UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10 - Q

 

(Mark One)

☑

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2016

 

OR

 

☐

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from _________ to __________.

 

Commission File Number: 000-53165

 

FSP 303 East Wacker Drive Corp.

(Exact name of registrant as specified in its charter)

 

Delaware	20-8061759
(State or other jurisdiction of	(I.R.S. Employer
incorporation or organization)	Identification No.)

 

401 Edgewater Place
Wakefield, MA 01880

(Address of principal executive offices)(Zip Code)

 

(781) 557-1300

(Registrant’s telephone number, including area code)

 

N/A

(Former name, former address and former fiscal year, if changed since last report)

 

 

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 90 days.

 

YES     ☑

NO     ☐

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

 

YES     ☑

NO     ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer ☐	Accelerated filer ☐
Non-accelerated filer   ☐    (Do not check if a smaller reporting company)	Smaller reporting company ☑

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

 

YES     ☐

NO     ☑

 

The number of shares of common stock outstanding was 1 and the number of shares of preferred stock outstanding was 2,210, each as of October 31, 2016.

 

FSP 303 East Wacker Drive Corp.

 

Form 10-Q

 

Quarterly Report

September 30, 2016

 

Table of Contents

 

				Page
Part I.	Financial Information
	Item 1.	Financial Statements
		Consolidated Balance Sheets as of September 30, 2016 and December 31, 2015		2
		Consolidated Statements of Operations for the three and nine months ended September 30, 2016 and 2015		3
		Consolidated Statements of Cash Flows for the nine months ended September 30, 2016 and 2015		4
		Notes to Consolidated Financial Statements		5-9
	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		10-15
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk		16
	Item 4.	Controls and Procedures		16
Part II.	Other Information
	Item 1.	Legal Proceedings		17
	Item 1A.	Risk Factors		17
	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		17
	Item 3.	Defaults Upon Senior Securities		17
	Item 4.	Mine Safety Disclosures		17
	Item 5.	Other Information		17
	Item 6.	Exhibits		17
Signatures				18

 

 

PART I – FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

FSP 303 East Wacker Drive Corp.
Consolidated Balance Sheets
(Unaudited)

 

		September 30,				December 31,
(in thousands, except share and par value amounts)		2016				2015
Assets:
Real estate investments, at cost:
Land		$	26,200			$	26,200
Building and improvements			155,839				154,014
Furniture and equipment			837				738
			182,876				180,952
Less accumulated depreciation			40,735				37,563
Real estate investments, net			142,141				143,389
Acquired real estate leases, net of accumulated amortization of $174 and $1,016, respectively			3				72
Acquired favorable real estate leases, net of accumulated amortization of $0 and $911, respectively			—				59
Cash and cash equivalents			24,081				23,810
Restricted cash			9,511				7,668
Restricted investments			2,000				5,998
Tenant rent and other receivables, net of allowance for doubtful accounts of $98 and $162, respectively			124				95
Step rent receivable			5,671				5,528
Deferred leasing costs, net of accumulated amortization of $2,367, and $2,119, respectively			4,984				4,994
Prepaid expenses and other assets			68				47
Total assets		$	188,583			$	191,660
Liabilities and Stockholders’ Equity:
Liabilities:
Accounts payable and accrued expenses		$	4,798			$	5,576
Tenant security deposits			447				385
Loan payable, less unamortized financing costs of $148 and $171, respectively			34,852				34,829
Acquired unfavorable real estate leases, net of accumulated amortization of $119 and $110, respectively			2				11
Total liabilities			40,099				40,801
Commitments and Contingencies			—				—
Stockholders’ Equity:
Preferred Stock, $.01 par value, 2,210 shares authorized, issued and outstanding, aggregate liquidation preference $221,000
Common Stock, $.01 par value, 1 share authorized, issued and outstanding			—				—
Additional paid-in capital			197,162				197,162
Retained earnings and distributions in excess of earnings			(48,678	)			(46,303	)
Total Stockholders’ Equity			148,484				150,859
Total Liabilities and Stockholders’ Equity		$	188,583			$	191,660
See accompanying notes to consolidated financial statements.

 

FSP 303 East Wacker Drive Corp.
Consolidated Statements of Operations
(Unaudited)

 

		For the Three Months								For the Nine Months
		Ended September 30,								Ended September 30,
(in thousands, except share and per share amounts)		2016				2015				2016				2015
Revenues:
Rental		$	4,584			$	3,973			$	13,328			$	11,764
Total revenue			4,584				3,973				13,328				11,764
Expenses:
Rental operating expenses			1,627				1,468				4,740				4,418
Real estate taxes and insurance			1,100				1,055				3,299				2,592
Depreciation and amortization			1,694				1,597				5,012				4,772
Interest expense			431				430				1,291				1,290
Total expenses			4,852				4,550				14,342				13,072
Loss before interest income			(268	)			(577	)			(1,014	)			(1,308	)
Interest income			11				8				36				22
Net loss attributable to preferred stockholders		$	(257	)		$	(569	)		$	(978	)		$	(1,286	)
Weighted average number of preferred shares outstanding, basic and diluted			2,210				2,210				2,210				2,210
Net loss per preferred share, basic and diluted		$	(116	)		$	(257	)		$	(443	)		$	(582	)
See accompanying notes to consolidated financial statements.

 

 

FSP 303 East Wacker Drive Corp.
Consolidated Statements of Cash Flows
(Unaudited)

 

		For the Nine Months Ended September 30,
(in thousands)		2016				2015
Cash flows from operating activities:
Net loss		$	(978	)		$	(1,286	)
Adjustments to reconcile net loss to net cash
provided by operating activities:
Depreciation and amortization			5,035				4,794
Amortization of favorable real estate leases			59				94
Amortization of unfavorable real estate leases			(9	)			(12	)
Decrease in bad debt reserve			(64	)			—
Changes in operating assets and liabilities:
Restricted cash			(1,843	)			(1,008	)
Tenant rent receivable			35				425
Step rent receivable			(143	)			(560	)
Prepaid expenses and other assets			(21	)			(91	)
Accounts payable and accrued expenses			(763	)			(1,169	)
Tenant security deposits			62				(88	)
Payment of deferred leasing costs			(648	)			(342	)
Net cash provided by operating activities			722				757
Cash flows from investing activities:
Purchase of real estate assets			(3,052	)			(2,544	)
Redemptions of restricted investments			15,000				25,014
Purchase of restricted investments			(11,002	)			(20,009	)
Net cash provided by investing activities			946				2,461
Cash flows from financing activities:
Distributions to stockholders			(1,397	)			—
Net cash used for financing activities			(1,397	)			—
Net increase in cash and cash equivalents			271				3,218
Cash and cash equivalents, beginning of period			23,810				19,981
Cash and cash equivalents, end of period		$	24,081			$	23,199
Supplemental disclosure of cash flow information:
Cash paid for interest		$	1,268			$	1,268
Disclosure of non-cash investing activities:
Accrued costs for purchase of real estate assets		$	222			$	1,378
See accompanying notes to consolidated financial statements.

 

FSP 303 East Wacker Drive Corp.
Notes to Consolidated Financial Statements
(Unaudited)

 

1.       Organization, Basis of Presentation, Real Estate and Depreciation, Financial Instruments, Restricted Cash / Investments, and Recent Accounting Standards

 

Organization

 

FSP 303 East Wacker Drive Corp. (the “Company”) was organized on December 13, 2006 as a corporation under the laws of the State of Delaware to purchase, own, and operate a twenty-eight story Class “A” multi-tenant office tower containing approximately 860,000 rentable square feet of space located in downtown Chicago, Illinois (the “Property”). The Company acquired the Property and commenced operations on January 5, 2007. Franklin Street Properties Corp. (“Franklin Street”) (NYSE MKT: FSP) holds the sole share of the Company’s common stock, $.01 par value per share (the “Common Stock”). Between February 2007 and December 2007, FSP Investments LLC, a wholly-owned subsidiary of Franklin Street, completed the sale on a best efforts basis of 2,210 shares of the Company’s preferred stock, $.01 par value per share (the “Preferred Stock”). FSP Investments LLC sold the Preferred Stock in a private placement offering to “accredited investors” within the meaning of Regulation D under the Securities Act of 1933.

 

All references to the Company refer to FSP 303 East Wacker Drive Corp. and its consolidated subsidiary, collectively, unless the context otherwise requires.

 

Basis of Presentation

 

The unaudited consolidated financial statements of the Company include all the accounts of the Company and its wholly owned subsidiary. These financial statements should be read in conjunction with the Company's consolidated financial statements and notes thereto contained in the Company's Annual Report on Form 10-K for the year ended December 31, 2015, as filed with the Securities and Exchange Commission (“SEC”).

 

The accompanying interim financial statements are unaudited; however, the financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”) for interim financial information and in conjunction with the rules and regulations of the SEC. Accordingly, they do not include all of the disclosures required by GAAP 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 nine months ended September 30, 2016 are not necessarily indicative of the results that may be expected for the year ending December 31, 2016 or for any other period.

 

Real Estate and Depreciation

 

Real estate assets are stated at cost, less accumulated depreciation. If the Company determines that impairment has occurred, the affected assets are reduced to their fair value.

 

Costs related to property acquisition and improvements are capitalized. Typical capital items include new roofs, site improvements, various exterior building improvements and major interior renovations.

 

Routine replacements and ordinary maintenance and repairs that do not extend the life of the asset are expensed as incurred. Funding for repairs and maintenance items typically is provided by cash flows from operating activities.

 

Depreciation is computed using the straight-line method over the assets’ estimated useful lives as follows:

 

	Category	Years
	Buildings	39
	Building Improvements	15-39
	Furniture and Equipment	5-7
	Tenant Improvements	shorter of estimated useful life or the term of the lease

 

The Company reviews the Property to determine if the carrying amount will be recovered from future cash flows if certain indicators of impairment are identified at the Property. The evaluation of anticipated cash flows is highly subjective and is based in part on assumptions regarding future occupancy, rental rates and capital requirements that could differ materially from actual results in future periods. When indicators of impairment are present and the sum of the undiscounted future cash flows is less than the carrying value of such asset, an impairment loss is recorded equal to the difference between the asset’s current carrying value and its fair value based on discounting its estimated future cash flows. At September 30, 2016 and December 31, 2015, no impairment charges were recorded.

FSP 303 East Wacker Drive Corp.
Notes to Consolidated Financial Statements
(Unaudited)

 

1.       Organization, Basis of Presentation, Real Estate and Depreciation, Financial Instruments, Restricted Cash / Investments, and Recent Accounting Standards (continued)

 

Financial Instruments

 

The Company estimates that the carrying value of cash and cash equivalents, restricted cash, restricted investments and loan payable approximate their fair values based on their short-term maturity and prevailing interest rates.

 

Restricted Cash and Investments

 

The Company is required under the loan payable to hold proceeds from the loan payable in a restricted reserve account or accounts.  These proceeds are classified as restricted cash or restricted investments on the Consolidated Balance Sheets, depending on the initial maturity of the respective instrument.  Restricted cash at September 30, 2016 and December 31, 2015 consisted of amounts in a money market account and certificates of deposit totaling $9,511,000 and $7,668,000, respectively.  Restricted investments at September 30, 2016 consisted of investments in certificates of deposit with a carrying value of $2,000,000. Restricted investments at December 31, 2015 consisted of investments in a U.S. Treasury Bill, which the Company has the ability and intent to hold until their maturity, with a total face value of $6,000,000 and a total carrying value of $5,998,000.

 

Recent Accounting Standards

 

In May 2014, the Financial Accounting Standards Board (the “ FASB”), issued Accounting Standards Update, or ASU No. 2014-09, “Revenue from Contracts with Customers (Topic 606),” which provides guidance for revenue recognition. The update’s core principle is that a company will recognize revenue when promised goods or services are transferred to customers in an amount that reflects the consideration to which a company expects to be entitled in exchange for those goods or services. In August 2015, the FASB issued ASU 2015-14 delaying the effective date for adoption. This update is now effective for interim and fiscal years beginning after December 15, 2017. The Company is currently in the process of evaluating the impact the adoption of this ASU 2014-09 will have on the consolidated financial statements.

 

In January 2016, the FASB issued ASU 2016-01, “Financial Instruments – Overall: Recognition and Measurement of Financial Assets and Financial Liabilities”. ASU 2016-01 requires equity investments (except those accounted for under the equity method of accounting, or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income, requires public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes, requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset, and eliminates the requirement for public business entities to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost. ASU 2016-01 is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Early adoption is permitted. The Company is currently assessing the potential impact that the adoption of ASU 2016-01 will have on the consolidated financial statements.

 

In February 2016, the FASB issued ASU No. 2016-02, “Leases (Topic 842)”. ASU 2016-02 requires that a lessee recognize the assets and liabilities that arise from operating leases by recognizing in the balance sheet a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to use the underlying asset for the lease term. For leases with a term of twelve months or less, a lessee is permitted to make an accounting policy election by class of underlying asset not to recognize lease assets and lease liabilities. In transition, lessee and lessors are required to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach. Topic 842 affects any entity that enters into a lease with some specified scope exemptions. ASU No. 2016-02 is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted. The Company is currently assessing the potential impact that the adoption of ASU No. 2016-02 will have on the consolidated financial statements.

FSP 303 East Wacker Drive Corp.
Notes to Consolidated Financial Statements
(Unaudited)

 

1.       Organization, Basis of Presentation, Real Estate and Depreciation, Financial Instruments, Restricted Cash / Investments, and Recent Accounting Standards (continued)

 

Reclassifications

 

Certain amounts from the 2015 financial statements have been reclassified to conform to the 2016 presentation. The reclassifications were related primarily to conform to ASU No. 2015-03, “Simplifying the Presentation of Debt Issuance Costs”, which requires debt issuance costs to be presented in the balance sheet as a direct deduction from the associated debt liability. This new standard is effective for interim and annual reporting periods beginning after December 15, 2015 and requires retrospective application. Approximately $171,000 of debt issuance costs were reclassified from unamortized deferred financing costs to contra term loans on the balance sheet at December 31, 2015. There was no change to net loss for any period presented as a result of these reclassifications.

 

Certain comparative information provided for prior periods have been reclassified to conform to the current period presentation.  This reclassification does not have any impact on net loss, but rather reclassifications within the investing activities section of the consolidated statements of cash flows.

 

2.       Income Taxes

 

The Company has elected to be taxed as a real estate investment trust (“REIT”) under the Internal Revenue Code of 1986, as amended. As a REIT, the Company generally is entitled to a tax deduction for dividends paid to its stockholders, 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 stockholders it can have and the concentration of their ownership, and the amount of the Company’s income that must be distributed annually.

 

Accrued interest and penalties will be recorded as income tax expense, if the Company records a liability in the future. The Company files income tax returns in the U.S. federal jurisdiction and the State of Illinois jurisdiction. The statute of limitations for the Company’s income tax returns is generally three years and as such, the Company’s returns that remain subject to examination would be primarily from 2013 and thereafter.

 

3.        Loan Payable

 

On August 3, 2011, the Company entered into a mortgage note in favor of John Hancock Life Insurance Company (U.S.A.) (the “Lender”) to evidence a loan in the original principal amount of $35,000,000 that matures on September 1, 2021 (the “Loan”). The proceeds of the Loan are being held by the Lender for the Company’s benefit in a restricted reserve account or accounts to be drawn upon by the Company from time to time for tenant improvement costs and leasing commissions at the Property upon satisfaction of certain conditions. The Loan bears interest at the fixed rate of 4.83% per annum. The Company was obligated to make monthly payments of interest only for the initial 60 months of the Loan. Thereafter, the Company is obligated to make monthly payments of principal and interest for the remaining 60 months, based on a 25-year amortization schedule, until the maturity date, when all outstanding amounts become due. Commencing on October 1, 2016, the Loan became payable in monthly payments of principal and interest in the amount of $201,155. The Company may prepay the Loan with a prepayment premium, as defined in the Loan agreement. The Loan is secured, in part, by a mortgage, assignment of leases and rents and security agreement (the “Mortgage”) from the Company in favor of the Lender. The Mortgage constitutes a lien against the Property and has been recorded in the land records of Cook County, Illinois. Subject to customary exceptions, the Loan is nonrecourse to the Company. As of September 30, 2016, the Company had drawn an aggregate of $23,508,000 from the restricted reserve account(s). Interest expense paid on the Loan for the nine months ended September 30, 2016 and 2015 was $1,268,000 for both periods. The documents evidencing and securing the Loan include restrictions on property liens and require compliance with various non-financial covenants, which include the requirement that the Company provide annual reports to the Lender. The Company was in compliance with the Loan covenants as of September 30, 2016 and December 31, 2015.

 

Fees paid associated with the Loan were $304,000 and are being amortized on the straight-line basis over the term of the Loan. Amortization expense for the nine months ended September 30, 2016 and 2015 was $23,000 and $22,000, respectively, and is included in interest expense in the Company’s Consolidated Statements of Operations.

FSP 303 East Wacker Drive Corp.
Notes to Consolidated Financial Statements
(Unaudited)

 

4.      Related Party Transactions

 

Asset Management Agreement

 

The Company has in the past engaged in and currently engages in transactions with a related party, Franklin Street, and its wholly-owned subsidiaries, FSP Investments LLC and FSP Property Management LLC (collectively “FSP”). The Company expects to continue to have related party transactions with FSP in the form of management fees paid to FSP to manage the Company on behalf of its stockholders. FSP Property Management LLC currently provides the Company with asset management and financial reporting services. The asset management agreement between the Company and FSP Property Management LLC requires the Company to pay FSP Property Management LLC a monthly fee equal to one-half of one percent (.5%) of the gross revenues of the Property. The asset management agreement between the Company and FSP Property Management LLC may be terminated by either party without cause at any time, upon at least thirty (30) days’ written notice. For the nine months ended September 30, 2016 and 2015, management fees paid to FSP Property Management LLC were approximately $66,000 and $57,000, respectively.

 

Investor Services Agreement

 

On August 14, 2012, the Company entered into an Investor Services Agreement (the “FSPI Agreement”) with FSP Investments LLC for the provision of investor services to holders of the Company’s preferred stock. FSP Investments LLC acted as a real estate investment firm and broker/dealer with respect to (a) the Company’s organization, (b) the Company’s acquisition of the Property and (c) the sale of the Company’s equity interests. The FSPI Agreement requires the Company to pay a monthly service fee of $500 for services performed under the FSPI Agreement, and to reimburse FSP Investments LLC for its reasonable out-of-pocket expenses incurred in connection with the FSPI Agreement. The FSPI Agreement may be terminated by either party with thirty days written notice or immediately upon certain events of default set forth in the FSPI Agreement. For the nine months ended September 30, 2016 and 2015, investor services fees and expenses paid to FSP Investments LLC were approximately $12,000 and $11,000, respectively.

 

Ownership of Preferred Stock and Common Stock

 

On December 27, 2007, Franklin Street purchased 965.75 shares of Preferred Stock (or approximately 43.7% of the currently issued and outstanding shares of Preferred Stock) for consideration totaling $82,813,000. Prior to purchasing any shares of the Preferred Stock, Franklin Street agreed to vote any shares of Preferred Stock held by it on any matter presented to the holders of the Preferred Stock in a manner that approximates as closely as possible the votes cast in favor of and opposed to such matter by the holders of the Preferred Stock other than Franklin Street and its affiliates. For purposes of determining how Franklin Street votes its shares of the Preferred Stock, abstentions and non-votes by stockholders other than Franklin Street are not considered. Franklin Street is entitled to distributions that are declared on the Preferred Stock.

 

Franklin Street is the sole holder of the Company’s one share of Common Stock that is issued and outstanding. Subsequent to the completion of the private placement of the Preferred Stock in December 2007, Franklin Street has not been entitled to share in the Company’s earnings or any dividend related to the Common Stock.

 

5.      Net Income Per Share

 

Basic net income per share is computed by dividing net income by the weighted average number of shares of Preferred Stock 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 September 30, 2016 and 2015.

 

6.      Segment Reporting

 

The Company operates in one industry segment, which is real estate ownership of commercial property. The Company owned and operated the Property for all periods presented.

 

 

FSP 303 East Wacker Drive Corp.

Notes to Consolidated Financial Statements

(Unaudited)

 

7.      Cash Distributions

 

The Company’s board of directors declared and paid cash distributions as follows:

 

Quarter Paid		Distributions Per Preferred Share				Total Distributions
First quarter of 2016		$	—			$	—
Second quarter of 2016		$	316			$	698,360
Third quarter of 2016		$	316			$	698,360
First quarter of 2015		$	—			$	—
Second quarter of 2015		$	—			$	—
Third quarter of 2015		$	—			$	—

 

8.      Subsequent Event

 

The Company declared a cash distribution of $316 per preferred share on October 20, 2016 to the holders of record of the Company’s Preferred Stock on November 3, 2016, payable on November 10, 2016.

 

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, 2015. 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, economic conditions in the United States and in the market where we own the Property, disruptions in the debt markets, risks of a lessening of demand for the type of real estate owned by us, changes in government regulations and regulatory uncertainty, geopolitical events, and expenditures that cannot be anticipated such as utility rate and usage increases, unanticipated repairs, uncertainties relating to fiscal policy, additional staffing, insurance increases and real estate tax valuation reassessments. Although we believe the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. We may not update any of the forward-looking statements after the date this Quarterly Report on Form 10-Q is filed to conform them to actual results or to changes in our expectations that occur after such date, other than as required by law.

 

Overview

 

FSP 303 East Wacker Drive Corp., which we refer to as the Company, is a Delaware corporation formed to purchase, own, and operate a twenty-eight story Class “A” multi-tenant office tower containing approximately 860,000 rentable square feet of space located in downtown Chicago, Illinois, which we refer to as the Property.

 

Franklin Street Properties Corp., which we refer to as Franklin Street, is the sole holder of our one share of common stock, $.01 par value per share, which we refer to as the Common Stock, that is issued and outstanding. Between February 2007 and December 2007, FSP Investments LLC, a wholly-owned subsidiary of Franklin Street, completed the sale on a best efforts basis of 2,210 shares of our preferred stock, $.01 par value per share, which we refer to as the Preferred Stock. FSP Investments LLC sold the Preferred Stock in a private placement offering to “accredited investors” within the meaning of Regulation D under the Securities Act of 1933. Since the completion of the placement of the Preferred Stock in December 2007, Franklin Street has not been entitled to share in any earnings or dividend related to the Common Stock.

 

We operate in one business segment, which is real estate operations, and own a single property. Our real estate operations involve real estate rental operations, leasing services and property management services. The main factor that affects our real estate operations is the broad economic market conditions in the United States and, more specifically, the economic conditions in Chicago, Illinois, the relevant local market. These market conditions affect the occupancy levels and the rent levels on both a national and local level. We have no influence on national or local market conditions.

 

Trends and Uncertainties

 

Economic Conditions

 

The economy in the United States is continuing to experience a period of slow economic growth, with continued declining unemployment rates, which directly affects the demand for office space, our primary income producing asset.  The broad economic market conditions in the United States are affected by numerous factors, including but not limited to, inflation and employment levels, energy prices, the pace of economic growth and/or recessionary concerns, uncertainty about government fiscal and tax policy, changes in currency exchange rates, geopolitical events, the regulatory environment, the availability of credit and interest rates. In addition, the Federal Reserve Bank has indicated that it may raise interest rates further in December 2016. Although the interest rate on our existing indebtedness is fixed, any increase in interest rates could result in increased future borrowing costs to us.  However, we could also benefit from any further improved economic fundamentals and increasing levels of employment.  We believe that the economy is in a cyclically-slower but prolonged broad-based upswing.  However, future economic factors may negatively affect real estate values, occupancy levels and property income.

 

Real Estate Operations

 

The Property was approximately 67% leased as of September 30, 2016 to a diverse group of tenants with staggered lease expirations. We believe that any tenant that leases 10% or more of the Property’s rentable space is material. As of September 30, 2016, 43 tenants were leasing space at the Property, with the largest being Maximus, Inc. at approximately 82,865 square feet, or approximately 9.6% of the Property’s rentable space, until November 2017.

 

Subsequent to September 30, 2016, we signed a new lease with Tribune Media for approximately 60,592 square feet, bringing the Property to approximately 74% leased.

 

During calendar year 2015, we added a number of new amenities to the Property and believe that they have been well received by both existing tenants and prospective tenants. The new amenities are intended to boost leasing activity at the Property from a much wider range of small and mid-sized companies. The new amenities include a conference center, Wi-Fi lounge and management office on the second floor (adjacent to the fitness center) and are now available to occupants of the Property. We believe that these types of amenities are popular with prospective tenants and increasingly critical for office buildings to attract the significant number of technology companies seeking flexible and modern working spaces in an urban environment. In addition, Bake for Me, a café and bakery food service, that provides breakfast, coffee and lunch options for occupants in the main lobby from early morning to mid-afternoon has been warmly received by occupants and visitors.

 

We believe that the downtown Chicago office market, which we refer to as the Central Business District, has witnessed significant net absorption during the past few years, which has reduced the overall Chicago vacancy rate. Although the overall conditions are not quite as good for office buildings in the East Loop submarket of Chicago, the Property’s specific submarket within the Central Business District, there has been meaningful net absorption in the East Loop as well.

 

It is difficult for management to predict what will happen to occupancy and rents in the future because the need for space and the price tenants are willing to pay are tied to both the local economy and to the larger trends in the national economy, such as job growth, interest rates, the availability of credit and corporate earnings, which in turn are tied to even larger macroeconomic and political factors, such as recessionary concerns, volatility in energy pricing and the risk of terrorism. In addition to the difficulty of predicting macroeconomic factors, it is difficult to predict how our local market or tenants (existing and potential) will suffer or benefit from changes in the larger economy. In addition, because the Property is in a single geographical market, these macroeconomic trends may have a different effect on the Property and on its tenants (existing and potential), some of which may operate on a national level. Although we cannot predict how long it will take to lease vacant space at the Property or what the terms and conditions of any new leases will be, we expect to sign new leases at then-current market rates which may be below the expiring rates.

 

During the three months ended September 30, 2016, we believe that vacancy rates decreased slightly and that rental rates increased slightly for buildings in Chicago’s East Loop office submarket. Our goal continues to be to lease the existing vacant space at the Property to new tenants.

 

The potential for any of our tenants to default on its lease or to seek the protection of bankruptcy laws exists. If any of our tenants defaults on its lease, we may experience delays in enforcing our rights as a landlord and may incur substantial costs in protecting our investment. In addition, at any time, a tenant 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. Bankruptcy or a material adverse change in the financial condition of a material tenant would likely have a material adverse effect on our results of operations.

 

Dividends, Future Tenant Improvement Costs and Leasing Commissions

 

Management believes that the Company will need to be able to quickly access cash in order to fund the potentially significant tenant improvements costs and leasing commissions that may be required in connection with any changes in the occupancy level and rent roll at the Property. On October 20, 2016, our Board of Directors declared a dividend in the amount of $316 per share of the Preferred Stock, representing operations from the Property for the three months ended September 30, 2016. We expect a similar level of dividend distributions in future periods until occupancy levels at the Property more fully recover and we have a better idea of the Property’s actual future capital and leasing needs. We cannot guarantee the future payment of dividends or the amount of any such dividends.

 

In light of the amount of vacant space that needed to be leased at the Property and the potential for significant tenant improvement allowance costs and leasing commissions, on August 3, 2011, we entered into a mortgage note in favor of John Hancock Life Insurance Company (U.S.A.), which we refer to as the Lender, to evidence a loan in the original principal amount of $35,000,000 that matures on September 1, 2021, which we refer to as the Loan. The proceeds of the Loan are being held by the Lender for our benefit in a restricted reserve account or accounts to be drawn upon by us from time to time for tenant improvement costs and leasing commissions at the Property upon satisfaction of certain conditions.

 

The Loan bears interest at the fixed rate of 4.83% per annum. We were obligated to make monthly payments of interest only for the initial 60 months of the Loan. Thereafter, we are obligated to make monthly payments of principal and interest for the remaining 60 months, based on a 25-year amortization schedule, until the maturity date, when all outstanding amounts become due. Commencing on October 1, 2016, the Loan became payable in monthly payments of principal and interest in the amount of $201,155. We may prepay the Loan with a prepayment premium, as defined in the Loan agreement. The Loan is secured, in part, by a mortgage, assignment of leases and rents and security agreement, which we refer to as the Mortgage, from us in favor of the Lender. The Mortgage constitutes a lien against the Property and has been recorded in the land records of Cook County, Illinois. Subject to customary exceptions, the Loan is nonrecourse to the Company. As of September 30, 2016, we had drawn an aggregate of $23,508,000 from the restricted reserve account(s). Interest expense paid on the Loan for the nine months ended September 30, 2016 and 2015 was $1,268,000 for both periods. The documents evidencing and securing the Loan include restrictions on property liens and requires compliance with various non-financial covenants, which include the requirement that we provide annual reporting. We were in compliance with the Loan covenants as of September 30, 2016 and December 31, 2015.

 

Potential Sale of the Property

 

On July 25, 2016, our Board of Directors made the decision to try to sell the Property. After soliciting interest and input from commercial real estate brokers familiar with the Property and the local market, we have retained Holliday Fenoglio Fowler, L.P. to facilitate a potential sale of the Property. We believe that the opportunity to lease the remaining vacant space at the Property, together with an improving and active Chicago office building investment climate, are combining to create a potentially advantageous sales opportunity for the holders of the Preferred Stock.

 

Any sale of the Property would be subject to a number of conditions, including a successful marketing of the Property and approval of the sale by our Board of Directors and a majority of the holders of the Preferred Stock. At this time, we are not able to predict when or if the satisfaction of any of these conditions will occur.

 

Critical Accounting Policies

 

We have certain critical accounting policies that are subject to judgments and estimates by our management and uncertainties of outcome that affect the application of these policies. We base our estimates on historical experience and on various other assumptions we believe to be reasonable under the circumstances. On an on-going basis, we evaluate our estimates. In the event estimates or assumptions prove to be different from actual results, adjustments are made in subsequent periods to reflect more current information. The accounting policies that we believe are most critical to the understanding of our financial position and results of operations and that require significant management estimates and judgments are discussed below.

 

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 estimates are consistently applied and produce financial information that fairly presents our results of operations.

 

No change to our critical accounting policies has occurred since the filing of our Annual Report on Form 10-K for the year ended December 31, 2015.

 

Results of Operations

 

As of September 30, 2016, the Property was approximately 67% leased to a diverse group of tenants with staggered lease expirations. Subsequent to September 30, 2016, we signed a new lease with Tribune Media for approximately 60,592 square feet, bringing the Property to approximately 74% leased.

 

Comparison of the three months ended September 30, 2016 to the three months September 30, 2015

 

Revenue

 

Total revenue increased by approximately $0.6 million to $4.6 million for the three months ended September 30, 2016, as compared to $4.0 million for the three months ended September 30, 2015. This increase was primarily due to an increase in overall rental income as a result of increased occupancy.

 

Expenses

 

Total expenses increased by approximately $0.4 million to $4.9 million for the three months ended September 30, 2016, as compared to $4.5 million for the three months ended September 30, 2015. The increase is primarily due to a $0.2 million increase in operating expenses, a $0.1 million increase in real estate taxes and insurance and a $0.1 million increase in depreciation and amortization.

 

Comparison of the nine months ended September 30, 2016 to the nine months ended September 30, 2015

 

Revenue

 

Total revenue increased by approximately $1.5 million to $13.3 million for the nine months ended September 30, 2016, as compared to $11.8 million for the nine months ended September 30, 2015. This increase was primarily due to an increase in overall rental income as a result of increased occupancy.

 

Expenses

 

Total expenses increased by approximately $1.2 million to $14.3 million for the nine months ended September 30, 2016, as compared to $13.1 million for the nine months ended September 30, 2015. The increase is primarily due to a $0.7 million increase in real estate taxes and insurance, a $0.3 million increase in operating expenses and $0.2 million increase in depreciation and amortization.

 

Liquidity and Capital Resources

 

Cash and cash equivalents were $24.1 million at September 30, 2016 and $23.8 million at December 31, 2015. The $0.3 million increase for the nine months ended September 30, 2016 was primarily attributable to approximately $1.0 million provided by investing activities and $0.7 million provided by operating activities, which was offset by $1.4 million used for financing activities.

 

Management believes that the existing cash and cash equivalents as of September 30, 2016 of $24.1 million and cash anticipated to be generated internally by operations will be sufficient to meet working capital requirements, any distributions required for us to maintain our status as a real estate investment trust and anticipated capital expenditures for at least the next 12 months.

 

Operating Activities

 

The cash provided by operating activities of $0.7 million for the nine months ended September 30, 2016 was primarily attributable to a net loss of approximately $1.0 million, an increase in restricted cash of $1.8 million, an increase in other current accounts of $0.1 million, a decrease in accounts payable and accrued expenses of $0.7 million, and payment of deferred leasing costs of $0.7 million, which was offset by an add-back of $5.0 million of depreciation and amortization.

 

Investing Activities

 

The cash provided by investing activities of approximately $1.0 million for the nine months ended September 30, 2016 was attributable to redemptions of restricted investments of $15.0 million, which was offset by purchases of real estate assets of $3.0 million and net purchases of restricted investments of $11.0 million.

 

Financing Activities

 

The cash used for financing activities of approximately $1.4 million for the nine months ended September 30, 2016 was attributable to dividend payments to holders of Preferred Stock.

 

Sources and Uses of Funds

 

The Company’s principal demands on liquidity are cash for operations, interest on debt payments and distributions to equity holders. As of September 30, 2016, we had approximately $4.8 million in accrued liabilities, and $35 million in long-term debt. In the near term, liquidity is generated by cash from operations.

 

Secured Debt

 

On August 3, 2011, we entered into the Loan in favor of the Lender, in the original principal amount of $35,000,000 that matures on September 1, 2021. The proceeds of the Loan are being held by the Lender for our benefit in a restricted reserve account or accounts to be drawn upon by us from time to time for tenant improvement costs and leasing commissions at the Property upon satisfaction of certain conditions. The Loan bears interest at the fixed rate of 4.83% per annum. We were obligated to make monthly payments of interest only for the initial 60 months of the Loan. Thereafter, we are obligated to make monthly payments of principal and interest for the remaining 60 months, based on a 25-year amortization schedule, until the maturity date, when all outstanding amounts become due. Commencing on October 1, 2016, the Loan became payable in monthly payments of principal and interest in the amount of $201,155. We may prepay the Loan with a prepayment premium, as defined in the Loan agreement. The Loan is secured, in part, by the Mortgage, from us in favor of the Lender. The Mortgage constitutes a lien against the Property and has been recorded in the land records of Cook County, Illinois. Subject to customary exceptions, the Loan is nonrecourse to the Company. As of September 30, 2016, we had drawn an aggregate of $23,508,000 from the restricted reserve account(s). Interest expense from the Loan for the nine months ended September 30, 2016 and 2015 is $1,268,000 for both periods.

 

The documents evidencing and securing the Loan include restrictions on property liens and require compliance with various non-financial covenants, which include the requirement that we provide annual reporting. We were in compliance with the Loan covenants as of September 30, 2016 and December 31, 2015.

 

Contingencies

 

We may be subject to various legal proceedings and claims that arise in the ordinary course of our 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.

 

Related Party Transactions

 

Asset Management Agreement

 

We have in the past engaged in and currently engage in transactions with a related party, Franklin Street, and its wholly-owned subsidiaries, FSP Investments LLC and FSP Property Management LLC, which we collectively refer to as FSP. We expect to continue to have related party transactions with FSP in the form of management fees paid to FSP to manage the Company on behalf of our stockholders. FSP Property Management LLC currently provides us with asset management and financial reporting services. The asset management agreement between us and FSP Property Management LLC requires us to pay FSP Property Management LLC a monthly fee equal to one-half of one percent (.5%) of the gross revenues of the Property. The asset management agreement between us and FSP Property Management LLC may be terminated by either party without cause at any time, upon at least thirty (30) days’ written notice. For the nine months ended September 30, 2016 and 2015, management fees paid to FSP Property Management LLC were approximately $66,000 and $57,000, respectively.

 

Investor Services Agreement

 

On August 14, 2012, we entered into an Investor Services Agreement, which we refer to as the FSPI Agreement, with FSP Investments LLC for the provision of investor services to holders of our Preferred Stock. FSP Investments LLC is a wholly-owned subsidiary of Franklin Street, which is the sole holder of our one share of Common Stock that is issued and outstanding. FSP Investments LLC acted as a real estate investment firm and broker/dealer with respect to (a) our organization, (b) our acquisition of the Property and (c) the sale of our equity interests. The FSPI Agreement requires us to pay a monthly service fee of $500 for services performed under the FSPI Agreement, and to reimburse FSP Investments LLC for its reasonable out-of-pocket expenses incurred in connection with the FSPI Agreement. The FSPI Agreement may be terminated by either party with thirty days written notice or immediately upon certain events of default set forth in the FSPI Agreement. For the nine months ended September 30, 2016 and 2015, investor services fees paid were approximately $12,000 and $11,000, respectively.

 

Ownership of Preferred Stock and Common Stock

 

On December 27, 2007, Franklin Street purchased 965.75 shares of Preferred Stock (or approximately 43.7% of the currently issued and outstanding shares of Preferred Stock) for consideration totaling $82,813,000. Prior to purchasing any shares of Preferred Stock, Franklin Street agreed to vote any shares of Preferred Stock held by it on any matter presented to the holders of the Preferred Stock in a manner that approximates as closely as possible the votes cast in favor of and opposed to such matter by the holders of the Preferred Stock other than Franklin Street and its affiliates. For purposes of determining how Franklin Street votes its shares of Preferred Stock, abstentions and non-votes by stockholders other than Franklin Street are not considered. Franklin Street is entitled to distributions that are declared on the Preferred Stock.

 

Franklin Street is the sole holder of the Company’s one share of Common Stock that is issued and outstanding. Subsequent to the completion of the private placement of the Preferred Stock in December 2007, Franklin Street has not been entitled to share in our earnings or any dividend related to the Common Stock of the Company.

Item 3.   Quantitative and Qualitative Disclosures About Market Risk.

 

Not applicable.

 

Item 4.   Controls and Procedures.

 

 

Disclosure Controls and Procedures

 

Our management, with the participation of our principal executive officer and principal financial officer, evaluated the effectiveness of our disclosure controls and procedures as of September 30, 2016. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, or the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission's rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on the evaluation of our disclosure controls and procedures as of September 30, 2016, our principal executive officer and principal financial officer concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.

 

Changes in Internal Control Over Financial Reporting

 

No change in 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 September 30, 2016 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

 

PART II – OTHER INFORMATION

 

Item 1.   Legal Proceedings.

 

From time to time, we may be subject to legal proceedings and claims that arise in the ordinary course of our 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, cash flows or results of operations.

 

Item 1A.   Risk Factors.

 

Not applicable.

 

Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds.

 

None.

 

Item 3.   Defaults Upon Senior Securities.

 

None.

 

Item 4.   Mine Safety Disclosures.

 

Not applicable.

 

Item 5.   Other Information.

 

None.

 

Item 6.   Exhibits.

 

See Exhibit Index attached hereto, which is incorporated herein by reference.

 

 

 

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.

 

 

FSP 303 East wacker drive corp.

 

 

Date	Signature	Title
Date: November 10, 2016	/s/ George J. Carter George J. Carter	Chief Executive Officer (Principal Executive Officer)
Date: November 10, 2016	/s/ John G. Demeritt John G. Demeritt	Chief Financial Officer (Principal Financial Officer)

 

 

 

EXHIBIT INDEX

 

Exhibit No.	Description
31.1*	Certification of FSP 303 East Wacker Drive Corp.'s principal executive officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2*	Certification of FSP 303 East Wacker Drive Corp.'s principal financial officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1*	Certification of FSP 303 East Wacker Drive Corp.'s principal executive officer 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 FSP 303 East Wacker Drive Corp.'s principal financial officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101*	The following materials from FSP 303 East Wacker Drive Corp.’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2016, formatted in XBRL (eXtensible Business Reporting Language): (i) the Consolidated Balance Sheets; (ii) the Consolidated Statements of Operations; (iii) the Consolidated Statements of Cash Flows; and (iv) the Notes to Consolidated Financial Statements.
*	Filed herewith.