-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Sz6S0Uu0XThRX48wtzC9m2C7MYAQJalUPwAMtPGy6N4mTCBxJPVndNAy0wrz5BF9 qyMRYzhE9ZriK36PnRPCVw== 0000903112-98-002046.txt : 19981214 0000903112-98-002046.hdr.sgml : 19981214 ACCESSION NUMBER: 0000903112-98-002046 CONFORMED SUBMISSION TYPE: 10-Q/A PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19980930 FILED AS OF DATE: 19981211 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CAPITAL TRUST CENTRAL INDEX KEY: 0000016387 STANDARD INDUSTRIAL CLASSIFICATION: REAL ESTATE INVESTMENT TRUSTS [6798] IRS NUMBER: 946181186 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q/A SEC ACT: SEC FILE NUMBER: 001-08063 FILM NUMBER: 98768245 BUSINESS ADDRESS: STREET 1: 605 THIRD AVENUE 26TH FLOOR STREET 2: STE 200 CITY: NEW YORK STATE: NY ZIP: 10016 BUSINESS PHONE: 2126550220 MAIL ADDRESS: STREET 1: 605 THIRD AVENUE 26TH FLOOR STREET 2: #200 CITY: NEW YORK STATE: NY ZIP: 10016 FORMER COMPANY: FORMER CONFORMED NAME: CALIFORNIA REAL ESTATE INVESTMENT TRUST DATE OF NAME CHANGE: 19920703 10-Q/A 1 FORM 10-Q/A As filed with the Securities and Exchange Commission on December 11, 1998 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q/A (Mark One) /X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 1998 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: 1-8063 CAPITAL TRUST (Exact name of registrant as specified in its charter) California 94-6181186 - ----------------------------------- ---------------------------------------- (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 605 Third Avenue, 26th Floor, New York, NY 10016 - -------------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) (212) 655-0220 (Registrant's telephone number, including area code) 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 / X / No / / APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the issuer's classes of common stock as of the close of the latest practical date. Class Outstanding at November 13, 1998 - ------------------------------------- ----------------------------------- Class A Common Shares of Beneficial Interest, 18,213,816 $1.00 par value ("Class A Common Shares") CAPITAL TRUST INDEX
Part I. Financial Information Item 1: Financial Statements 1 Consolidated Balance Sheets - September 30, 1998 (unaudited) and December 31, 1997 (audited) 1 Consolidated Statements of Operations - Three and Nine Months Ended September 30, 1998 (unaudited) and Three and Nine Months Ended September 30, 1997 (unaudited and audited, respectively) 2 Consolidated Statements of Changes in Shareholders' Equity - Nine Months Ended September 30, 1998 (unaudited) and Nine Months Ended September 30, 1997 (audited) 3 Consolidated Statements of Cash Flows - Nine Months Ended September 30, 1998 (unaudited) and Nine Months Ended September 30, 1997 (audited) 4 Notes to Consolidated Financial Statements (unaudited) 5 Item 2: Management's Discussion and Analysis of Financial Condition and Results of Operations 14 Part II. Other Information Item 1: Legal Proceedings 24 Item 2: Changes in Securities and Use of Proceeds 24 Item 3: Defaults Upon Senior Securities 24 Item 4: Submission of Matters to a Vote of Security Holders 24 Item 5: Other Information 24 Item 6: Exhibits and Reports on Form 8-K 25 Signatures 27
Capital Trust and Subsidiaries Consolidated Balance Sheets September 30, 1998 and December 31, 1997 (in thousands)
September 30, December 31, 1998 1997 -------------------- -------------------- (unaudited) (audited) Assets Cash and cash equivalents $ 16,420 $ 49,268 Other available-for-sale securities, at market value 5,497 11,975 Commercial mortgage-backed securities, available-for-sale and recorded at market value at September 30, 1998, held to maturity and recorded at amortized cost at December 31, 1998 33,974 49,490 Certificated mezzanine investments available-for-sale, at market value 43,253 21,993 Loans receivable, net of $2,821 (unaudited) and $462 reserve for possible credit losses at September 30, 1998 and December 31, 1997, respectively 627,324 180,324 Excess of purchase price over net tangible assets acquired, net 314 331 Deposits and other receivables 331 284 Accrued interest receivable 8,249 818 Prepaid and other assets 7,164 2,878 -------------------- -------------------- Total assets $ 742,526 $ 317,366 ==================== ==================== Liabilities and Shareholders' Equity Liabilities: Accounts payable and accrued expenses $ 7,781 $ 5,718 Notes payable 4,181 4,953 Credit facilities 348,780 79,864 Repurchase obligations 80,420 82,173 Deferred origination fees and other revenue 6,054 1,369 -------------------- -------------------- Total liabilities 447,216 174,077 -------------------- -------------------- Company-obligated, mandatorily redeemable, convertible preferred securities of CT Convertible Trust I, holding solely 8.25% junior subordinated debentures of Capital Trust ("Convertible Trust Preferred Securities") 145,334 - -------------------- -------------------- Shareholders' equity: Class A Convertible Preferred Shares, $1.00 par value, $0.26 cumulative annual dividend, 12,639 shares authorized, 12,268 shares issued and outstanding (liquidation preference of $33,000) 12,268 12,268 Class A Common Shares, $1.00 par value; unlimited shares authorized, 18,159 and 18,157 shares issued and outstanding at September 30, 1998 and December 31, 1997, respectively 18,159 18,157 Restricted Class A Common Shares, $1.00 par value, 55 shares issued and outstanding at September 30, 1998 55 - Additional paid-in capital 158,641 158,137 Unearned compensation (454) - Accumulated other comprehensive income (2,306) 387 Accumulated deficit (36,387) (45,660) -------------------- -------------------- Total shareholders' equity 149,976 143,289 -------------------- -------------------- Total liabilities and shareholders' equity $ 742,526 $ 317,366 ==================== ====================
See accompanying notes to unaudited consolidated financial statements. -1- Capital Trust and Subsidiaries Consolidated Statements of Operations Three and Nine Months Ended September 30, 1998 and 1997 (in thousands, except per share data)
Three Months Ended Nine months Ended September 30, September 30, ------------------------------------ ----------------------------------- 1998 1997 1998 1997 ---------------- ----------------- --------------- ----------------- (unaudited) (unaudited) (unaudited) (audited) Income from loans and other investments: Interest and related income $ 20,782 $ 1,787 $ 42,825 $ 1,863 Less: interest and related expenses 8,714 790 18,311 790 ---------------- ----------------- ---------------- ----------------- Net income from loans and other investments 12,068 997 24,514 1,073 ---------------- ----------------- ---------------- ------------------ Other revenues: Advisory and investment banking fees 829 529 9,479 529 Rental income - 8 - 313 Other interest income 261 405 941 1,008 Loss on sale of rental properties - - - (432) ---------------- ---------------- ----------------- --------------- Total other revenues 1,090 942 10,420 1,418 ---------------- ----------------- ----------------- --------------- Other expenses: General and administrative 4,482 3,328 11,743 4,470 Other interest expense 98 21 309 144 Rental property expenses - - - 123 Depreciation and amortization 63 28 171 52 Provision for possible credit losses 1,119 155 2,359 155 ---------------- ----------------- ----------------- --------------- Total other expenses 5,762 3,532 14,582 4,944 ---------------- ----------------- ---------------- ---------------- Net income (loss) before income taxes and distributions and amortization on Convertible Trust Preferred Securities 7,396 (1,593) 20,352 (2,453) Provision for income taxes 3,053 - 8,312 - ---------------- ----------------- ----------------- --------------- Net income (loss) before distributions and amortization on Convertible Trust Preferred Securities 4,343 (1,593) 12,040 (2,453) Distributions and amortization on Convertible Trust Preferred Securities, net of income tax benefit of $1,069 1,199 - 1,199 - ---------------- ----------------- ----------------- --------------- Net income (loss) $ 3,144 $ (1,593) $ 10,841 $ (2,453) Less: Class A Preferred Share dividend and dividend requirement 783 679 2,351 679 ---------------- ----------------- ----------------- --------------- Net income (loss) allocable to Class A Common Shares $ 2,361 $ (2,272) $ 8,490 $ (3,132) ================ ================= ================= =============== Per share information: Net income (loss) per Class A Common Share: Basic $ 0.13 $ (0.25) $ 0.47 $ (0.34) ================ ================= ================= =============== Diluted $ 0.10 $ (0.25) $ 0.35 $ (0.34) ================ ================= ================= =============== Weighted average Class A Common Shares outstanding: Basic 18,217,186 9,157,150 18,218,279 9,157,150 ================ ================= ================= =============== Diluted 30,612,406 9,157,150 30,705,867 9,157,150 ================ ================= ================= ===============
See accompanying notes to unaudited consolidated financial statements. Capital Trust and Subsidiaries Consolidated Statements of Changes in Shareholders' Equity For the Nine Months Ended September 30, 1998 (unaudited) and Nine Months Ended September 30, 1997 (audited) (in thousands)
Class A Class A Comprehensive Preferred Common Income (Loss) Shares Shares ----------------- ----------------------------- Nine months ended September 30, 1997 - ------------------------------------ Balance at December 31, 1996 $ - $ - $ 9,157 Net loss (2,453) - - Change in unrealized gain (loss) on 481 - - available-for-sale securities Issuance of Class A Preferred Shares - 12,268 - ----------------- ----------------------------- Balance at September 30, 1997 $ (1,972) $ 12,268 $ 9,157 ================= ============================= Nine months ended September 30, 1998 - ------------------------------------ Balance at December 31, 1997 $ - $ 12,268 $ 18,157 Net income 10,841 - - Change in unrealized gain (loss) on available-for-sale securities (2,693) - - Issuance of Class A Common Shares under stock option plan - - 2 Issuance of restricted Class A Common Shares - - - Cancellation of previously issued - - - restricted Class A Common Shares Restricted Class A Common Shares earned - - - Class A Preferred Share Dividend - - - ----------------- ----------------------------- Balance at September 30, 1998 $ 8,148 $ 12,268 $ 18,159 ================= =============================
Restricted Accumulated Class A Additional Other Common Paid-In Unearned Comprehensive Accumulated Shares Capital Compensation Income Deficit Total ------------------------------------------------------------------------------------ Nine months ended September 30, 1997 - ------------------------------------ Balance at December 31, 1996 $ - $ 55,098 $ - $ (22) $ (39,762) $ 24,471 Net loss - - - - (2,453) (2,453) Change in unrealized gain (loss) on - - - 481 - 481 available-for-sale securities Issuance of Class A Preferred Shares - 20,602 - - - 32,870 ------------------------------------------------------------------------------------ Balance at September 30, 1997 $ - $ 75,700 $ - $ 459 $ (42,215) $ 55,369 ==================================================================================== Nine months ended September 30, 1998 - ------------------------------------ Balance at December 31, 1997 $ - $158,137 $ - $ 387 $ (45,660) $ 143,289 Net income - - - - 10,841 10,841 Change in unrealized gain (loss) on available-for-sale securities - - - (2,693) - (2,693) Issuance of Class A Common Shares under stock option plan - 8 - - - 10 Issuance of restricted Class A Common Shares 72 653 (725) - - - Cancellation of previously issued restricted Class A Common Shares (17) (157) 156 - - (18) Restricted Class A Common Shares earned - - 115 - - 115 Class A Preferred Share Dividend - - - - (1,568) (1,568) ------------------------------------------------------------------------------------ Balance at September 30, 1998 $ 55 $158,641 $ (454) $ (2,306) $ (36,387) $ 149,976 ====================================================================================
See accompanying notes to unaudited consolidated financial statements. -3- Capital Trust and Subsidiaries Consolidated Statements of Cash Flows Nine months ended September 30, 1998 and 1997 (in thousands)
1998 1997 ---------------- ------------------ (unaudited) (audited) Cash flows from operating activities: Net income (loss) $ 10,841 $ (2,453) Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Depreciation and amortization 171 52 Restricted Class A Common Shares earned 115 - Net amortization of premiums and accretion of discounts on loans and other investments 1,025 - Net accretion of discounts and fees on Convertible Trust Preferred Securities 137 - (Gain) loss on sale of investments and properties (100) 432 Expenses reversed on cancellation of restricted shares previously issued (18) - Provision for possible credit losses 2,359 155 Changes in assets and liabilities net of effects from subsidiaries purchased: Deposits and receivables (47) (804) Accrued interest receivable (7,431) (334) Prepaid and other assets (4,095) (2,512) Deferred revenue 4,685 725 Accounts payable and accrued expenses 2,063 2,877 Other liabilities - (64) --------------- ------------------ Net cash provided by (used in) operating activities 9,705 (1,926) --------------- ------------------ Cash flows from investing activities: Purchases of commercial mortgage-backed securities (36,335) (49,524) Principal collections and proceeds from sale of commercial mortgage-backed securities 49,591 33 Purchase of certificated mezzanine investments (21,583) - Principal collections of certificated mezzanine investments (328) - Origination and purchases of loans receivable (500,981) (38,102) Principal collections of loans receivable 50,901 90 Purchases of equipment and leasehold improvements (345) (421) Improvements to rental properties - - Proceeds from sale of rental properties - 8,153 Principal collections on available-for-sale securities 5,841 3,964 Acquisition of Victor Capital Group, L.P., net of cash acquired - (4,066) --------------- ------------------ Net cash used in investing activities (452,583) (79,873) --------------- ------------------ Cash flows from financing activities: Proceeds from repurchase obligations 41,837 54,166 Repayment of repurchase obligations (43,590) (17,285) Proceeds from credit facilities 564,646 11,715 Repayment of credit facilities (295,730) - Proceeds from notes payable 10,000 4,001 Repayment of notes payable (10,772) (4,303) Net proceeds from issuance of Convertible Trust Preferred Securities 145,197 - Dividends paid on Class A Preferred Shares (1,568) - Net proceeds from issuance of Class A Common Shares under stock option plan 10 - Net proceeds from issuance of Class A Preferred Shares - 32,870 --------------- ----------------- Net cash provided by financing activities 410,030 81,164 --------------- ----------------- Net decrease in cash and cash equivalents (32,848) (635) Cash and cash equivalents at beginning of period 49,268 4,698 --------------- ------------------ Cash and cash equivalents at end of period $ 16,420 $ 4,063 =============== ================== Supplemental disclosure of cash flow information Interest paid during the period $ 18,007 $ 858 =============== ================== Taxes paid during the period $ 7,741 $ - =============== ==================
See accompanying notes to unaudited consolidated financial statements. -4- Capital Trust and Subsidiaries Notes to Consolidated Financial Statements September 30, 1998 (unaudited) 1. Presentation of Financial Information The accompanying unaudited consolidated interim financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. The accompanying unaudited consolidated interim financial statements should be read in conjunction with the financial statements and the related management's discussion and analysis of financial condition and results of operations filed with the 1997 Form 10-K of Capital Trust and Subsidiaries (the "Company"). In the opinion of management, all adjustments (consisting only of normal recurring accruals) considered necessary for a fair presentation have been included. The results of operations for the three and nine months ended September 30, 1998, are not necessarily indicative of results that may be expected for the entire year ending December 31, 1998. At December 31, 1996, the Company owned commercial rental property in Sacramento, California through a 59% limited partnership interest in Totem Square L.P., a Washington limited partnership ("Totem"), and an indirect 1% general partnership interest in Totem through its wholly-owned subsidiary, Cal-REIT Totem Square, Inc. An unrelated party held the remaining 40% interest. This property was sold during the quarter ended September 30, 1997 and the Totem Square L.P. and Totem Square, Inc. subsidiaries were liquidated and dissolved. The unaudited consolidated interim financial statements of the Company include the accounts of the Company, Victor Capital Group, L.P. ("Victor Capital") and its wholly-owned subsidiaries (included in the consolidated statement of operations since their acquisition on July 15, 1997) and the results from the disposition of the Company's rental property held by Totem, which was sold on March 4, 1997. All significant intercompany balances and transactions have been eliminated in consolidation. The accounting and reporting policies of the Company conform in all material respects to generally accepted accounting principles. Certain prior period amounts have been reclassified to conform to current period classifications. 2. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principals requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Capital Trust and Subsidiaries Notes to Consolidated Financial Statements (continued) (unaudited) 3. Earnings Per Class A Common Share Earnings per Class A Common Share is presented based on the requirements of Statement of Accounting Standards No. 128 ("SFAS No. 128") which is effective for periods ending after December 15, 1997. SFAS No. 128 simplifies the standard for computing earnings per share and makes them comparable with international earnings per share standards. The statement replaces primary earnings per share with basic earnings per share ("Basic EPS") and fully diluted earnings per share with diluted earnings per share ("Diluted EPS"). Basic EPS is computed based on the income applicable to Class A Common Shares (which is net income (loss) reduced by the dividends on the class A 9.5% cumulative convertible preferred shares of beneficial interest, $1.00 par value ("Class A Preferred Shares")) divided by the weighted-average number of Class A Common Shares outstanding during the period. Diluted EPS is based on the net earnings applicable to Class A Common Shares plus dividends on the Class A Preferred Shares, divided by the weighted average number of Class A Common Shares and dilutive potential Class A Common Shares that were outstanding during the period. Dilutive potential Class A Common Shares include the convertible Class A Preferred Shares and dilutive options to purchase Class A Common Shares. At September 30, 1998, the Class A Preferred Shares and dilutive portion of options to purchase Class A Common Shares were considered Class A Common Share equivalents for purposes of calculating Diluted EPS. At September 30, 1997, there was no difference between Basic EPS and Diluted EPS or weighted average Class A Common Shares outstanding, as there were no dilutive securities outstanding. 4. Comprehensive Income In June 1997, the FASB issued Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS No. 130") which is effective for fiscal years beginning after December 15, 1997. The statement changes the reporting of certain items currently reported in the shareholders' equity section of the balance sheet and establishes standards for reporting of comprehensive income and its components in a full set of general purpose financial statements. The Company has adopted this standard effective January 1, 1998. Total comprehensive income (loss) was $893,000 and $(1,269,000) for the three months ended September 30, 1998 and 1997, respectively, and $8,148,000 and $(1,972,000) for the nine months ended September 30, 1998 and 1997, respectively. The primary component of comprehensive income other than net income was unrealized gain (loss) on available-for-sale securities. -6- Capital Trust and Subsidiaries Notes to Consolidated Financial Statements (continued) (unaudited) 5. Commercial Mortgage-Backed Securities During the nine months ended September 30, 1998, the Company purchased interests in three subordinated commercial mortgage-backed securities issued by a financial asset securitization investment trust for $36.3 million. During the quarter ended June 30, 1998, due to prepayments made on underlying securities that reduced the interest rate/risk profile and maturity of a commercial mortgage-backed security, the Company concluded that it no longer anticipated holding this security to maturity. The security was sold during the quarter ended September 30, 1998 at a gain of approximately $100,000. Because of this decision to sell a held-to-maturity security, the Company has transferred all of its investments in commercial mortgage-backed securities from held-to-maturity securities to available-for-sale. As of September 30, 1998, the remaining securities, consisting of three subordinated commercial mortgage-backed securities issued by a financial asset securitization investment trust, had an amortized cost of $36.4 million and a market value of $34.0 million. These securities bear interest at floating rates, for which the weighted average interest rate in effect at September 30, 1998 is 10.68%. 6. Certificated Mezzanine Investments During the nine months ended September 30, 1998, the Company purchased a certificated mezzanine investment committing a total of $32.5 million of capital of which $21.6 million was funded through September 30, 1998. The certificated mezzanine investment has a remaining term of 8 months with 36 months of additional extensions and pays distributions at a specified rate over LIBOR until redemption. The weighted average rate in effect for all certificated mezzanine investments is 10.13% at September 30, 1998. 7. Loans Receivable At September 30, 1998, the amount and weighted average interest rate of the Company's loans receivable by category was as follows (in thousands):
Weighted Average Amount Interest Rate ------------------- ------------------- Mortgage Loans $ 291,407 10.99% Mezzanine Loans 336,706 11.55% Other mortgage loans receivable 2,029 8.41% ------------------- Total loans and other investments 630,324 11.28% Less: Reserve for possible credit losses (2,821) ------------------- Net loans and other investments $ 627,324 ===================
At September 30, 1998, $466.9 million of the aforementioned loans bear interest at floating rates ranging from LIBOR plus 320 basis points to LIBOR plus 700 basis points before amortization -7- Capital Trust and Subsidiaries Notes to Consolidated Financial Statements (continued) (unaudited) of fees, premiums and discounts. The remaining $163.2 million of loans were originated or purchased with fixed rates ranging from 8.50% to 12.00% at September 30, 1998. All of the loans with fixed rates were the subject of interest rate swaps to provide a floating rate. The weighted average interest rate in effect at September 30, 1998, including interest rate swaps and amortization of fees, premiums and discounts, was 11.28%. During the nine months ended September 30, 1998, the Company completed nineteen new loan transactions totaling approximately $513.9 million and provided $7.5 million of additional fundings on two loans originated in the prior year. The Company funded $493.5 million of the foregoing loans receivable originated during the nine months ended September 30, 1998 and has outstanding commitments at September 30, 1998 totaling $32.2 million. 8. Long-Term Debt Credit Facilities Effective January 1, 1998, pursuant to an amended and restated credit agreement, the Company increased its existing line of credit with a commercial lender to $250 million (the "Credit Facility") and subsequently further amended the credit agreement to increase the facility to $300 million effective June 22, 1998 and $355 million effective July 23, 1998. An additional commitment fee was paid when the Company's borrowings exceeded $250 million and will be paid when borrowings exceed $300 million. The Credit Facility provides for advances to fund lender-approved loans and investments made by the Company. The amended and restated agreement expires on December 31, 2000. On June 8, 1998, the Company entered into an additional credit agreement with another commercial lender that provides for a $300 million line of credit that expires in December 1999 (the "Second Credit Facility" together with the Credit Facility, the "Credit Facilities"). The Second Credit Facility provides for advances to fund lender-approved loans and investments made by the Company (such loans and investments together with loans and investments approved under the Credit Facility, the "Funded Portfolio Assets"). The Company incurred an initial commitment fee upon the signing of the Second Credit Facility and will pay an additional commitment fee when borrowings exceed $250 million. Future repayments and redrawdowns of amounts previously subject to the drawdown fee will not require the Company to pay any additional fees. The Second Credit Facility provides for margin calls on asset-specific borrowings in the event of asset quality and/or market value deterioration as determined under the Second Credit Facility. The Second Credit Facility contains customary representations and warranties, covenants and conditions and events of default. The Second Credit Facility also contains a covenant obligating the Company to avoid undergoing an ownership change that results in Craig M. Hatkoff, John R. Klopp or Samuel Zell no longer retaining their senior offices and trusteeships with the Company and practical control of the Company's business and operations. The obligations of the Company under the Credit Facilities are secured by pledges of the Funded Portfolio Assets acquired with advances under the Credit Facilities. Borrowings under the Credit Facilities bear interest at specified rates over LIBOR (averaging approximately 7.25% for the -8- Capital Trust and Subsidiaries Notes to Consolidated Financial Statements (continued) (unaudited) borrowings outstanding at September 30, 1998) which rates vary according to the credit quality of the Funded Portfolio Assets and the advance rate. On September 30, 1998, the unused amounts available under the Credit Facilities were $306.2 million. Repurchase Obligations During the nine months ended September 30, 1998, the Company entered into four new repurchase agreements. In February 1998, the Company entered into a repurchase agreement in connection with the purchase of a subordinated participation in a note. At September 30, 1998, the Company had sold such assets totaling $10.0 million and had a liability to repurchase these assets for $7.5 million. The liability bears interest at specified rates over LIBOR (reflecting a total borrowing rate of 6.74% at September 30, 1998) and had an original maturity in February 1999 which was extended to August 1999. In March 1998, the Company entered into a repurchase agreement in connection with the purchase of a subordinated participation in a first mortgage loan. At September 30, 1998, the Company had sold such assets totaling $14.0 million and had a liability to repurchase these assets for $10.5 million. The liability bears interest at specified rates over LIBOR (reflecting a total borrowing rate of 7.29% at September 30, 1998) and matures in March 1999. In March 1998, the Company entered into a repurchase agreement in conjunction with the purchase of a class of subordinated commercial mortgage-backed securities issued by a financial asset securitization investment trust. At September 30, 1998, the Company had sold such securities with a book value totaling $10.0 million and had a liability to repurchase these assets for $8.0 million. The liability bears interest at specified rates over LIBOR (reflecting a total borrowing rate of 6.58% at September 30, 1998) and matures in March 1999. In May 1998, the Company entered into a repurchase agreement in connection with the purchase of a certificated mezzanine investment. At September 30, 1998, the Company had sold such assets totaling $21.4 million and had a liability to repurchase these assets for $15.2 million. The liability bears interest at specified rates over LIBOR (reflecting a total borrowing rate of 7.14% at September 30, 1998) and matures in May 1999. At September 30, 1998, the Company had sold, in total, 106.6 million of assets and had a liability to repurchase these assets for $80.4 million. These liabilities bear interest at specified rates over LIBOR reflecting a total borrowing rate that averaged 6.74% at September 30, 1998. -9- Capital Trust and Subsidiaries Notes to Consolidated Financial Statements (continued) (unaudited) 9. Junior Subordinated Debt On July 28, 1998, the Company privately placed 150,000 8.25% Step Up Convertible Trust Preferred Securities (liquidation amount $1,000 per security) with an aggregate liquidation amount of $150 million (the "Convertible Trust Preferred Securities"). The Convertible Trust Preferred Securities were issued by the Company's consolidated statutory trust subsidiary, CT Convertible Trust I (the "Trust"). The Convertible Trust Preferred Securities represent an undivided beneficial interest in the assets of the Trust which consist solely of the Company's Convertible Debentures (as hereafter defined). This private placement transaction was completed concurrently with the related issuance and sale to the Trust of the Company's 8.25% Step Up Convertible Junior Subordinated Debentures in the aggregate principal amount of $154,650,000 (the "Convertible Debentures"). Distributions on the Convertible Trust Preferred Securities are payable quarterly in arrears on each calendar quarter-end and correspond to the payments of interest made on the Convertible Debentures, the sole assets of the Trust. Distributions are payable only to the extent payments are made in respect to the Convertible Debentures. The Company received $145.2 million in net proceeds, after original issue discount and transaction expenses, pursuant to the above transactions, reflecting an original issue discount of 3% from the liquidation amount of the Convertible Trust Preferred Securities. The proceeds were used to pay down the Company's Credit Facilities. The Convertible Trust Preferred Securities are convertible into class A common shares of beneficial interest, $1.00 par value, of the Company, at the direction of the holders of the Convertible Trust Preferred Securities to the conversion agent to exchange such Convertible Trust Preferred Securities for a portion of the Convertible Debentures held by the Trust on the basis of one security per $1,000 principal amount of Convertible Debentures, and immediately convert such amount of Convertible Debentures into Class A Common Shares at an initial rate of 85.47 Class A Common Shares per $1,000 principal amount of the Convertible Debentures (which is equivalent to a conversion price of $11.70 per Class A Common Share). The Convertible Debentures have a 20-year maturity and are non-callable for five years. Upon repayment of the Convertible Debentures at maturity or upon redemption, the proceeds of such repayment or payment shall be simultaneously paid and applied to redeem, among other things, the Convertible Trust Preferred Securities. If the securities have not been redeemed by September 30, 2004, the distribution rate will step up by 0.75% per annum for each annual period thereafter. The 3% ($4.5 million) discount on the issuance will be amortized over the expected life of the Convertible Trust Preferred Securities. For financial reporting purposes, the Trust is treated as a subsidiary of the Company and, accordingly, the accounts of the Trust are included in the consolidated financial statements of the Company. Intercompany transactions between the Trust and the Company, including the Junior Subordinated Debentures, are eliminated in the consolidated financial statements of the Company. The Convertible Trust Preferred Securities are presented as a separate caption between liabilities and shareholders' equity in the consolidated balance sheet of the Company as "Company-obligated, mandatorily redeemable, convertible preferred securities of CT Convertible Trust I, holding solely 8.25% junior subordinated debentures of Capital Trust ("Convertible Trust Preferred Securities")". Distributions on the Convertible Trust Preferred Securities are recorded, -10- Capital Trust and Subsidiaries Notes to Consolidated Financial Statements (continued) (unaudited) net of the tax benefit, in a separate caption immediately following the provision for income taxes in the Consolidated Statement of Operations of the Company. 10. Income Taxes The Company will elect to file a consolidated federal income tax return for the year ending December 31, 1998. The provision for income taxes for the nine months ended September 30, 1998 is comprised of the following (in thousands): Current Federal $ 4,516 State 1,995 Local 1,801 Deferred Federal - State - Local - -------------- Provision for income taxes $ 8,312 ============== The Company has federal net operating loss carryforwards ("NOLs") as of September 30, 1998 of approximately $16.5 million. Such NOLs expire through 2012. The Company also has a federal capital loss carryover of approximately $1.6 million that can be used to offset future capital gains. Due to an affiliate's purchase of 6,959,593 Class A Common Shares from the Company's former parent in January 1997 and another prior ownership change, a substantial portion of the NOLs are limited for federal income tax purposes to approximately $1.5 million annually. Any unused portion of such annual limitation can be carried forward to future periods. The Company also has approximately $3.5 million of NOL's from losses in 1997 (after the ownership changes described above) that can be utilized against taxable income in 1998. The reconciliation of income tax computed at the U.S. federal statutory tax rate to the effective income tax rate for the nine months ended September 30, 1998 is as follows (in thousands):
Federal income tax at statutory rate $ 6,920 34.0% State and local taxes, net of federal tax benefit 2,505 12.3 Tax benefit of utilization of net operating loss carryforward (1,275) (6.5) Other 162 0.8 ------------------------------ $ 8,312 40.6% ==============================
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for tax reporting purposes. -11- Capital Trust and Subsidiaries Notes to Consolidated Financial Statements (continued) (unaudited) The components of the net deferred tax assets recorded under SFAS No. 109 as of September 30, 1998 are as follows (in thousands): Net operating loss carryforward $ 7,815 Reserves on other assets and for possible credit losses 4,664 Deferred revenue 616 Reserve for uncollectible accounts 208 ----------------- Deferred tax assets $ 13,303 Valuation allowance (13,303) ----------------- $ - ================= The Company recorded a valuation allowance to fully reserve its net deferred assets. Under SFAS No. 109, this valuation allowance will be adjusted in future years, as appropriate. However, the timing and extent of such future adjustments can not presently be determined. 11. Employee Benefit Plans 1997 Long-Term Incentive Share Plan On May 23, 1997, the Board of Trustees adopted the 1997 Long-Term Incentive Plan (the "Incentive Share Plan"), which became effective upon shareholder approval on July 15, 1997 at the 1997 annual meeting of shareholders (the "1997 Annual Meeting"). The Incentive Share Plan permits the grant of nonqualified share option ("NQSO"), incentive share option ("ISO"), restricted share, share appreciation right ("SAR"), performance unit, performance share and share unit awards. The Company has reserved an aggregate of 2,000,000 Class A Common Shares for issuance pursuant to awards under the Incentive Share Plan and the Company Non-Employee Trustee Share Plan. The maximum number of shares that may be subject of awards to any employee during the term of the Incentive Share Plan may not exceed 500,000 shares and the maximum amount payable in cash to any employee with respect to any performance period pursuant to any performance unit or performance share award is $1.0 million. During the three months ended September 30, 1998, the Company issued an aggregate of 105,000 options to acquire Class A Common Shares with an exercise price of between $9.00 and $10.00 per share (which were issued at or above the Class A Common Share price on the date of the grant). -12- Capital Trust and Subsidiaries Notes to Consolidated Financial Statements (continued) (unaudited) The following table summarizes the activity under the Incentive Share Plan for the nine months ended September 30, 1998:
Options Exercise Price Outstanding per Share -------------------------- -------------------------- Outstanding at January 1, 1998 607,000 $6.00 Granted 1,112,250 $9.00 - $11.38 Exercised (1,666) $6.00 Canceled (156,501) $6.00 - $10.00 -------------------------- -------------------------- Outstanding at September 30, 1998 1,561,083 $6.00 - $11.38 ========================== ==========================
-13- ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations The following discussion should be read in conjunction with the consolidated financial statements and notes thereto appearing elsewhere in this Form 10-Q. Historical results set forth are not necessarily indicative of the future financial position and results of operations of the Company. The following discussion reflects the reclassification on July 15, 1997 of the Company's common shares of beneficial interest, $1.00 par value ("Old Common Shares"), as class A common shares of beneficial interest, $1.00 par value (the "Class A Common Shares"). Recent Developments - ------------------- On January 3, 1997, Capital Trust Investors Limited Partnership ("CTILP"), an affiliate of Equity Group Investments, Inc. ("EGI") and Samuel Zell, purchased from the Company's former parent, 6,959,593 Class A Common Shares (representing approximately 76% of the then-outstanding Class A Common Shares) for an aggregate purchase price of $20,222,011. Prior to the purchase, which was approved by the then-incumbent Board of Trustees, EGI and Victor Capital Group, L.P. ("Victor Capital") presented to the Company's then-incumbent Board of Trustees a proposed new business plan in which the Company would cease to be a REIT and instead become a specialty finance company designed primarily to take advantage of high-yielding mezzanine investment and other real estate asset opportunities in commercial real estate. EGI and Victor Capital also proposed that they provide the Company with a new management team to implement the business plan and that they invest through an affiliate a minimum of $30.0 million in a new class of preferred shares to be issued by the Company. The Board of Trustees approved CTILP's purchase of the former parent's Class A Common Shares, the new business plan and the issuance of a minimum of $30.0 million of a new class of preferred shares of the Company at $2.69 per share, such shares to be convertible into Class A Common Shares of the Company on a one-for-one basis. The Company subsequently agreed that, concurrently with the consummation of the proposed preferred equity investment, it would acquire for $5.0 million Victor Capital's real estate investment banking, advisory and asset management businesses, including the services of its experienced management team. At the Company's 1997 annual meeting of shareholders ("1997 Annual Meeting"), the Company's shareholders approved the investment, pursuant to which the Company would issue and sell up to approximately $34.0 million of class A 9.5% cumulative convertible preferred shares of beneficial interest, $1.00 par value ("Class A Preferred Shares"), to Veqtor Finance Company, LLC ("Veqtor"), an affiliate of Samuel Zell and the principals of Victor Capital (the "Investment"). The Company's shareholders also approved the amended and restated declaration of trust, which, among other things, reclassified the Company's Old Common Shares as Class A Common Shares and changed the Company's name to "Capital Trust." Immediately following the 1997 Annual Meeting, the Investment was consummated; 12,267,658 Class A Preferred Shares were sold to Veqtor for an aggregate purchase price of $33,000,000. Concurrently with the foregoing transaction, Veqtor purchased the 6,959,593 Class A Common Shares held by CTILP for an aggregate purchase price of approximately $21.3 million. As a result of these transactions, currently, Veqtor beneficially owns 19,227,251 (or approximately 63%) of the outstanding voting shares of the Company. Veqtor funded the -14- approximately $54.3 million aggregate purchase price for the Class A Common Shares and Class A Preferred Shares with $5.0 million of capital contributions from its members and $50.0 million of borrowings under the 12% convertible redeemable notes (the "Veqtor Notes") issued to institutional investors. In June 1998, the Veqtor Notes were converted into preferred units of Veqtor by agreement between the common members of Veqtor and the institutional investors. Pursuant to an amended and restated limited liability company agreement of Veqtor, the Veqtor notes were converted into preferred units of Veqtor (the "Veqtor Preferred Units") and the institutional investors were admitted as preferred members of Veqtor. Veqtor may in the future redeem the Veqtor Preferred Units for an aggregate of 9,899,710 shares (assuming redemption by Veqtor on the earliest possible date, July 16, 1999). The common members of Veqtor and Veqtor previously, in December 1997, agreed with the Company that Veqtor should redeem the preferred units then authorized by the original limited liability company agreement of Veqtor in effect at such time at the earliest date upon which Veqtor has the right to effectuate such redemption. Veqtor has confirmed to the Company that the foregoing agreement obligates Veqtor to redeem the Veqtor Preferred Units according to the timetable specified therein. In addition, immediately following the 1997 Annual Meeting, the acquisition of the real estate services businesses of Victor Capital was consummated and a new management team was appointed by the Company from among the ranks of Victor Capital's professional team and elsewhere. The Company thereafter immediately commenced full implementation of its current business plan under the direction of its newly elected board of trustees and new management team. After the 1997 Annual Meeting, the Company completed two significant financing and capital raising transactions. As of September 30, 1997, the Company obtained a $150 million line of credit ("Credit Facility") from a commercial lender, which was subsequently increased to $250 million as of January 1, 1998, $300 million as of June 22, 1998 and $355 million as of July 23, 1998. On December 16, 1997, the Company completed a public offering of 9,000,000 Class A Common Shares resulting in net proceeds to the Company of approximately $91.4 million. This significant source of borrowed funds and infusion of cash allowed the Company to commence full scale operations as a specialty finance company pursuant to its current business plan. On July 28, 1998, the Company privately placed 150,000 8.25% Step Up Convertible Trust Preferred Securities (liquidation amount $1,000 per security) with an aggregate liquidation amount of $150 million (the "Convertible Trust Preferred Securities"). The Convertible Trust Preferred Securities were issued by the Company's consolidated statutory trust subsidiary, CT Convertible Trust I (the "Trust"). This private placement transaction was completed concurrently with the related issuance and sale to the Trust of the Company's 8.25% Step Up Convertible Junior Subordinated Debentures in the aggregate principal amount of $154,650,000 (the "Convertible Debentures"). Distributions on the Convertible Trust Preferred Securities are payable quarterly in arrears on each calendar quarter-end and correspond to the payments of interest made on the Convertible Debentures, the sole assets of the Trust. Distributions are payable only to the extent payments are made in respect to the Convertible Debentures. The Company received $145.2 million in net proceeds, after original issue discount and transaction expenses, pursuant to the above transactions, reflecting an original issue discount of 3% from the liquidation amount of the Convertible Trust Preferred Securities. The proceeds -15- were used to pay down the Company's Credit Facilities (as defined below). The Convertible Trust Preferred Securities are convertible at any time by the holders thereof into the Company's listed Class A Common Shares at a conversion price of $11.70. The Convertible Debentures have a 20-year maturity and are non-callable for five years. Upon repayment of the Convertible Debentures at maturity or upon redemption, the proceeds of such repayment or payment shall be simultaneously paid and applied to redeem, among other things, the Convertible Trust Preferred Securities. If the securities have not been redeemed by September 30, 2004, the distribution rate will step up by 0.75% per annum for each annual period thereafter. The 3% ($4.5 million) discount and $0.3 million of transaction costs on the issuance will be amortized over the expected life of the Convertible Trust Preferred Securities. In light of the significant volatility in the global capital markets experienced during the period, the Company has strategically reduced its loan origination pace. Likewise, the Company's advisory business has also been affected as fee producing activity related to real estate acquisitions, dispositions and financings by its clients has slowed in reaction to market conditions. In the short term, the Company believes that its asset growth will be slower and that its advisory fee revenues will be less, as compared to the first three fiscal quarters of 1998, although there can be no assurance as to when market conditions will improve. The Company has significant liquidity and believes it is positioned to take advantage of portfolio growth opportunities that meet its risk/yield profile which it expects will develop as overall market conditions improve. Overview of Financial Condition - ------------------------------- The significant infusion of cash from the public offering of Class A Common Shares in December 1997, the issuance of the Convertible Trust Preferred Securities in July 1998 and borrowings under the Credit Facilities allowed the Company to expand its specialty finance company operations. During the nine months ended September 30, 1998, the Company completed twenty-two new loan, certificated mezzanine investment and investment in commercial mortgage-backed securities transactions totaling approximately $582.7 million and provided $7.5 million of additional fundings on two loans originated in the prior year. The Company funded $551.4 million of the foregoing loans and investments through September 30, 1998 with the foregoing sources of cash, which enabled the Company to grow its total assets from $317.4 million at December 31, 1997 to $742.5 million at September 30, 1998. Since December 31, 1997, the Company has identified, negotiated and committed to fund or acquire twenty-two loan, certificated mezzanine investment and commercial mortgage-backed securities transactions. These include ten Mortgage Loan transactions totaling $220.5 million (of which $20.4 million remains unfunded at September 30, 1998), nine Mezzanine Loan transactions totaling $293.4 million, one certificated mezzanine investment for $32.5 million (of which $10.9 million remains unfunded at September 30, 1998), and two acquisitions of three classes of subordinated interests issued by a financial asset securitization investment trust totaling $36.3 million. The Company also funded $7.5 million of commitments under two loans originated in the prior year. The Company believes that these investments will provide investment yields within the Company's target range of 400 to 600 basis points above LIBOR. The Company maximizes its return on equity by utilizing its existing cash on hand and then employing leverage on its investments (employing a cash optimization model). The Company may make investments with yields that fall outside of the investment range set forth above, but -16- that correspond with the level of risk perceived by the Company to be inherent in such investments. At September 30, 1998, the Company had outstanding loans, certificated mezzanine investments and investments in commercial mortgage-backed securities totaling in excess of $709 million and additional commitments for fundings on outstanding loans and certificated mezzanine investments of approximately $43.1 million. When possible, in connection with the acquisition of investments, the Company obtains seller financing in the form of repurchase agreements. Four of the transactions completed during the nine months ended September 30, 1998 described above were financed in this manner representing total original repurchase financings of $41.8 million. These financings are generally completed at discounted terms as compared to those available under the Credit Facilities. Effective January 1, 1998, pursuant to an amended and restated credit agreement, the Company increased its line of credit under the Credit Facility to $250 million and subsequently increased the facility to $300 million effective June 22, 1998 and $355 million effective July 23, 1998. An additional commitment fee was paid when the Company's borrowings exceeded $250 million and an additional commitment fee will be paid when the Company's borrowings exceed $300 million. The Credit Facility provides for advances to fund lender-approved loans and investments made by the Company. The Credit Facility expires on December 31, 2000. On June 8, 1998, the Company entered into an additional credit agreement with another commercial lender that provides for a $300 million line of credit that expires in December 1999 (the "Second Credit Facility" together with the Credit Facility, the "Credit Facilities"). The Second Credit Facility provides for advances to fund lender-approved loans and investments made by the Company (such loans and investments together with loans and investments approved under the Credit Facility, "Funded Portfolio Assets"). The Company incurred an initial commitment fee upon the signing of the Second Credit Facility and an additional commitment fee will be due when borrowings exceed $250 million. Future repayments and redrawdowns of amounts previously subject to the drawdown fee will not require the Company to pay any additional fees. The Second Credit Facility provides for margin calls on asset-specific borrowings in the event of asset quality and/or market value deterioration as determined under the Second Credit Facility. The Second Credit Facility contains customary representations and warranties, covenants and conditions and events of default. The Second Credit Facility also contains a covenant obligating the Company to avoid undergoing an ownership change that results in Craig M. Hatkoff, John R. Klopp or Samuel Zell no longer retaining their senior offices and trusteeships with the Company and practical control of the Company's business and operations. At September 30, 1998, the Company had $348.8 million of outstanding borrowings under the Credit Facilities. As of September 30, 1998, certain of the Company's loans and other investments have been hedged so that the assets and the corresponding liabilities were matched at floating rates over LIBOR. The Company has entered into interest rate swap agreements for notional amounts totaling approximately $119.9 million with financial institution counterparties whereby the Company swapped fixed rate instruments, which averages approximately 5.96%, for floating rate -17- instruments at the London Interbank Offered Rate ("LIBOR"). The agreements mature at varying times from December 1999 to July 2008. As of January 1, 1997, the Company's real estate portfolio, which included two commercial properties, was carried at a book value of $8,585,000. The portfolio included a shopping center in Sacramento, California and a 60% interest in a mixed-use retail property in Kirkland, Washington. During the first quarter of 1997, these two commercial properties were sold. The proceeds from these sales were invested in mortgage loans and in liquid mortgage-backed securities. Comparison of the Nine and Three Months Ended September 30, 1998 to the - ----------------------------------------------------------------------- Nine and Three Months Ended September 30, 1997 ---------------------------------------------- The Company reported net income allocable to Class A Common Shares of $8,490,000 for the nine months ended September 30, 1998, an increase of $11,622,000 from the net loss allocable to Class A Common Shares of $3,132,000 for the nine months ended September 30, 1997. The Company reported net income allocable to Class A Common Shares of $2,361,000 for the three months ended September 30, 1998, an increase of $4,633,000, from the net loss allocable to Class A Common Shares of $2,272,000 for the three months ended September 30, 1997. These changes were primarily the result of the revenues generated from loans and other investments and significant advisory and investment banking fees. Net income from loans and other investments amounted to $24,514,000 for the nine months ended September 30, 1998, an increase of $23,441,000 over the $1,073,000 for the nine months ended September 30, 1997. This increase was primarily due to the increase in the average interest earning assets from approximately $24.4 million earning 10.2% for the nine months ended September 30, 1997 to approximately $468.8 million earning 12.2% for the nine months ended September 30, 1998. This was partially offset by an increase in the average interest bearing liabilities from approximately $13.9 million at an average rate of 7.6% for the nine months ended September 30, 1997 to approximately $299.8 million at an average rate of 8.2% for the nine months ended September 30, 1998. Net income from loans and other investments amounted to $12,068,000 for the three months ended September 30, 1998, an increase of $11,071,000 over the $997,000 for the three months ended September 30, 1997. This increase was primarily due to the increase in the average interest earning assets from approximately $65.7 million earning 10.8% for the three months ended September 30, 1997 to approximately $659.0 million earning 12.5% for the three months ended September 30, 1998. This was partially offset by an increase in the average interest bearing liabilities from approximately $41.4 million at an average rate of 7.6% for the three months ended September 30, 1997 to approximately $417.8 million at an average rate of 8.3% for the three months ended September 30, 1998. During the nine months ended September 30, 1998, other revenues totaled $10,420,000, an increase of $9,002,000 over the same nine month period in 1997. The increase during the three months ended September 30, 1998 over the same three month period in 1997 was $148,000 to $1,090,000. The increase for the nine months ended September 30, 1998 was primarily due to an additional of $8,950,000 of advisory and investment banking fees generated by Victor Capital -18- and its related subsidiaries over the amount of such fees generated in the prior year, which was partially offset by a $313,000 decrease in rental income as the Company sold its remaining rental properties during the first quarter of 1997. The sales of the rental properties in the first quarter of 1997 resulted in the Company recognizing a loss of $432,000. The Company sold a shopping center in Sacramento, California and recognized a net loss of approximately $34,000. The Company also sold a retail property located in Kirkland, Washington, resulting in a net loss of approximately $398,000, the majority of which was attributable to transfer taxes and the elimination of unamortized tenant improvements and leasing commissions. The increase for the three months ended September 30, 1998 was primarily due to the addition of $300,000 of advisory and investment banking fees generated by Victor Capital and its related subsidiaries offset by a $144,000 decrease in other interest income. Other expenses increased from $4,944,000 for the nine months ended September 30, 1997 to $14,582,000 for nine months ended September 30, 1998 and from $3,532,000 for the three months ended September 30, 1997 to $5,762,000 for the three months ended September 30, 1998. The increase was primarily due to the additional general and administrative expenses necessary for the commencement and continuation of full-scale operations as a specialty finance company, the largest components of such expenses are employee salaries and related costs and the provision for possible credit losses. As of September 30, 1998, the Company had 44 full time employees as compared to 27 at September 30, 1997. The provision for possible credit losses was $2,359,000 for the nine months ended September 30, 1998 and was $1,119,000 for the three months ended September 30, 1998 as the Company provided reserves on its loan and investment portfolio pursuant to its reserve policy. The significant increase from the $155,000 provision for possible credit loss for the quarter and nine months ended September 30, 1997 was due to the increase in average earning assets as previously described. In 1997, the Company did not incur any income tax expense or benefit associated with the loss it incurred due to the uncertainty of realization of net operating loss carryforwards. In the nine and three months ended September 30, 1998, the Company accrued $8,312,000 and 3,053,000, respectively, of income tax expense for federal, state and local income taxes. For federal purposes, the Company utilized three-quarters of the expected net operating loss carryforward to be utilized in 1998 in calculating the accrual for the nine months ended September 30, 1998 and one quarter of the expected net operating loss carryforward to be utilized in 1998 in calculating the accrual for the three months ended September 30, 1998. As previously discussed, the Company issued $150,000,000 of Convertible Trust Preferred Securities on July 28, 1998. The Company recognized $1,199,000 of net expenses related to these securities during the quarter ended September 30, 1998. This amount consisted of distributions to the holders totaling $2,131,000 and amortization of discount and origination costs totaling $137,000. This was partially offset by a tax benefit of $1,069,000. The preferred share dividend and dividend requirement arose in 1997 as a result of the Company's issuance of $33 million of Class A Preferred Shares on July 15, 1997. Dividends accrue on these shares at a rate of 9.5% per annum on a per share price of $2.69 for the 12,267,658 shares outstanding. -19- Liquidity and Capital Resources - ------------------------------- At September 30, 1998, the Company had $16,420,000 in cash. The primary sources of liquidity for the Company for the remainder of 1998, which the Company believes will adequately meet future operating liquidity and capital resource requirements, will be cash on hand, cash generated from operations, interest payments received on its investments, loans and securities and additional borrowings under the Company's Credit Facilities. The primary demands on the Company's capital resources will be the funding required for the origination or acquisition of loans and other investments as the Company continues with its specialty finance operations and the growth of its portfolio of loans and other investments. The Company experienced a net decrease in cash of $32,848,000 for the nine months ended September 30, 1998, compared to the net decrease of $635,000 for the nine months ended September 30, 1997. This use of cash was primarily due to the utilization of the proceeds of the Class A Common Share offering completed in the fourth quarter of 1997 and the utilization of the proceeds of the Convertible Trust Preferred Securities issuance completed in July 1998 in making loans and other investments during the first nine months of 1998 offset by additional borrowings. Cash provided by operating activities during the nine months ended September 30, 1998 increased by $11,631,000 to $9,705,000, from cash used in operating activities of $1,926,000 during the same period of 1997. For the nine months ended September 30, 1998, cash used in investing activities was $452,583,000, an increase of $372,710,000 from $79,873,000 during the same period in 1997 primarily the result of the loans and other investments completed since December 31, 1997. The increase in cash provided by financing activities, which increased $328,866,000 to $410,030,000 from $81,164,000, was due primarily to the proceeds of repurchase obligations and net borrowings under the Credit Facilities. At September 30, 1998, the Company has two outstanding notes payable totaling $4,181,000, outstanding borrowings on the Credit Facilities of $348,780,000 and outstanding repurchase obligations of $80,420,000. At September 30, 1998, the Company had $306,220,000 of borrowing capacity available under its Credit Facilities. General Description of the Year 2000 Issue and the Nature and Effects of the - -------------------------------------------------------------------------------- Year 2000 on Information Technology (IT) and Non-IT Systems - ----------------------------------------------------------- The Year 2000 Issue is the result of computer programs being written using two digits rather than four to define the applicable year. Any of the Company's computer programs or hardware that have date-sensitive software or embedded chips may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in a system failure or miscalculations causing disruptions of operations, including, among other things, a temporary inability to process transactions, send invoices, or engage in similar business activities. Based upon recent assessments, the Company determined that it was required to replace certain of its software and certain hardware so that those systems will properly utilize dates beyond December 31, 1999. The Company believes that with the replacement of the previously existing software and certain hardware, the Year 2000 Issue can be mitigated. However, if certain replacements are not made, or not completed timely, the Year 2000 Issue could have a material impact on the operations of the Company. -20- The Company's plan to resolve the Year 2000 Issue involves the following four phases: assessment, remediation, testing and implementation. To date, the Company has completed its assessment of all its in-house systems that could be significantly affected by the Year 2000. The completed assessment indicated that all of the Company's accounting software could be affected, particularly the general ledger and accounts payable systems. That assessment also included the software included in modeling and evaluating opportunities for new business and the equipment supporting such applications. In addition, the Company will gather information about the Year 2000 compliance status of its significant service providers to monitor their compliance. Status of Progress in Becoming Year 2000 Compliant, Including Timetable for - -------------------------------------------------------------------------------- Completion of Each Remaining Phase - ---------------------------------- For its information technology exposures, to date the Company believes it is 100% complete on the remediation phase of its in-house IT systems (both software and hardware). Implementation had been completed and the Company plans to begin testing of all the software and hardware systems in November 1998. Completion of the testing phase is expected to be completed by March 31, 1999, with 100% completion targeted for September 30, 1999. Nature and Level of Importance of Third Parties and their Exposure to the Year - -------------------------------------------------------------------------------- 2000 - ---- The Company's loan servicing function is performed by an independent third party. This service includes the calculation of interest and principal for the Company's loans receivable, the processing of bills to the Company's customers and the maintenance of lock boxes and escrow accounts on behalf of borrowers. The vendor has advised the Company that they will be Year 2000 compliant by the end of 1999. The Company will query its significant service providers that do not share information systems with the Company (external agents). To date, the Company is not aware of any external agent with a Year 2000 issue that would materially impact the Company's results of operations, liquidity, or capital resources. However, the Company has no means of ensuring that any external agents used by the Company will be Year 2000 ready. The inability of external agents to complete their Year 2000 resolution process in a timely manner could materially impact the Company. The effect of non-compliance by external agents is not determinable. Costs of Year 2000 Compliance The Company will utilize both internal and external resources to replace, test, and implement the software and operating equipment for Year 2000 modifications. The total cost of the Year 2000 project is $250,000 and is being funded through operating cash flows. To date, the Company has incurred approximately $175,000 ($5,000 expensed and $170,000 capitalized for new systems and equipment), related to all phases of the Year 2000 project. Of the remaining project costs, approximately $75,000 is attributable to the testing of equipment and software. -21- Risks of Year 2000 - ------------------ The Company believes that it has an effective program in place to resolve the Year 2000 issue in a timely manner. As noted above, the Company has not yet completed all the necessary phases of the Year 2000 program. In the event that the Company does not complete any additional phases, the Company is not certain that the systems would operate correctly, as the systems have not been adequately tested. In addition, disruptions in the economy generally resulting from Year 2000 issues could materially adversely affect the Company. The amount of potential liability and lost revenue cannot be reasonably estimated at this time. The Company currently has no contingency plans in the event it does not complete all phases of the Year 2000 program. The Company plans to evaluate the status of completion in March 1999 and determine whether such a plan is necessary. Explanatory Note for the Use of Forward-Looking Statements - ---------------------------------------------------------- Certain statements in this quarterly report may constitute "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. These statements, which are not statements of historical fact, may contain estimates, assumptions, projections and/or expectations regarding the Company's financial position, results of operations, market position, growth opportunities and growth rates and other similar statements of expectation. Words such as "expects," "anticipates," "intends," "plans," "believes," "seeks," "will," "may," "estimates," and "should," and variations of these words and similar expressions, are intended to identify these forward-looking statements. Such forward-looking statements are not guarantees of future performance. They involve known and unknown risks, uncertainties, and other factors which may cause the actual results, performance or achievements of the Company to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Representative examples of such factors are discussed in more detail in the Company's Annual Report on Form 10-K, as amended, and include, among other things, the availability of desirable loan and investment opportunities, the ability to obtain and maintain targeted levels of leverage and borrowing costs, changes in interest rates, continued loan performance and repayment and the maintenance of loan loss allowance levels. The Company disclaims any intention or obligation to update publicly or revise any forward-looking statements, whether as a result of new information, future events or otherwise. -22- SIGNATURES Pursuant to the requirement 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. CAPITAL TRUST December 11, 1998 /s/ John R. Klopp - ----------------- ------------------ Date John R. Klopp Chief Executive Officer /s/ Edward L. Shugrue III ------------------------- Edward L. Shugrue III Managing Director and Chief Financial Officer -23- EX-27 2 EXHIBIT
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL EXTRACTED FROM THE FINANCIAL STATEMENTS OF CAPITAL TRUST FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 9-MOS DEC-31-1998 JAN-01-1998 SEP-30-1998 16,420 39,471 673,398 2,821 0 15,511 795 248 742,526 7,781 439,435 157,602 0 18,214 119,494 742,526 0 53,245 0 31,733 0 2,359 0 19,153 8,312 10,841 0 0 0 10,841 0.47 0.35
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