823 Increase in taxes resulting from: State income taxes, net of federal impact 18 153 ------ ------ $ 114 $ 976 ====== ====== 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. 15
Franklin Street Properties Corp. Notes to Consolidated Financial Statements (Unaudited) 10. Discontinued Operations During June 2005 an agreement was reached to sell a property called Blue Ravine, which is located in Folsom, California. The sale was completed on July 13, 2005 and resulted in a loss of approximately $1,055,000, which was recorded during the three months ended June 30, 2005 as an estimated loss on an asset held for sale. The property had been vacant since mid-2003 and had operating expenses of approximately $70,000 and $83,000 for the three months ended June 30, 2005 and 2004, respectively and $158,000 and $163,000 for the six months ended June 30, 2005 and 2004, respectively. The offer to purchase the property was compared to estimated future costs to convert the property from a single tenant to a multi-tenant facility and lease the building. The Company concluded that accepting the offer was the more prudent decision because the management time and oversight of such a conversion outweighed the potential future benefit. The Company will continue to evaluate its portfolio, and from time-to-time may decide to dispose of properties. 11. Subsequent Events On July 6, 2005 the Company borrowed approximately $42 million under its Loan Agreement. The Company used the borrowed funds to make an interim mortgage loan for a property located in Indiana. On July 13, 2005 the Company completed the sale of Blue Ravine for approximately $4.7 million. Proceeds were applied to the outstanding balance on the Loan Agreement. On July 27, 2005 the Company received a commitment letter from its bank group committing to increase its line of credit to $150,000,000 and extending its maturity to August, 2008 at substantially the same terms and covenants as the current facility. The Company expects the loan agreement to be finalized in August 2005. On July 29, 2005, the Board of Directors of the Company declared a cash dividend of $0.21 per share of common stock payable on August 29, 2005 to stockholders of record on August 8, 2005. The cash dividend represents two months of operations. The Company's past practice is to declare quarterly cash dividends representing three months of operations. However, on April 19, 2005, in anticipation of the consummation of the acquisition of four REITs by merger on April 30, 2005, the Company declared a dividend in respect of the first four months of operations in 2005. The dividend declared by the Company on July 29, 2005 is therefore in respect of the remaining two months in the second quarter of 2005. 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 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. 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. 17
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) 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: June 30, ----------------------- 2005 2004 Residential: Number of properties 4 4 Number of apartment units 837 837 Commercial: Number of properties 28 24 Square footage 3,952,011 3,049,357 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 for the balance of 2005 are likely to be below our 2004 levels. Future business in this area is very 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 relatively low interest rates, a growing general economy and a substantial increase to capital allocation for real estate assests 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 continue to reduce the cash available for distribution to stockholders as dividends. As the third 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 experienced slower sales of these investments to our clients and prospective clients. We expect this trend to continue for the balance of 2005. 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 June 30, 2005 and 2004. <TABLE> <CAPTION> (in thousands) Three months ended June 30, -------------------------------------- Real Estate Operations 2005 2004 Change ---- ---- ------ <S> <C> <C> <C> Real estate: Rental income $ 21,748 $ 17,564 $ 4,184 Transaction fees 1,397 4,778 (3,381) Management fees and interest income from loans 481 125 356 Other -- 11 (11) ------------------------------------- 23,626 22,478 1,149 ------------------------------------- Expenses: Real estate operating expenses 4,528 3,576 952 Real estate taxes and insurance 2,902 2,279 623 Depreciation and amortization 4,585 3,489 1,096 Interest 788 253 535 ------------------------------------- 12,803 9,597 3,206 ------------------------------------- Other items: Interest income 360 122 238 Equity in earnings in non-consolidated REIT's 302 6 296 ------------------------------------- 662 128 534 ------------------------------------- Contribution from real estate 11,485 13,009 (1,523) ------------------------------------- Investment Banking/Investment Services: Syndication fees 1,603 5,407 (3,804) Transaction fees 198 415 (217) ------------------------------------- 1,801 5,822 (4,021) ------------------------------------- Expenses: Depreciation and amortization 36 55 (19) Commissions 867 2,767 (1,900) ------------------------------------- 903 2,822 (1,919) ------------------------------------- Other items: Interest income 7 5 2 Taxes on income (70) (648) 578 ------------------------------------- (63) (643) 580 ------------------------------------- Contribution from investment banking/investment services 835 2,357 (1,522) ------------------------------------- Selling, general and administrative expenses 1,741 1,607 (134) ------------------------------------- Loss from discontinued operations 70 83 (13) Loss on sale of asset 1,055 -- 1,055 ------------------------------------- Net income $ 9,454 $ 13,676 $(4,222) ===================================== </TABLE> On April 30, 2005 we completed the acquisition by merger of four Sponsored REITs. The results of operations for these four properties are included in our operating results as of May 1, 2005. We operated 28 properties for the first four months of 2005 and 32 properties for May and June 2005. During the three and six months ended June 30, 2004, we operated 28 properties. Increases in rental revenues and expenses for the three and six months ended June 30, 2005 as compared to the three and six months ended June 30, 2004 are primarily a result of these mergers. 19
Comparison of the three months ended June 30, 2005 to the three months ended June 30, 2004 Total revenues decreased $2.9 million, or 10.1%, to $25.4 million for the three months ended June 30, 2005, as compared to $28.3 million for the three months ended June 30, 2004. Total expenses were $15.4 million for the three months ended June 30, 2005; an increase of $1.4 million, or 10.1%, compared to the three months ended June 30, 2004. The decrease in revenues was primarily attributable to a decrease in revenue from our investment banking/investment services business that was partially offset by increases in rental revenue as a result of the mergers described above. The increase in total expenses was primarily attributable to an increase in real estate expenses associated with these mergers. During the three months ended June 30, 2005 our investment banking/investment services segment had total gross proceeds of $24.3 million, which included proceeds from the continuing syndication of FSP Galleria North Corp. that began in the fourth quarter of 2004. During the three months ended June 30, 2004, our investment banking/investment services segment had total gross proceeds of $83.0 million, which included completion of the syndication of two Sponsored REITs and substantial completion of the syndication of a third Sponsored REIT. As a result, total gross proceeds decreased $58.7 million for the three months ended June 30, 2005 compared to three months ended June 30, 2004. This decrease was attributable to a slower pace of syndication investment by our client base and a more difficult environment in which to find suitable properties to syndicate during the three months ended June 30, 2005 compared to the same period in 2004. Revenues and expenses for investment banking/investment services are directly related to the gross proceeds of these syndications. Each segment is discussed in greater detail below. Real Estate Operations Contribution from the real estate segment was $11.5 million for the three months ended June 30, 2005, a decrease of $1.5 million or 11.7%, compared to the three months ended June 30, 2004. The decrease is primarily attributable to: o A decrease in transaction fee revenues of $3.4 million to $1.4 million for the three months ended June 30, 2005 as compared to $4.8 million for the three months ended June 30, 2004. The decrease was principally caused by the decrease in gross syndication proceeds in the quarter compared to the same period in 2004; o An increase in interest expense of $0.5 million resulting from larger loan balances outstanding for assets held for syndication during the three months ended June 30, 2005 compared to the three months ended June 30, 2004; and o An increase to depreciation and amortization of $1.1 million to $4.6 million for three months ended June 30, 2005 compared to $3.5 million for the comparable 2004 period, which primarily relates to the four properties owned by the Sponsored REITs we acquired on April 30, 2005. These decreases were partially offset by: o An increase in real estate operating income from real estate of $2.6 million to $14.3 million for three months ended June 30, 2005 compared to $11.7 million for the comparable 2004 period, which primarily relates to the four properties owned by the Sponsored REITs, which we acquired by on April 30, 2005. Real estate operating income is rental revenues less real estate operating expenses, real estate taxes and insurance; o An increase in management fees and interest income of $0.4 million to $0.5 million for the three months ended June 30, 2005 compared to $0.1 million for the three months ended June 30, 2004. The increase is primarily attributed to interest income from Sponsored REITs, which had larger loan balances outstanding for a longer period of time during the comparable three month period ending June 30, 2004; o An increase from 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 June 30, 2005 compared to the three months ended June 30, 2004; o An increase to interest income of $.2 million during the three months ended June 30, 2005, which was primarily a result of higher interest rates on cash and cash equivalents compared to the three months ended June 30, 2004. 20
Investment Banking/Investment Services Contribution from the investment banking and services segment decreased $1.5 million to $0.8 million for the three months ended June 30, 2005, compared to $2.4 million for the three months ended June 30, 2004. The decrease is primarily attributable to: o A decrease in syndication and transaction fee revenues of $4.0 million, which was primarily attributable to a lower level of gross syndication proceeds during the three months ended June 30, 2005 compared to the three months ended June 30, 2004. This decrease was partially offset by: o A decrease in commission expense of $1.9 million, which relates to the decrease in gross syndication proceeds; o A decrease in tax expense of $0.6 million to $0.1 million for the three months ended June 30, 2005 as compared to $0.7 million for the three months ended June 30, 2004; Selling, general and administrative expenses Selling, general and administrative expenses arise primarily from corporate related expenses and costs associated with our headquarters in Wakefield, Massachusetts where both business segments are managed. Over the last few years there has been a shift in expense and cost allocation between the segments from being primarily related to investment banking activity to a greater focus on real estate operations. This shift has occurred as a result of: o The increase in the number of owned properties in our real estate portfolio. o The trend to a lower level of syndication proceeds from the investment banking segment. o An increased level of management time related to our real estate operations. As a result of this internal shift, we compare the total selling, general and administrative expenses from period-to-period as we believe it more meaningful than comparison of allocated expenses to each segment. Selling, general and administrative costs increased $0.1 million to $1.7 million for the three months ended June 30, 2005 compared to $1.6 million for the three months ended June 30, 2004, which were primarily from costs of monitoring and managing a larger portfolio of REITs, initial expenses incurred to prepare for public trading of our stock, which occurred on June 2, 2005, and increases to franchise taxes. We had approximately 39 employees as of June 30, 2005 at our headquarters in Wakefield compared to 36 employees as of June 30, 2004. Discontinued Operations During June 2005 an agreement was reached to sell a property called Blue Ravine, which is located in Folsom, California. The sale was completed on July 13, 2005 and resulted in a loss of approximately $1.1 million, which was recorded during the three months ended June 30, 2005 as an estimated loss on an asset held for sale. The property had been vacant since mid-2003 and had operating expenses of approximately $70 thousand and $83 thousand for the three months ended June 30, 2005 and 2004. The offer to purchase the property was compared to estimated future costs to convert the property from a single tenant to a multi-tenant facility and lease the building. We concluded that accepting the offer was the more prudent decision because the management time and oversight of such a conversion outweighed the potential future benefit. We will continue to evaluate our portfolio, and from time-to-time we may decide to dispose of properties. Net Income Net income for the three months ended June 30, 2005 decreased $4.2 million to $9.5 million compared to $13.7 million for the reasons discussed above. 21
The following table shows each segment for the six months ended June 30, 2005 and 2004. <TABLE> <CAPTION> (in thousands) Six months ended June 30, -------------------------------------- Real Estate Operations 2005 2004 Change ---- ---- ------ <S> <C> <C> <C> Revenues: Rental income $ 38,982 $ 36,439 $ 2,543 Transaction fees 3,522 7,606 (4,084) Management fees and interest income from loans 1,451 254 1,197 Other 13 15 (2) ------------------------------------- 43,968 44,314 (346) ------------------------------------- Expenses: Real estate operating expenses 8,067 6,942 1,125 Real estate taxes and insurance 5,239 4,729 510 Depreciation and amortization 8,089 6,764 1,325 Interest 1,743 517 1,226 ------------------------------------- 23,138 18,952 4,186 ------------------------------------- Other items: Interest income 582 342 240 Equity in earnings in non-consolidated REIT's 968 385 583 ------------------------------------- 1,550 727 823 ------------------------------------- Contribution from real estate 22,380 26,089 (3,709) ------------------------------------- Investment Banking/Investment Services: Revenues: Syndication fees 4,122 8,448 (4,326) Transaction fees 516 1,136 (620) ------------------------------------- 4,638 9,584 (4,946) ------------------------------------- Expenses: Depreciation and amortization 71 79 (9) Commissions 2,191 4,287 (2,096) ------------------------------------- 2,262 4,366 (2,104) ------------------------------------- Other items: Interest income 15 21 (6) Taxes on income (114) (976) 862 ------------------------------------- (99) (955) 856 ------------------------------------- Contribution from investment banking/investment services 2,277 4,263 (1,986) ------------------------------------- Selling, general and administrative expenses 3,567 3,294 (273) ------------------------------------- Loss from discontinued operations 158 163 (5) Loss from sale of asset 1,055 -- 1,055 ------------------------------------- Net income $ 19,877 $ 26,895 $(7,018) ===================================== </TABLE> 22
Comparison of the six months ended June 30, 2005 to the six months ended June 30, 2004: Total revenues decreased $5.3 million, or 9.8%, to $48.6 million for the six months ended June 30, 2005, as compared to $53.9 million for the six months ended June 30, 2004. Total expenses were $29.0 million for the six months ended June 30, 2005; an increase of $2.4 million, or 8.8%, compared to the three months ended June 30, 2004. The decrease in revenues was primarily attributable to a decrease in revenue from our investment banking/investment services business that was partially offset by increases in rental revenue as a result of the acquisition by merger of four Sponsored REITs on April 30, 2005. During the six months ended June 30, 2005 our investment banking/investment services segment had total gross proceeds of $61.3 million, which included completion of the syndication of FSP 505 Waterford Corp. and the continuing syndication of FSP Galleria North Corp., both of which had been started in the fourth quarter of 2004. During the six months ended June 30, 2004, our investment banking/investment services segment had total gross proceeds of $132.2 million, which included completion of the syndication of four Sponsored REITs and substantial completion of the syndication of a fifth Sponsored REIT. Total gross proceeds decreased $70.9 million for the six months ended June 30, 2005 compared to six months ended June 30, 2004. This decrease was attributable to a slower pace of syndication investments and a more difficult environment to find suitable properties to syndicate during the six months ended June 30, 2005 compared to the same period in 2004. Revenues and expenses for investment banking/investment services are directly related to the gross proceeds of these syndications. Each segment is discussed in greater detail below. Real Estate Operations Contribution from the real estate segment was $22.4 million for the six months ended June 30, 2005; a decrease of $3.7 million, or 14.2%, compared to the six months ended June 30, 2004. The decrease is primarily attributable to: o A decrease in transaction fee revenues of $4.1 million to $3.5 million for the six months ended June 30, 2005 as compared to $7.6 million for the six months ended June 30, 2004. The decrease was principally caused by the decrease in gross syndication proceeds compared to the same period in 2004; o An increase in interest expense of $1.2 million resulting from higher interest rates and larger loan balances outstanding for assets held for syndication during the six months ended June 30, 2005 compared to the six months ended June 30, 2004; and o An increase to depreciation and amortization of $1.3 million to $8.1 million for six months ended June 30, 2005 compared to $6.8 million for the comparable 2004 period, which relates to the four properties owned by the Sponsored REITs we acquired on April 30 2005. These decreases were partially offset by: o An increase in real estate operating income of $0.9 million to $25.7 million for the six months ended June 30, 2005 compared to $24.8 million for the six months ended June 30, 2004. Real estate operating income is rental revenues less real estate operating expenses, real estate taxes and insurance. The increase was attributable to: o An increase of approximately $2.1 million arising from the four properties owned by the Sponsored REITs, which we acquired on April 30, 2005, and o A decrease, which partially offset the increase, to rental revenues of $1.2 million, that resulted from a lease termination payment made by a tenant during the six months ended June 30, 2004, which did not recur during the six months ended June 30, 2005; o An increase in management fees and interest income of $1.2 million to $1.5 million for the six months ended June 30, 2005 compared to $0.3 million for the six months ended June 30, 2004. The increase is primarily attributable to interest income from Sponsored REITs, which had higher interest rates charged and larger loan balances outstanding for a longer period of time during the comparable six month period ending June 30, 2004. o An increase from equity in income from non-consolidated REITs of $0.6 million as a result of Sponsored REITs in syndication with greater net operating income during the six months ended June 30, 2005 compared to the six months ended June 30, 2004; and 23
o An increase to interest income of $0.2 million during the six months ended June 30, 2005, which was primarily a result of higher interest rates on cash and cash equivalents compared to the six months ended June 30, 2004. Investment Banking/Investment Services Contribution from the investment banking and services segment decreased $2.0 million to $2.3 million for the six months ended June 30, 2005, compared to $4.3 million for the six months ended June 30, 2004. The decrease is primarily attributable to: o A decrease in syndication and transaction fee revenues of $4.9 million, which was primarily attributable to a lower level of gross syndication proceeds during the six months ended June 30, 2005 compared to the six months ended June 30, 2004. This decrease was partially offset by: o A decrease in commission expense of $2.1 million, which relates to the decrease in gross syndication proceeds; and o A decrease in tax expense of $0.9 million to $0.1 million for the six months ended June 30, 2005 as compared to $1.0 million for the six months ended June 30, 2004. Selling, general and administrative expenses Selling, general and administrative costs increased $0.3 million to $3.6 million for the six months ended June 30, 2005 compared to $3.3 million for the six months ended June 30, 2004, which were primarily from costs of monitoring and managing a larger portfolio of REITs, initial expenses incurred to prepare for public trading of our stock, which occurred on June 2, 2005, and increases to franchise taxes. These increases were partially offset by decreases to professional fees related to an investor related project completed in 2004. We had approximately 39 employees as of June 30, 2005 at our headquarters in Wakefield compared to 36 employees as of June 30, 2004. Discontinued Operations During June 2005 an agreement was reached to sell a property called Blue Ravine, which is located in Folsom, California. The sale was completed on July 13, 2005 and resulted in a loss of approximately $1.1 million, which was recorded during the three months ended June 30, 2005 as an estimated loss on an asset held for sale. The property had been vacant since mid-2003 and had operating expenses of approximately $159 thousand and $163 thousand for the six months ended June 30, 2005 and 2004, respectively. The offer to purchase the property was compared to estimated future costs to convert the property from a single tenant to a multi-tenant facility and lease the building. We concluded that accepting the offer was the more prudent decision because the management time and oversight of such a conversion outweighed the potential future benefit. We will continue to evaluate our portfolio, and from time-to-time we may decide to dispose of properties. Net Income Net income for the six months ended June 30, 2005 decreased $7.0 million to $19.9 million compared to $26.9 million for the reasons discussed above. Liquidity and Capital Resources Cash and cash equivalents were $51.5 million and $52.8 million at June 30, 2005 and December 31, 2004, respectively. This decrease of $1.3 million is attributable to $26.1 million provided by operating activities, $14.6 million provided by investing activities less $42.0 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 and improvements for at least the next 12 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 24
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. Operating Activities The cash provided by our operating activities of $26.1 million is primarily attributable to net income of $19.9 million, plus the add-back of $10.2 million of non-cash activity and was partially offset by a net decrease arising from changes in operating assets and liabilities of $4.0 million. Investing Activities Our cash provided by investing activities of $14.6 million is primarily attributable to cash added as a result of our acquisition of the four Sponsored REITs on April 30, 2005 of $10.6 million and the sale of assets held for syndication of $6.3 million, which were partially offset by uses of $1.9 million to acquire or improve real estate assets and $0.4 million in costs related to the merger of four properties in the second quarter of 2005. Financing Activities Our cash used by financing activities of $42.0 million is primarily attributable to $35.8 million of distributions to shareholders; and net repayments on our line of credit of $6.2 million made during the six months ended June 30, 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 (6.25% at June 30, 2005) or at LIBOR plus 125 basis points (4.55% at June 30, 2005), as defined. Borrowings outstanding under the line of credit at June 30, 2005 were $53.2 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. On July 27, 2005 we received a commitment letter from our bank group increasing our line of credit to $150 million and extending its maturity to August 2008 at substantially the same terms and covenants as the current facility. We expect the new loan agreement to be finalized in August 2005. On July 6, 2005 the Company borrowed approximately $42 million under its Loan Agreement. The Company used the borrowed funds to make an interim mortgage loan for a property located in Indiana. On July 13, 2005 the Company completed the sale of Blue Ravine for approximately $4.7 million. Proceeds were applied to the outstanding balance on the Loan Agreement. 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 June 30, 2005 we had 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 another was purchased during the six months ended June 30, 2005, but the syndication has not commenced. Assets Held for Sale During June 2005 an agreement was reached to sell a property called Blue Ravine, which is located in Folsom, California. The sale was completed on July 13, 2005 and resulted in a loss of approximately $1.1 million. As of June 30, 2005 the property to be sold was classified as held for sale on the balance sheet and at a carrying value that reflected the approximate net sale proceeds received for the property. 25
Related Party Transactions In the six months ended June 30, 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 June 30, 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 and six months ended June 30, 2005 and 2004 the rental income exceeded the expenses for each individual property, with the exception of Lyberty Way and Blue Ravine. The single tenant lease at the Lyberty Way property located in Westford, Massachusetts expired October 31, 2004. We have not re-let this property and expect that it will not produce revenue to cover its expenses in the third quarter. The property called Blue Ravine was sold on July 13, 2005, which had been vacant since June 2003 and had operating expenses of approximately $70 thousand and $158 thousand for the three and six months ended June 30, 2005. 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 26
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. On July 27, 2005, we received a commitment letter from our bank group increasing our Line of Credit to $150 million and extending its maturity to August 2008 at substantially the same terms and covenants as the current facility. We expect the new loan agreement to be finalized in August 2005. 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. 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 June 30, 2005, we owned 32 properties. 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. 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. 27
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 six months and some have not. We face risks from geographic concentration. The properties in our portfolio as of June 30, 2005, by aggregate square footage, are distributed geographically as follows: Southwest - 34%, Northeast - 25%, Midwest - 16%, West - 16% and Southeast 10%. However, within certain of those regions, we hold a larger concentration of our properties in Houston, Texas - 15% and Dallas, Texas - 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. 28
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. 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 consummated on April 30, 2005, 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. 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. 29
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 price of our common stock may vary. Our common stock has recently been listed for trading on the AMEX. We can provide no assurances as to the development of an ongoing meaningful trading market in our common stock. If a meaningful 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. 30
Item 3. Quantitative and Qualitative Disclosures about Market Risk We were not a party to any derivative financial instruments at or during the six months ended June 30, 2005. We borrow from time-to-time on our line of credit. These borrowings bear interest at the bank's base rate (6.25% at June 30, 2005) or at LIBOR plus 125 basis points (4.55% at June 30, 2005), as elected by us when requesting funds as defined. As of June 30, 2005, $53,213,000 was outstanding under the line of credit consisting of one borrowing of $9,213,000 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. 31
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 June 30, 2005. Based on this evaluation, FSP Corp.'s President and Chief Executive Officer and FSP Corp.'s Chief Financial Officer concluded that, as of June 30, 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 June 30, 2005 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. 32
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 June 30, 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> 04/01/05-04/30/05 0 N/A 0 0 - ------------------------- --------------------- --------------------- --------------------- --------------------------- 05/01/05-05/31/05 0 N/A 0 0 - ------------------------- --------------------- --------------------- --------------------- --------------------------- 06/01/05-06/30/05 0 N/A 0 0 - ------------------------- --------------------- --------------------- --------------------- --------------------------- Total: 0 N/A 0 0 - ------------------------- --------------------- --------------------- --------------------- --------------------------- </TABLE> (1) 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. As our common stock is currently listed for trading on AMEX, we are no longer obligated to, and do not intend to, effect any redemption. Item 3. Defaults Upon Senior Securities: Not applicable. 33
Item 4. Submission of Matters to a Vote of Security Holders: On April 29, 2005, the Registrant held its 2005 Annual Meeting of Stockholders (the "2005 Annual Meeting"). The 2005 Annual Meeting was called for the following purposes: (1) to elect two Class III directors to serve until the 2008 annual meeting and (2) to transact such other business as may properly come before the meeting or any adjournment thereof. The following table sets forth the names of the directors elected at the 2005 Annual Meeting for new three-year terms and the number of votes cast for and withheld for each director: Directors For Withheld Authority to Vote --------- --- -------------------------- George J. Carter 33,094,788 132,999 Georgia Murray 33,060,244 167,543 Prior to the election Richard R. Norris announced his retirement as director. The names of each of the other directors whose terms of office continued after the 2005 Annual Meeting are as follows: Barry Silverstein, Dennis J. McGillicuddy, John N. Burke, Barbara J. Fournier and Janet P. Notopoulos. Item 5. Other Information: None. 34
PART II - OTHER INFORMATION (Continued) Item 6. Exhibits: 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. 35
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. <TABLE> <CAPTION> Date Signature Title ---- --------- ----- <C> <C> <C> Date: August 4, 2005 /s/ George J. Carter Chief Executive Officer and Director -------------------------- (Principal Executive Officer) George J. Carter Date: August 4, 2005 /s/ John G. Demeritt Senior Vice President and Chief Financial -------------------------- Officer (Principal Financial Officer) John G. Demeritt </TABLE> 36