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 June 30, 2017

 

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, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth 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 ☑
		Emerging growth company ☐

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

 

 

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 July 31, 2017.

 

FSP 303 East Wacker Drive Corp.

 

Form 10-Q

 

Quarterly Report

June 30, 2017

 

Table of Contents

				Page
Part I.	Financial Information
	Item 1.	Financial Statements
		Consolidated Balance Sheets as of June 30, 2017 and December 31, 2016		2
		Consolidated Statements of Operations for the three and six months ended June 30, 2017 and 2016		3
		Consolidated Statements of Cash Flows for the six months ended June 30, 2017 and 2016		4
		Notes to Consolidated Financial Statements		5-8
	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		9-14
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk		15
	Item 4.	Controls and Procedures		15
Part II.	Other Information
	Item 1.	Legal Proceedings		16
	Item 1A.	Risk Factors		16
	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		16
	Item 3.	Defaults Upon Senior Securities		16
	Item 4.	Mine Safety Disclosures		16
	Item 5.	Other Information		16
	Item 6.	Exhibits		16
Signatures				17

 

PART I – FINANCIAL INFORMATION

Item 1. Financial Statements

 

FSP 303 East Wacker Drive Corp.

Consolidated Balance Sheets

(Unaudited)

 

		June 30,				December 31,
(in thousands, except share and par value amounts)		2017				2016
Assets:
Real estate investments, at cost:
Land		$	26,200			$	26,200
Buildings and improvements			160,956				159,834
Furniture and equipment			837				837
			187,993				186,871
Less accumulated depreciation			44,786				42,223
Real estate investments, net			143,207				144,648
Cash and cash equivalents			24,970				25,355
Restricted cash			5,332				6,519
Tenant rent receivables, net of allowance        for doubtful accounts of $133 and $98, respectively			170				125
Step rent receivable			6,716				6,060
Deferred leasing costs, net of accumulated       amortization of $2,950 and $2,603, respectively			6,198				5,774
Prepaid expenses and other assets			98				66
Total assets		$	186,691			$	188,547
Liabilities and Stockholders’ Equity:
Liabilities:
Accounts payable and accrued expenses		$	6,457			$	5,918
Tenant security deposits			446				455
Loan payable, less unamortized financing       costs of $126 and $141, respectively			34,323				34,678
Total liabilities			41,226				41,051
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			(51,697	)			(49,666	)
Total Stockholders’ Equity			145,465				147,496
Total Liabilities and Stockholders’ Equity		$	186,691			$	188,547

 

See accompanying notes to consolidated financial statements.

 

FSP 303 East Wacker Drive Corp.

Consolidated Statements of Operations

(Unaudited)

 

 

		For the Three Months								For the Six Months
		Ended June 30,								Ended June 30,
(in thousands, except share and per share amounts)		2017				2016				2017				2016
Revenues:
Rental		$	4,926			$	4,506			$	9,695			$	8,744
Total revenue			4,926				4,506				9,695				8,744
Expenses:
Rental operating expenses			1,557				1,503				3,232				3,113
Real estate taxes and insurance			1,409				1,027				2,645				2,199
Depreciation and amortization			1,785				1,715				3,544				3,318
Interest expense			424				429				851				860
Total expenses			5,175				4,674				10,272				9,490
Loss before interest income			(249	)			(168	)			(577	)			(746	)
Interest income			2				15				4				25
Net loss attributable to preferred stockholders		$	(247	)		$	(153	)		$	(573	)		$	(721	)
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		$	(112	)		$	(69	)		$	(259	)		$	(326	)

 

See accompanying notes to consolidated financial statements.

 

 

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

 

		For the Six Months Ended June 30,
(in thousands)		2017				2016
Cash flows from operating activities:
Net loss		$	(573	)		$	(721	)
Adjustments to reconcile net loss to net cash
provided by operating activities:
Depreciation and amortization			3,559				3,333
Amortization of favorable real estate leases			—				51
Amortization of unfavorable real estate leases			—				(6	)
Increase (decrease) in bad debt reserve			35				(48	)
Changes in operating assets and liabilities:
Restricted cash			1,187				1,654
Tenant rent receivable			(80	)			(229	)
Step rent receivable			(656	)			46
Prepaid expenses and other assets			(32	)			(90	)
Accounts payable and accrued expenses			448				268
Tenant security deposits			(9	)			25
Payment of deferred leasing costs			(921	)			(424	)
Net cash provided by operating activities			2,958				3,859
Cash flows from investing activities:
Purchase of real estate assets			(1,515	)			(2,466	)
Redemptions of restricted investments			—				10,000
Purchase of restricted investments			—				(11,002	)
Net cash used for investing activities			(1,515	)			(3,468	)
Cash flows from financing activities:
Principal payments of the loan payable			(370	)			—
Distributions to stockholders			(1,458	)			(698	)
Net cash used for financing activities			(1,828	)			(698	)
Net decrease in cash and cash equivalents			(385	)			(307	)
Cash and cash equivalents, beginning of period			25,355				23,810
Cash and cash equivalents, end of period		$	24,970			$	23,503
Supplemental disclosure of cash flow information:
Cash paid for interest		$	837			$	845
Disclosure of non-cash investing activities:
Accrued costs for purchase of real estate assets		$	176			$	216

 

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, 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 office and retail space and a 294 stall underground parking garage 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 American: 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, 2016, 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 six months ended June 30, 2017 are not necessarily indicative of the results that may be expected for the year ending December 31, 2017 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 June 30, 2017 and December 31, 2016, 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, and Recent Accounting Standards (continued)

 

Financial Instruments

 

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

 

Restricted Cash

 

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 on the Consolidated Balance Sheets.  Restricted cash at June 30, 2017 and December 31, 2016 consisted of amounts in a money market account totaling $5,332,000 and $6,519,000, respectively.

 

Recent Accounting Standards

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers (“Topic 606”), which provides guidance for revenue recognition. The standard’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. This update is effective for interim and annual reporting periods beginning after December 15, 2017. A substantial portion of our revenue consists of rental income from leasing arrangements, which is specifically excluded from Topic 606. We are continuing to evaluate Topic 606; however, we do not believe there will be a material impact on the timing of our revenue recognition in the consolidated financial statements. We currently expect to adopt the standard using the modified retrospective approach.

 

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842), (“ASU 2016-02”). ASU 2016-02 requires lessees to establish a lease liability for the obligation to make lease payments and a right of use asset for the right to use the underlying asset for the lease term on their balance sheets. Lessees will continue to recognize lease expenses on their income statements in a manner similar to current accounting. The guidance also eliminates current real estate-specific provisions for all entities. For lessors, the guidance modifies the classification criteria and the accounting for sales-type and direct financing leases. This new standard is effective for annual periods beginning after December 15, 2018, and interim periods thereafter with early adoption permitted. The Company is currently evaluating the potential changes from ASU 2016-02 to future financial reporting and disclosures. Adoption of this standard is not expected to have a material impact on the consolidated financial statements.

 

In November 2016, the FASB issued ASU No. 2016-18, Statement of Cash Flows (“ASU 2016-18”). ASU 2016-18 provides guidance on the presentation of cash, cash equivalents and restricted cash in the statement of cash flows to reduce the current diversity in practice. The amendments in this update are effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. Early adoption is permitted. Adoption of this standard is not expected to have a material impact on the consolidated financial statements.

 

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.

 

FSP 303 East Wacker Drive Corp.

Notes to Consolidated Financial Statements

(Unaudited)

 

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 June 30, 2017, the Company had drawn an aggregate of $29,680,000 from the restricted reserve account(s). Interest expense paid on the Loan for the six months ended June 30, 2017 and 2016 was $837,000 and $845,000, respectively. 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 June 30, 2017 and December 31, 2016.

 

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 each of the six months ended June 30, 2017 and 2016 was $15,000, and is included in interest expense in the Company’s Consolidated Statements of Operations.

 

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 six months ended June 30, 2017 and 2016, management fees paid to FSP Property Management LLC were approximately $45,000 and $44,000, 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 six months ended June 30, 2017 and 2016, investor services fees and expenses paid to FSP Investments LLC were approximately $8,400 and $7,900, respectively.

 

FSP 303 East Wacker Drive Corp.

Notes to Consolidated Financial Statements

(Unaudited)

 

4.   Related Party Transactions (continued)

 

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 or loss by the weighted average number of shares of Preferred Stock outstanding during the period. Diluted net income or loss 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, 2017 and 2016.

 

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.

 

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 2017		$	330			$	729,300
Second quarter of 2017		$	330			$	729,300
First quarter of 2016		$	—			$	—
Second quarter of 2016		$	316			$	698,360

 

8.   Subsequent Event

 

The Company declared a cash distribution of $335 per preferred share on July 21, 2017 to the holders of record of the Company’s Preferred Stock on August 4, 2017, payable on August 11, 2017.

 

 

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, 2016. 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, 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 office and retail space and a 294 stall underground parking garage 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, 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 could raise interest rates further in 2017 and 2018. 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 77.7% leased as of June 30, 2017 to a diverse group of tenants with staggered lease expirations, compared to approximately 73.5% leased as of December 31, 2016. We believe that any tenant that leases 10% or more of the Property’s rentable space is material. As of June 30, 2017, 45 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 September 30, 2017 for approximately 52,281 square feet and until November 16, 2017 for approximately 30,584 square feet.

 

During the three months ended June 30, 2017, we signed a new lease with Mosaic Financial Group for approximately 7,513 square feet and RBN & Associates, an existing tenant, expanded by 4,404 square feet to a total of approximately 12,779 square feet.

 

We believe that the downtown Chicago office market, which we refer to as the Central Business District, experienced an increase in vacancy again, for the second consecutive quarter, due to negative net absorption from large tenants relocating and downsizing. The office leasing conditions in the East Loop submarket, the Property’s specific submarket, also experienced a similar increase in vacancy during the same period.

 

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 June 30, 2017, we believe that vacancy rates increased 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 or existing 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

 

On July 21, 2017, our Board of Directors declared a dividend in the amount of $335 per share of Preferred Stock, in light of results of operations of the Property for the three months ended June 30, 2017. Although we currently expect a similar level of dividend distributions in future periods until occupancy levels at the Property more fully recover, the level of dividend payments in future periods may vary and will depend on the Property’s actual operating results and future capital and leasing needs. We cannot guarantee the future payment of dividends or the amount of any such dividends.

 

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 to stabilize the occupancy and rent roll at the Property. In light of the amount of vacant space that needs 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 remaining 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 June 30, 2017, we had drawn an aggregate of $29,680,000 from the restricted reserve account(s). Interest expense paid on the Loan for the six months ended June 30, 2017 and 2016 was $837,000 and $845,000, respectively. 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 reports to the Lender. We were in compliance with the Loan covenants as of June 30, 2017 and December 31, 2016.

 

Potential Sale of the Property

 

In July 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 retained Holliday Fenoglio Fowler, L.P., a commercial real estate broker, to facilitate a potential sale of the Property. Despite an aggressive marketing campaign that included several offers, we did not achieve buyer interest at pricing levels that our Board of Directors were prepared to recommend to the holders of the Preferred Stock. Our objective, as always, is to maximize shareholder value by trying to get the best overall rate of return for the holders of the Preferred Stock considering both current dividend distribution levels and the proceeds of the sale of the Property, all in the context of current market conditions. Accordingly, we have directed Holliday Fenoglio Fowler, L.P. to cease marketing of the Property and we intend to continue to own and operate the Property. We believe that in time we can stabilize the Property at a higher occupancy level. If successful and if market conditions warrant doing so at that time, our Board of Directors intends to attempt another sale of the Property. As a result, we are very focused on leasing the Property’s remaining existing vacancy.

 

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 and as a result there can be no assurance that we will be able to sell the Property on acceptable terms or within any particular time frame.

 

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, 2016.

Results of Operations

 

As of June 30, 2017, the Property was approximately 77.7% leased to a diverse group of tenants with staggered lease expirations.

 

Comparison of the three months ended June 30, 2017 to the three months ended June 30, 2016

 

Revenue

 

Total revenue increased by approximately $0.4 million to $4.9 million for the three months ended June 30, 2017, as compared to $4.5 million for the three months ended June 30, 2016. This increase was primarily due to an increase in overall rental revenue as a result of increased occupancy.

 

Expenses

 

Total expenses increased by approximately $0.5 million to $5.2 million for the three months ended June 30, 2017, as compared to $4.7 million for the three months ended June 30, 2016. The increase is primarily due to $0.4 million increase in real estate taxes and insurance and a $0.1 million increase in depreciation and amortization.

 

Comparison of the six months ended June 30, 2017 to the six months ended June 30, 2016

 

Revenue

 

Total revenue increased by approximately $1.0 million to $9.7 million for the six months ended June 30, 2017, as compared to $8.7 million for the six months ended June 30, 2016. This increase was primarily due to an increase in overall rental revenue as a result of increased occupancy.

 

Expenses

 

Total expenses increased by approximately $0.8 million to $10.3 million for the six months ended June 30, 2017, as compared to $9.5 million for the six months ended June 30, 2016. The increase is primarily due to a $0.1 million increase in operating expenses, a $0.4 million increase in real estate taxes and insurance and a $0.2 million increase in depreciation and amortization.

 

Liquidity and Capital Resources

 

Cash and cash equivalents were $25.0 million at June 30, 2017 and $25.3 million at December 31, 2016. The $0.3 million decrease for the six months ended June 30, 2017 was primarily attributable to approximately $1.5 million used for investing activities and $1.8 million used for financing activities, offset by $3.0 million provided by operating activities.

 

Management believes that the existing cash and cash equivalents as of June 30, 2017 of $25.0 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 $3.0 million for the six months ended June 30, 2017 was primarily attributable to an add-back of non-cash items of $3.6 million, consisting primarily of depreciation and amortization, and a decrease in restricted cash of $1.2 million, which was partially offset by a net loss of approximately $0.6 million, uses arising from other current operations of $0.3 million and payments of deferred leasing costs of $0.9 million.

 

Investing Activities

 

The cash used for investing activities of approximately $1.5 million for the six months ended June 30, 2017 was attributable to purchases of real estate assets.

 

Financing Activities

 

The cash used for financing activities of approximately $1.8 million for the six months ended June 30, 2017 was attributable to the distributions to stockholders of approximately $1.4 million and $0.4 million of principal payments on the Loan.

 

Sources and Uses of Funds

 

Our principal demands on liquidity are cash for operations, interest on debt payments and distributions to equity holders. As of June 30, 2017, we had approximately $6.5 million in accrued liabilities, and $34.3 million in loan payable. 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 an 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 June 30, 2017, we had drawn an aggregate of $29,680,000 from the restricted reserve account(s). Interest expense paid on the Loan for the six months ended June 30, 2017 and 2016 was $837,000 and $845,000, respectively.

 

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 June 30, 2017 and December 31, 2016.

 

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 six months ended June 30, 2017 and 2016, management fees paid to FSP Property Management LLC were approximately $45,000 and $44,000, 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 six months ended June 30, 2017 and 2016, investor services fees paid were approximately $8,400 and $7,900, 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 our 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 June 30, 2017. 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 June 30, 2017, 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 June 30, 2017 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: August 11, 2017	/s/ George J. Carter George J. Carter	Chief Executive Officer (Principal Executive Officer)
Date: August 11, 2017	/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 June 30, 2017, 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.