SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
(x) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended MARCH 31, 1997
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 1-12708
FRANKLIN SELECT REALTY TRUST
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(Exact name of registrant as specified in its charter)
CALIFORNIA 94-3095938
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(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
P. O. BOX 7777, SAN MATEO, CALIFORNIA 94403-7777
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (415) 312-2000
N/A
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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 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 X No
Common Stock Shares Outstanding as of March 31, 1997, Series A: 12,250,384
Common Stock Shares Outstanding as of March 31, 1997, Series B: 745,584
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
FRANKLIN SELECT REALTY TRUST
BALANCE SHEETS
AS OF MARCH 31, 1997 AND DECEMBER 31,1996
UNAUDITED
(In thousands, except per share data) 1997 1996
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ASSETS
Rental property:
Land $38,286 $38,286
Buildings and improvements 103,399 103,339
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141,685 141,625
Less: accumulated depreciation 18,487 17,583
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123,198 124,042
Cash and cash equivalents 3,156 2,558
Mortgage-backed securities, available for sale 571 578
Deferred rent receivable 1,905 1,916
Deferred costs and other assets 2,447 2,204
=====================
Total assets $131,277 $131,298
=====================
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LIABILITIES AND STOCKHOLDERS' EQUITY
Notes and bonds payable $22,821 $22,745
Tenant deposits, accounts payable
and accrued expenses 1,292 1,197
Advance rents 17 26
Distributions payable 1,448 1,348
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Total liabilities 25,578 25,316
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Minority interest 9,311 9,329
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Commitments and contingencies
Stockholders' equity:
Common stock, Series A, without par value;
stated value $10 per share; 110,000 shares
authorized; 12,250 issued and outstanding 103,161 103,161
Common stock, Series B, without par value;
stated value $10 per share; 2,500 shares
authorized; 746 shares issued and outstanding 6,294 6,294
Unrealized loss on mortgage-backed securities (32) (36)
Accumulated distributions in
excess of net income (13,035) (12,766)
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Total stockholders' equity 96,388 96,653
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Total liabilities and
stockholders' equity $131,277 $131,298
=====================
The accompanying notes are an integral part of these consolidated financial
statements.
FRANKLIN SELECT REALTY TRUST
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS ENDED MARCH 31, 1997 AND 1996
UNAUDITED
Restated
(In thousands, except per share data) 1997 1996
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REVENUE:
Rent $4,096 $3,285
Interest, dividends, and other 36 189
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Total revenue 4,132 3,474
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EXPENSES:
Interest 592 162
Depreciation and amortization 972 824
Property operating 829 830
Related party 337 250
Consolidation expense - 462
General and administrative 162 193
Minority interest 161 -
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Total expenses 3,053 2,721
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NET INCOME $1,079 $753
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Net income per share, based on the weighted
average shares outstanding of Series A
common stock of 12,250 and 14,145 for
the three months ended March 31, 1997
and 1996, respectively $ .09 $ .05
=====================
Distributions per share, based on the weighted
average shares outstanding of Series A
common stock of 12,250 and 14,145 for
the three months ended March 31, 1997
and 1996, respectively $ .11 $ .11
=====================
The accompanying notes are an integral part of these consolidated financial
statements.
FRANKLIN SELECT REALTY TRUST
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31, 1997 AND 1996
UNAUDITED
Restated
(In thousands) 1997 1996
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CASH FLOWS FROM OPERATING ACTIVITIES:
NET INCOME $1,079 $753
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Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 1,013 824
Minority interest 161 -
Decrease in deferred rent receivable 11 12
Increase in other assets (268) (305)
Increase in tenant deposits, accounts
payable and accrued expenses 35 135
Decrease in advance rents (9) (9)
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943 657
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NET CASH PROVIDED BY OPERATING ACTIVITIES 2,022 1,410
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CASH FLOWS FROM INVESTING ACTIVITIES:
Improvements to rental property (60) (123)
Leasing commissions paid (81) (120)
Disposition of mortgage-backed securities 11 284
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NET CASH (USED IN) PROVIDED BY
INVESTING ACTIVITIES (130) 41
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CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowings under bonds payable 2,478 -
Repayment of notes and bonds payable (2,402) (498)
Payment of loan costs (3) -
Distributions paid to limited partners (119) -
Distributions paid to shareholders (1,248) (1,521)
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NET CASH USED IN FINANCING ACTIVITIES (1,294) (2,019)
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NET INCREASE (DECREASE) IN CASH
AND CASH EQUIVALENTS 598 (568)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 2,558 6,186
====================
CASH AND CASH EQUIVALENTS, END OF PERIOD $3,156 $5,618
====================
The accompanying notes are an integral part of these consolidated financial
statements.
FRANKLIN SELECT REALTY TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1997
UNAUDITED
NOTE 1 - BASIS OF PRESENTATION
The accompanying consolidated financial statements of Franklin Select Realty
Trust (the "Company") have been prepared in accordance with generally
accepted accounting principles applicable to interim financial information
and pursuant to the rules and regulations of the Securities and Exchange
Commission. Accordingly, certain information and footnote disclosures
normally included in financial statements prepared in accordance with
generally accepted accounting principles have been condensed or omitted
pursuant to such rules and regulations. However, in the opinion of
management, all adjustments, consisting only of normal recurring adjustments,
necessary for a fair presentation have been included. The Company presumes
that users of the interim financial information herein have read or have
access to the audited financial statements for the preceding fiscal year and
that the adequacy of additional disclosure needed for a fair presentation may
be determined in that context. Accordingly, footnote disclosure which would
substantially duplicate the disclosure contained in the Company's 1996 Annual
Report on Form 10-K has been omitted. The accompanying unaudited
consolidated financial statements for the period ended, March 31, 1996, have
been restated to give effect to the Merger (See Note 2) accounted for as a
reorganization of entities under common control.
NOTE 2 - NET INCOME PER SHARE
On May 7, 1996 Franklin Real Estate Income Fund ("FREIF") and Franklin
Advantage Real Estate Income Fund ("Advantage") merged into the Company (the
"Merger"). On November 1, 1996 in connection with the merger, the Company
repurchased shares of FREIF and Advantage common stock, equivalent to
approximately 1.9 million shares of the Company's common stock, which was
held by certain FREIF and Advantage shareholders who dissented from the
merger.
For purposes of calculating net income per share for the period ended March
31, 1996, the weighted average shares outstanding of Series A common stock
has been calculated assuming the shares attributable to dissenting
shareholders (equivalent to approximately 1.9 million shares of the Company's
common stock) were converted into the Company's common stock and were
outstanding for the period.
FRANKLIN SELECT REALTY TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1997
UNAUDITED
NOTE 3 - LITIGATION
On December 2, 1996, two stockholders, for themselves and purportedly on
behalf of certain other minority stockholders of Advantage, filed a purported
class action complaint in the California Superior Court for San Mateo County
against Advantage, its directors, the Advisor, Franklin Resources, Inc. and
the Massachusetts State Teachers' and Employees' Retirement Systems Trust
("MASTERS"). The complaint alleges that defendants breached fiduciary duties
to plaintiffs and other minority stockholders in connection with the purchase
by Franklin Resources, Inc. in August 1994 of MASTERS' 46.6% interest in
Advantage and in connection with the Merger of Advantage into the Company in
May 1996, which was approved by a majority of the outstanding shares of each
of the three companies. Plaintiffs also allege that defendants misstated
certain material facts or omitted to state material facts in connection with
these transactions. The complaint includes a variety of additional claims,
including claims relating to the investment of Advantage assets, the
suspension of the dividend reinvestment program, the allocation of
merger-related expenses, revisions to the investment policies of Advantage,
and the restructuring of the contractual relationship with the Advisor.
Plaintiffs seek damages in an unspecified amount and certain equitable
relief. The defendants deny any wrongdoing in these matters and intend to
vigorously defend the action. Management does not believe that the outcome
of this litigation will have a material adverse affect on the Company's
financial condition or results of operations.
NOTE 4 - SUBSEQUENT EVENT
On April 1, 1997, FSRT, L.P., a majority-owned subsidiary of the Company,
acquired an industrial R&D building located in Fremont, California, for $8.51
million. The acquisition was financed by a $8.6 million draw under the
Company's line of credit with Bank of America. Management intends to
refinance approximately $5.1 million of the borrowings under the line of
credit with fixed rate mortgage debt.
FRANKLIN SELECT REALTY TRUST
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
INTRODUCTION
The following discussion is based primarily on the consolidated financial
statements of the Company for the period ended March 31, 1997 and the
restated, combined financial statements of the Company, FREIF, and Advantage
as of, and for the period ended, March 31, 1996 to give effect to the
Merger. The information should be read in conjunction with the accompanying
consolidated financial statements and the notes thereto.
When used in the following discussion, the words "believes," "anticipates"
and similar expressions are intended to identify forward-looking statements.
Such statements are subject to certain risks and uncertainties which could
cause actual results to differ materially from those projected, including,
but not limited to, those set forth in the section entitled "Potential
Factors Affecting Future Operating Results," below. Readers are cautioned not
to place undue reliance on these forward-looking statements which speak only
as of the date hereof. The Company undertakes no obligation to publicly
release the result of any revisions to these forward-looking statements which
may be made to reflect events or circumstances after the date hereof or to
reflect the occurrence of unanticipated events.
RESULTS OF OPERATIONS
COMPARISON OF THE THREE MONTH PERIODS ENDED MARCH 31, 1997 AND 1996
Total revenue for the three month period ended March 31, 1997 increased
$658,000, or 19%, compared to the same period in 1996 primarily due to rental
revenue provided by the LAM Research Buildings acquired in October, 1996, and
to an increase in the average portfolio occupancy rate of the other seven
properties from 94.1% at March 31, 1996 to 96.9% at March 31, 1997. The
increase in rental revenue was partially offset by a decrease in interest
revenue due to the sale of mortgage-backed securities in the fourth quarter
of 1996.
Total expenses for the three month period ended March 31, 1997, increased
$332,000, or 12%, compared to the same period in 1996 primarily as a result
of increases in interest, depreciation and amortization and minority interest
expenses related to the LAM Research Buildings. These increases were
partially offset by a decrease in non-recurring expenses related to the
Merger.
Related party expense for the three month period ended March 31, 1997
increased 35%, primarily as a result of an increase in advisory fees caused
by the acquisition of the LAM Research Buildings and to the adoption of the
Company's advisory agreement by the two REITs that merged with the Company in
May, 1996. Prior to the merger, the REITs operated under advisory agreements
containing different methods of compensation to the Advisor.
General and administrative expense for the three month period ended March 31,
1997 decreased 16%, due to decreases in legal fees and directors' and
officers' insurance premiums, and due to merger related expenses reported in
1996 of $33,000. These decreases were partially offset by increases in
transfer agent expense and accounting expense.
Net income increased $326,000, or 43%, for the three month period ended March
31, 1997, primarily as a result of an increase in rental income, and a
decrease in merger expenses.
FRANKLIN SELECT REALTY TRUST
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
(Continued)
LIQUIDITY AND CAPITAL RESOURCES
At March 31, 1997, cash and cash equivalents aggregated $3,156,000 which the
Company believes is adequate to meet its short-term operating cash
requirements. The Company also has access to a revolving line of credit in
the amount of $25 million and holds $571,000 in mortgage-backed securities.
At March 31, 1997, there were no amounts outstanding under the Company's
credit facility.
Management continues to evaluate properties for acquisition by the Company.
The Company expects to fund the cost of acquisitions, capital expenditures,
costs associated with lease renewals and reletting of space, repayment of
indebtedness, and development of properties from (i) cash flow from
operations, (ii) borrowings under its credit facility and, if available,
other indebtedness (which may include indebtedness assumed in acquisitions),
(iii) proceeds from the sale of the Company's equity securities, and (iv) the
issuance of partnership interests in connection with acquisitions. The
Company's operating cash flow has been its principal source of capital for
minor property improvements, leasing costs and the payment of quarterly
distributions.
Net cash provided by operating activities for the three month period ended
March 31, 1997 was $2,022,000, or $612,000 more than the same period in
1996. The increase in cash flow provided by operating activities is
primarily attributable to the increase in net income as described under
"Results of Operations".
Net cash provided by investing activities for the three month period ended
March 31, 1997, decreased $171,000 when compared to the same period in 1996
primarily due to a decline in principal payments received from the
mortgage-backed securities.
Net cash used in financing activities decreased $725,000 reflecting cash used
in 1996 to payoff the Fairway Center note in the amount of $480,000, and in
1997, the Company paid a constant dividend rate on a smaller number of
outstanding shares than were outstanding in 1996.
On April 1, 1997, the Company acquired an R&D building located in Fremont,
California. The Company acquired the property for a purchase price of $8.51
million utilizing a portion of the line of credit facility available to the
Company. Borrowings under the line of credit bear interest at the London
Interbank Offered Rate plus 1.90%, or at Bank of America's Reference rate at
the Company's option. At May 1, 1997 the weighted average interest rate of
borrowings under the line of credit was 7.75%. The Company expects to
refinance such borrowings under the line of credit with fixed-rate debt
collateralized by the newly acquired property.
Management does not believe that the outcome of the litigation described at
Note 2 to the accompanying financial statements will have a material adverse
affect on the Company's financial condition or results of operations.
Management believes that the Company's sources of capital as described under
Liquidity and Capital Resources are adequate to meet its liquidity needs in
the foreseeable future.
IMPACT OF INFLATION
The Company's policy of negotiating leases which incorporate operating
expense "pass-through" provisions is intended to protect the Company against
increased operating costs resulting from inflation.
FRANKLIN SELECT REALTY TRUST
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
(Continued)
LIQUIDITY AND CAPITAL RESOURCES (Continued)
CASH DISTRIBUTION POLICY
Distributions are declared quarterly at the discretion of the Board of
Directors. The Company's present distribution policy is to at least annually
evaluate the current distribution rate in light of anticipated tenant
turnover over the next two or three years, the estimated level of associated
improvements and leasing commissions, planned capital expenditures, any debt
service requirements and the Company's other working capital requirements.
After balancing these considerations, and considering the Company's earnings
and cash flow, the level of its liquid reserves and other relevant factors,
the Company seeks to establish a distribution rate which:
i) provides a stable distribution which is sustainable
despite short-term fluctuations in property cash
flows;
ii) maximizes the amount of cash flow paid out as
distributions consistent with the above listed
objective; and
iii) complies with the Internal Revenue Code requirement
that a REIT annually pay out as distributions not less
than 95% of its taxable income.
During the three month period ended March 31, 1997, the Company declared
distributions totaling $1,348,000.
FUNDS FROM OPERATIONS
The Company considers funds from operations to be a useful measure of the
operating performance of an equity REIT because, together with net income and
cash flows, Funds from operations provides investors with an additional basis
to evaluate the ability of a REIT to support general operating expense and
interest expense before the impact of certain activities, such as gains and
losses from property sales and changes in the accounts receivable and
accounts payable. However, it does not measure whether income is sufficient
to fund all of the Company's cash needs including principal amortization,
capital improvements and distributions to stockholders. Funds from
operations should not be considered an alternative to net income or any other
GAAP measurement of performance, as an indicator of the Company's operating
performance or as an alternative to cash flows from operating, investing or
financing activities as a measure of liquidity. As defined by the National
Association of Real Estate Investment Trusts, funds from operations is net
income (computed in accordance with GAAP), excluding gains or losses from
debt restructuring and sales of property, plus depreciation and amortization,
and after adjustment for unconsolidated joint ventures. The Company reports
funds from operations in accordance with the revised NAREIT definition. The
measure of funds from operations as reported by the Company may not be
comparable to similarly titled measures of other companies that follow
different definitions.
For the Three Months Ended
Funds from Operations March 31,
(In thousands) 1997 1996
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Net income $1,079 $753
Add: Depreciation and amortization 972 824
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Funds from Operations $2,051 $1,577
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The primary difference between the periods reflects the changes in net income
as discussed under "Results of Operations".
FRANKLIN SELECT REALTY TRUST
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
(Continued)
POTENTIAL FACTORS AFFECTING FUTURE OPERATING RESULTS
DECLINE IN INTEREST INCOME, LOSS ON SALE OF MORTGAGE-BACKED SECURITIES
In prior years, net income has been positively affected by interest income
that the Company earned on its investments in mortgage-backed securities. In
addition, the Company periodically incurred losses upon the sale of certain
of the securities. Late in 1996, the Company liquidated substantially all of
its mortgage-backed securities in order to provide funds to repurchase a
portion of its outstanding common stock. Therefore, the Company does not
anticipate generating significant amounts of interest income, or losses on
the sale of mortgage-backed securities, in future years. The repurchase of
the Company's common stock was not detrimental to the Company's operating
results in 1996 calculated on a per share basis, due to the related decline
in the number of shares outstanding.
LEASING TURNOVER
In connection with any lease renewal or new lease, the Company typically
incurs costs for tenant improvements and leasing commissions which will be
funded first from operating cash flow and, if necessary, from cash reserves
or the line of credit. In addition, while the Company has historically been
successful in renewing and releasing space, the Company will be subject to
the risk that leases expiring in the future may be renewed or released at
terms that are less favorable than current lease terms.
LEASING TURNOVER - CONTINENTAL CASUALTY COMPANY
An important event in the near-term is the expiration of the Continental
Casualty Company ("CNA") lease in November, 1997. The lease covers 74,515
square feet of space and represents approximately 12% of the Company's
current base rental income. The Company has commenced renewal negotiations
with CNA; however, it is currently unknown whether an agreement will be
consummated. Currently, the base annual rental rate of this lease is $22.80
per square foot, and the Company has offered to extend the tenant's lease for
five years at a lower rental rate. In addition, the Company expects to incur
approximately $870,000 for tenant improvements and leasing commissions.
Although it is impossible to predict the final outcome of negotiations with
CNA, if the tenant were to accept the Company's proposal, the Company's
annual rental income and expense reimbursements would decline by
approximately $420,000, or 2.9% of the Company's total revenue in 1996.
Alternatively, if CNA were to vacate its space and a single replacement
tenant could not be located, the Company may have to reconfigure the space
for multiple tenants at a cost which could exceed $2 million. The most
likely sources for such funds are the Company's cash reserves, debt
financing, or the sale of an undeveloped parcel of land at the Fairway
Center. No assurance can be given that CNA will renew under the terms set
forth above or whether the space currently occupied by CNA can be rented
without detrimental impact to the Company's current annual rental income and
expense reimbursements.
FRANKLIN SELECT REALTY TRUST
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
(Continued)
POTENTIAL FACTORS AFFECTING FUTURE OPERATING RESULTS(Continued)
LEASING TURNOVER - DATA GENERAL BUILDING
The Data General Building is located in an area of Los Angeles County that is
dominated by aerospace and defense-related companies. Because many of the
defense programs that these companies are engaged in have been curtailed,
their office space requirements were substantially reduced, causing greater
vacancies and lower market rental rates. Based on reports from CB Commercial
Real Estate Group, at December 31, 1996, the Manhattan Beach/El Segundo
sub-market, had a total vacancy factor of 31% and an average asking full
service rental rate of $19.32 per square foot. New leases and renewals that
the Company executes while these soft market conditions persist may be at
lower rental rates and require greater tenant improvements than current
leases at the property. However, according to the CB Commercial reports, the
severe job losses experienced by the aerospace and defense industries appear
to have bottomed out in February of 1996, and occupancy rates in the El
Segundo market are expected to increase in 1997; however, there can be no
assurance that this will occur.
Over the next two years, the Company's leasing exposure at the Data General
Building consists of two leases each covering 48,000 square feet, which
expire in November, 1997 and January 1999. The Company believes that the
effective rental rate that is provided by the lease expiring in 1997 is
substantially at the current market rate. However, the lease expiring in
1999 carries a triple net rental rate that is equivalent to approximately
$28.00 per square foot on a full service basis. Compared to the current
market asking rate of $19.32 per square foot, this lease provides overmarket
rent of approximately $417,000 annually, or 2.9% of the Company's total
revenue in 1996. It is impossible to predict the market rental rate in 1999;
however, the Company expects that when this lease expires, the rental income
related to this space will be less than $28.00 per square foot regardless of
whether the lease is renewed or new leases are signed. The Company will also
incur costs for tenant improvements and leasing commissions related to both
spaces upon the renewal or re-leasing of the spaces, however, the amounts are
unknown at this time.
FRANKLIN SELECT REALTY TRUST
PART II - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Not applicable
(b) Reports on Form 8-K
No reports on Form 8-K were filed by the Registrant during the quarter
ended March 31, 1997.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
FRANKLIN SELECT REALTY TRUST
By: /S/ DAVID P. GOSS
David P. Goss
Chief Executive Officer
Date: MAY 9, 1997