10-Q 1 c27132_10q.txt FORM 10-Q FORM 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended DECEMBER 31, 2002 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: 1-8122 GRUBB & ELLIS COMPANY -------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) DELAWARE 94-1424307 ----------------------------------- ---------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 2215 Sanders Road, Suite 400, Northbrook, IL 60062 ---------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) (847) 753-7500 ---------------------------------------------------------------------- (Registrant's telephone number, including area code) No Change ---------------------------------------------------------------------- (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes No X --- --- 15,174,226 -------------------------------------------- (Number of shares outstanding of the registrant's common stock at February 1, 2003) PART I FINANCIAL INFORMATION 2 ITEM 1. FINANCIAL STATEMENTS GRUBB & ELLIS COMPANY CONDENSED CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE DATA) (UNAUDITED) ASSETS
December 31, June 30, 2002 2002 -------------- ------------ Current assets: Cash and cash equivalents $ 17,534 $ 14,085 Services fees receivable, net 16,409 13,212 Other receivables 2,739 3,396 Professional service contracts, net 1,919 1,974 Prepaid income taxes 5,880 6,890 Prepaid and other current assets 1,826 586 Deferred tax assets, net 1,585 1,563 -------------- ------------ Total current assets 47,892 41,706 Noncurrent assets: Equipment, software and leasehold improvements, net 16,533 17,843 Goodwill, net 26,958 26,958 Deferred tax assets, net 468 947 Other assets 4,109 2,923 -------------- ------------ Total assets $ 95,960 $ 90,377 ============== ============ LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 5,045 $ 5,569 Commissions payable 8,047 5,347 Credit facility debt 8,700 5,750 Accrued compensation and employee benefits 13,819 16,243 Deferred commissions payable 7,577 403 Other accrued expenses 6,353 4,143 -------------- ------------ Total current liabilities 49,541 37,455 Long-term liabilities: Credit facility debt 20,300 26,000 Note payable - affiliate, net -- 10,660 Accrued claims and settlements 7,454 7,823 Other liabilities 2,209 2,573 -------------- ------------ Total liabilities 79,504 84,511 -------------- ------------ Stockholders' equity: Preferred stock: 1,000,000 shares authorized; 11,725 Series A shares issued and outstanding at $1,000 stated value at December 31, 2002 11,725 -- Common stock, $.01 par value: 50,000,000 shares authorized; 15,116,825 shares issued and outstanding at December 31, 2002 and 15,028,839 shares at June 30, 2002 151 150 Additional paid-in-capital 71,477 72,084 Accumulated other comprehensive loss (288) (283) Retained deficit (66,609) (66,085) -------------- ------------ Total stockholders' equity 16,456 5,866 -------------- ------------ Total liabilities and stockholders' equity $ 95,960 $ 90,377 ============== ============
See notes to condensed consolidated financial statements. 3 GRUBB & ELLIS COMPANY CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT SHARE DATA) (UNAUDITED)
For the three months For the six months ended December 31, ended December 31, ------------------------------ ------------------------------- 2002 2001 2002 2001 ------------ -------------- ------------- ------------- Revenue: Transaction services fees $ 75,148 $ 88,366 $ 139,799 $ 151,976 Management services fees 12,955 12,992 25,154 26,170 ------------ -------------- ------------- ------------- Total revenue 88,103 101,358 164,953 178,146 ------------ -------------- ------------- ------------- Costs and expenses: Services commissions 45,235 53,385 83,347 90,178 Salaries, wages and benefits 18,200 26,049 41,073 51,202 Selling, general and administrative 18,420 17,604 34,100 33,019 Depreciation and amortization 2,060 2,790 4,107 5,590 Impairment and other non-recurring items 884 (1,700) 1,784 (1,700) ------------ -------------- ------------- ------------- Total costs and expenses 84,799 98,128 164,411 178,289 ------------ -------------- ------------- ------------- Total operating income (loss) 3,304 3,230 542 (143) Other income and expenses: Interest income 78 101 171 199 Interest expense (624) (615) (1,558) (1,247) ------------ -------------- ------------- ------------- Income (loss) before income taxes 2,758 2,716 (845) (1,191) Benefit (provision) for income taxes (1,048) (1,422) 321 219 ------------ -------------- ------------- ------------- Net income (loss) 1,294 (524) (972) 1,710 Preferred stock dividends accrued (356) -- (398) -- ------------ -------------- ------------- ------------- Net income (loss) to common stockholders $ 1,354 $ 1,294 $ (922) $ (972) ============ ============== ============= ============= Net income (loss) per weighted average common share outstanding: Basic - $ 0.09 $ 0.10 $ (0.06) $ (0.07) ============ ============== ============= ============= Diluted - $ 0.09 $ 0.09 $ (0.06) $ (0.07) ============ ============== ============= ============= Weighted average common shares outstanding: Basic - 15,109,706 13,545,489 15,090,777 13,496,298 ============ ============== ============= ============= Diluted - 15,109,706 13,679,015 15,090,777 13,496,298 ============ ============== ============= =============
See notes to condensed consolidated financial statements. 4 GRUBB & ELLIS COMPANY CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS) (UNAUDITED)
For the six months ended December 31, -------------------------------- 2002 2001 -------------- -------------- Cash Flows from Operating Activities: Net loss $ (524) $ (972) Deferral of payment of services commissions expense 7,174 14,174 Depreciation and amortization expense 4,107 5,590 Accrued compensation and employee benefits (2,279) 7,401 Other adjustments to reconcile net loss to net cash provided by operating activities (50) (852) -------------- -------------- Net cash provided by operating activities 8,428 25,341 -------------- -------------- Cash Flows from Investing Activities: Purchases of equipment, software and leasehold improvements (2,242) (2,551) -------------- -------------- Net cash used in investing activities (2,242) (2,551) -------------- -------------- Cash Flows from Financing Activities: Repayment of credit facility debt (2,750) (5,000) Other financing sources 13 583 -------------- -------------- Net cash used in financing activities (2,737) (4,417) -------------- -------------- Net increase in cash and cash equivalents 3,449 18,373 Cash and cash equivalents at beginning of period 14,085 7,248 -------------- -------------- Cash and cash equivalents at end of period $ 17,534 $ 25,621 ============== ==============
See notes to condensed consolidated financial statements. 5 GRUBB & ELLIS COMPANY NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 1. INTERIM PERIOD REPORTING The accompanying unaudited condensed consolidated financial statements include the accounts of Grubb & Ellis Company and its wholly owned subsidiaries (collectively, the "Company") and are prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements and, therefore, should be read in conjunction with the Company's Annual Report on Form 10-K for the year ended June 30, 2002. The financial statements have been prepared in conformity with accounting principles generally accepted in the United States that require management to make estimates and assumptions that affect the reported amounts of assets and liabilities (including 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. In the opinion of management, all adjustments necessary for a fair statement of the financial position and results of operations for the interim periods presented have been included in these financial statements and are of a normal and recurring nature. Certain amounts in prior periods have been reclassified to conform to the current presentation. Such reclassifications have not changed previously reported results of operations or cash flows. Operating results for the six months ended December 31, 2002 are not necessarily indicative of the results that may be achieved in future periods. 2. TOTAL COMPREHENSIVE LOSS The Company is a party to two interest rate swap agreements that effectively fix the interest rate on a portion of the Company's outstanding term loan obligations. The Company has determined that these agreements are to be characterized as effective under the definitions included within Statement of Financial Accounting Standards No. 133 "Accounting for Derivative Instruments and Hedging Activities." The change in value of these instruments during a reporting period is characterized as Other Comprehensive Income or Loss, and totaled approximately $5,000 and $220,000 of unrealized losses during the six months ended December 31, 2002 and 2001, respectively. These losses, along with the Company's net losses of $922,000 and $972,000 for the six months ended December 31, 2002 and 2001, results in a Total Comprehensive Loss of $927,000 and $1,192,000 for the periods, respectively. 3. INCOME TAXES The benefit (provision) for income taxes for the six months ended December 31, 2002 and 2001 is as follows (in thousands): For the six months ended December 31, -------------------------------- 2002 2001 -------------- ------------- Current $778 $ 350 Deferred (457) (131) ------------- ------------ $321 $ 219 ============= ============ 6 GRUBB & ELLIS COMPANY NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 3. INCOME TAXES (CONTINUED) The Company recorded prepaid taxes totaling approximately $5,880,000 and $6,890,000 as of December 31, 2002 and June 30, 2002, respectively. Included in these assets are tax refund receivables resulting from filed federal and state returns for the tax year ended December 31, 2001 totaling approximately $885,000 and $2,584,000 at December 31, 2002 and June 30, 2002, respectively. Also included are tax effected operating loss carrybacks totaling approximately $4,995,000 and $4,306,000 at December 31, 2002 and June 30, 2002, respectively, which the Company will realize or has realized primarily against the federal tax liability payments made in prior tax years. 4. EARNINGS PER COMMON SHARE The following table sets forth the computation of basic and diluted earnings per common share from continuing operations (in thousands, except per share data):
For the three months ended For the six months ended December 31, December 31, ----------------------------- --------------------------- 2002 2001 2002 2001 ------------ ------------ ----------- ---------- NET INCOME (LOSS) TO COMMON STOCKHOLDERS $ 1,354 $ 1,294 $ (922) $ (972) ============ ============ =========== ========== BASIC EARNINGS PER COMMON SHARE: Weighted average common shares outstanding $ 15,110 13,545 15,091 13,496 ============ ============ =========== ========== Net income (loss) per common share - basic $ 0.09 $ 0.10 $ (0.06) $ (0.07) ============ ============ =========== ========== DILUTED EARNINGS PER COMMON SHARE: Weighted average common shares outstanding 15,110 13,545 15,091 13,496 Effect of dilutive securities: Stock options and warrants -- 134 -- -- ------------ ------------ ----------- ---------- Weighted average dilutive common shares outstanding 15,110 13,679 15,091 13,496 ============ ============ =========== ========== Net income (loss) per common share - diluted $ 0.09 $ 0.09 $ (0.06) $ (0.07) ============ ============ =========== ==========
Additionally, options outstanding to purchase shares of common stock, the effect of which would be anti-dilutive, were approximately 2,450,000 and 2,544,000 at December 31, 2002 and 2001, respectively, and were not included in the computation of diluted earnings per share either because the option exercise price was greater than the average market price of the common shares for the six months or an operating loss was reported for the six months ending December 31, 2002 and 2001. 5. ISSUANCE OF PREFERRED STOCK On September 19, 2002, Kojaian Ventures, L.L.C. ("KV"), a related party, exercised its right to convert a subordinated promissory note it held into preferred stock of the Company. As a result of this conversion, 11,725 shares of the Company's Series A Preferred Stock were issued, with a stated value of $1,000 per share. The outstanding related party principal and interest obligations totaling $11,725,000 were reclassified to stockholders' equity on the date of conversion. Issuance costs of $783,000, previously offset against the note obligations, were also reclassified as a reduction of additional paid in capital. The preferred stock carries a dividend coupon of 12%, compounded quarterly on a cumulative basis. Accrued dividends at December 31, 2002 totaled approximately $398,000. 7 GRUBB & ELLIS COMPANY NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 5. ISSUANCE OF PREFERRED STOCK (CONTINUED) The preferred stock contains liquidation preference and voting rights equal to 990 common shares for each share of preferred stock, or a total of 11,607,750 common share equivalents, subject to adjustment. As a consequence of the conversion, there has been a change in the voting control of the Company, as these equivalents, along with 3,762,884 shares of outstanding common stock owned by KV and its affiliates (approximately 25% of the outstanding common stock of the Company), represent approximately 57% of the total voting power of the Company. The preferred stock is not convertible into any other securities of the Company or subject to redemption. Warburg Pincus Investors, L.P., which currently owns approximately 39% of the outstanding common stock of the Company, has approximately 22% of the total voting power. 6. SECURITIES EXCHANGE LISTING The Company's common stock was listed on the New York Stock Exchange ("NYSE") pursuant to a listing agreement. As previously disclosed by the Company, the NYSE had accepted the Company's proposed business plan to attain compliance with the NYSE's listing standards on or before July 4, 2003. This plan had been submitted in response to a notification received by the Company on January 4, 2002 regarding non-compliance with such listing standards. As a result of the business plan's acceptance, the Company's common stock continued to be traded on the exchange, subject to the Company maintaining compliance with the plan and periodic review by the NYSE. Upon completion of a recent review, the NYSE announced on October 8, 2002 that the Company's common stock was being de-listed from the NYSE, due primarily to the Company's book value and market capitalization value being below minimum levels required by their listing standards. The Company's common stock commenced trading on the over-the-counter market ("OTC") effective October 17, 2002, under the symbol GBEL.OB, and ceased trading on the NYSE prior to the opening that day. 7. CHANGE IN ACCOUNTING PRINCIPLE In June 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets," effective for fiscal years beginning after December 15, 2001. Under the new rules, goodwill is no longer amortized but is subject to annual impairment tests in accordance with the Statement. Other intangible assets will continue to be amortized over their useful lives. The Company applied the new rules on accounting for goodwill and other intangible assets beginning in the quarter ended September 30, 2002 and completed the transitional impairment tests of goodwill as of July 1, 2002. The Company has determined that no goodwill impairment will impact the earnings and financial position of the Company as of that date. Application of the non-amortization provisions of the Statement resulted in an increase in net operating income of approximately $391,000 and $783,000 for the three and six month periods ended December 31, 2002 as compared to the same periods in 2001, or $0.03 and $0.05 per share, respectively, and is expected to result in an increase in net operating income of approximately $1.6 million for the fiscal year. 8. SEGMENT INFORMATION The Company has two reportable segments - Transaction Services and Management Services, and evaluates segment performance and allocates resources based on earnings before interest, taxes, depreciation and amortization, and other non-recurring expenses ("EBITDA") that include an allocation (primarily based on segment revenue) of certain corporate level administrative expenses (amounts in thousands). 8 GRUBB & ELLIS COMPANY NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 8. SEGMENT INFORMATION (CONTINUED)
Transaction Management Segment Services Services Totals ----------- ----------- --------- Six months ended December 31, 2002 Total revenue $139,799 $ 25,154 $164,953 EBITDA 7,169 (736) 6,433 Total assets as of December 31, 2002 67,383 20,486 87,869 Six months ended December 31, 2001 Total revenue $151,976 $ 26,170 $178,146 EBITDA 5,320 (1,573) 3,747 Total assets as of December 31, 2001 81,294 20,467 101,761
RECONCILIATION OF SEGMENT EBITDA TO INCOME (LOSS) BEFORE INCOME TAXES SIX MONTHS ENDED DECEMBER 31, ----------------------------- 2002 2001 ----------- ---------- Total segment EBITDA $ 6,433 $ 3,747 Less: Depreciation & amortization (4,107) (5,590) Non-recurring items (1,784) 1,700 Net interest expense (1,387) (1,048) ----------- ---------- Loss before income taxes $ (845) $ (1,191) =========== ========== RECONCILIATION OF SEGMENT ASSETS TO BALANCE SHEET (IN THOUSANDS): AS OF DECEMBER 31, -------------------------------- 2002 2001 ------------- --------------- Total segment assets $ 87,869 $ 101,761 Current tax assets 6,038 5,349 Deferred tax assets 2,053 4,700 ------------- --------------- Total assets $ 95,960 $ 111,810 ============= =============== In evaluating segment performance, the Company's management utilizes EBITDA as a measure of the segment's ability to generate cash flow from its operations. Other items contained within the measurement of net income, such as interest and taxes, and non-recurring items, are generated and managed at the corporate administration level rather than the segment level. In addition, net income measures also include non-cash amounts such as depreciation and amortization expense. 9 GRUBB & ELLIS COMPANY NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 8. SEGMENT INFORMATION (CONTINUED) Management believes that EBITDA as presented with respect to the Company's reportable segments is an important measure of cash generated by the Company's operating activities. EBITDA is similar to net cash flow from operations because it excludes certain non-cash items, however, it also excludes interest and income taxes. Management believes that EBITDA is relevant because it assists investors in evaluating the Company's ability to service its debt by providing a commonly used measure of cash available to pay interest. EBITDA should not be considered as an alternative to net income (loss) or cash flows from operating activities (which are determined in accordance with GAAP), as an indicator of operating performance or a measure of liquidity. EBITDA also facilitates comparison of the Company's results of operations with those companies having different capital structures. Other companies may define EBITDA differently, and, as a result, such measures may not be comparable to the Company's EBITDA. 9. COMMITMENTS AND CONTINGENCIES CREDIT AGREEMENT COVENANTS: The Company is subject to certain financial covenants pursuant to the terms of its credit agreement, including minimum EBITDA (as defined in the credit agreement) levels it must achieve. On December 20, 2002, the Company received a waiver through March 31, 2003 with respect to any default regarding the minimum EBITDA levels for the quarter ended December 31, 2002 which levels were not achieved. The waiver also provided for an increase in interest rates of 50 basis points on borrowings until such time as the outstanding principal due falls below $24.0 million, and accelerated certain principal repayments of $1.7 million. Prior to the expiration of the EBITDA waiver at March 31, 2003 the Company will seek to reach an amendment agreement with its lenders establishing new EBITDA thresholds to avoid future defaults under the credit agreement. The Company remains current on its debt service payments under the credit agreement, and has initiated discussions with the lenders to achieve appropriate amended terms. The Company also has continued to provide additional historical and forecasted financial information to the lenders to support efforts to accomplish these amended terms. There can be no assurance that the Company will conclude an amendment with its lending group by March 31, 2003. ENVIRONMENTAL: A corporate subsidiary of the Company owns a 33% interest in a general partnership, which in turn owns property in the State of Texas which is the subject of an environmental assessment and remediation effort, due to the discovery of certain chemicals related to a release of dry cleaning solvent in the soil and groundwater of the partnership's property and adjacent properties. Prior assessments had determined that minimal costs would be incurred to remediate the release. However, subsequent findings at and around the partnership's property have increased the probability that additional remediation costs will be necessary. The partnership is working with the Texas Natural Resource Conservation Commission and the local municipality to implement a multi-faceted plan, which includes both remediation and ongoing monitoring of the affected properties. Although the partnership's other partners have made all past contributions and are expected to make all future required contributions, there can be no assurances to this effect. The Company's share of anticipated costs to remediate and monitor this situation is estimated at approximately $818,000, based upon a comprehensive project plan prepared by an independent third party environmental remediation firm. As of December 31, 2002, approximately $351,000 of this amount has been paid and the remaining 10 GRUBB & ELLIS COMPANY NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 9. COMMITMENTS AND CONTINGENCIES (CONTINUED) $467,000 has been reflected as a loss reserve for such matters in the consolidated balance sheet. The Company's management believes that the outcome of these events will not have a material adverse effect on the Company's consolidated financial position or results of operations. INSOLVENT INSURANCE PROVIDER: In fiscal years 1999 and 2000, the Company's primary errors and omissions insurance carrier was Reliance Insurance Company (of Illinois and California, collectively "Reliance"). The Company has six open claims that were covered by Reliance policies upon the exhaustion of a self-insured retention. In October 2001, Reliance was placed in liquidation by order of the Commonwealth of Pennsylvania, and as a result casts doubt on the recovery of the Company's open claims. The Company has established loss reserves for the estimated settlement costs of the claims. The Company is seeking reimbursement for the costs of defense, settlement and/or judgment on these claims both from appropriate state insurance guaranty associations and from the liquidator. The Company is unable to estimate the probability and timing of any potential reimbursement at this time, and therefore, has not assumed any potential recoveries in establishing its reserves. EXECUTIVE CHANGE OF CONTROL PLAN: In December 2002, the Company was named as a defendant in a complaint filed by an executive officer of the Company in the Eastern Division of the U.S. District Court for the Northern District of Illinois, pursuant to which such executive officer is seeking a determination whether a "change of control" has occurred at the Company, as that term is defined in the Company's Executive Change of Control Plan. The Company believes the litigation is without merit and intends to vigorously defend the litigation. Accordingly, the Company's financial statements for the period ended December 31, 2002 do not reflect any adjustments for this contingency. GENERAL: The Company is involved in various claims and lawsuits arising out of the conduct of its business, as well as in connection with its participation in various joint ventures and partnerships, many of which may not be covered by the Company's insurance policies. In the opinion of management, the eventual outcome of such claims and lawsuits is not expected to have a material adverse effect on the Company's financial position or results of operations. 10. NON-RECURRING ITEMS A non-recurring expense consisting of severance and other costs totaling $900,000 was incurred during the quarter ended September 30, 2002 in connection with the termination of employment of the Company's former Chief Operating Officer. During the quarter ended December 31, 2002, additional non-recurring expenses totaling $884,000 were incurred, consisting of severance of $150,000 and other costs totaling $734,000 related to office closure costs. During the quarter ended December 31, 2001 the Company concluded long standing litigation proceedings on the JOHN W. MATTHEWS, ET AL. V KIDDER, PEABODY & CO., ET AL. AND HSM INC., ET AL. ("Matthews") case for which it had previously recorded loss reserves. In addition, during this period, loss reserves were recorded as a result of the liquidation proceedings surrounding one of the Company's insurance carriers ("Reliance" 11 GRUBB & ELLIS COMPANY NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 10. NON-RECURRING ITEMS (CONTINUED) liquidation). (See Note 9 for additional information.) The positive outcome of the Matthews case, partially offset by the additional exposure on the Reliance liquidation, resulted in $2.2 million of net income from claim related reserves. The Company also incurred other non-recurring expense in the quarter ending December 31, 2001 totaling $500,000 related to a write-down of the carrying basis of an investment in a commercial real estate services internet venture. The Company's decision to write-down its interest in the venture was due to a dilution in the Company's ownership position, as well as uncertainty in the venture's ability to achieve its business plan. As a result of these events, the Company recognized net non-recurring income of $1.7 million for the quarter and six months ended December 31, 2001. 11. CHANGE IN ACCOUNTING ESTIMATE During the quarter ended December 31, 2002, the Company reduced its estimate of incentive bonus payments expected to be made to eligible employees based upon calendar year 2002 operating results. This change in estimate was a result of the continuing economic downturn being encountered in the real estate services industry which directly impacted the Company's operations for the year. The Company recorded this revision as a reduction to salaries, wages and benefits expense totaling approximately $3.9 million in its statement of operations for the quarter ended December 31, 2002. 12 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS NOTE REGARDING FORWARD-LOOKING STATEMENTS This Report contains statements that are not historical facts and constitute projections, forecasts or forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The statements are not guarantees of performance. They involve known and unknown risks, uncertainties and other factors that may cause the actual results, performance or achievements of the Company in future periods to be materially different from any future results, performance or achievements expressed or suggested by these statements. You can identify such statements by the fact that they do not relate strictly to historical or current facts. These statements use words such as "believe," "expect," "should," "strive," "plan," "intend," "estimate" and "anticipate" or similar expressions. When we discuss strategy or plans, we are making projections, forecasts or forward-looking statements. Actual results and stockholder's value will be affected by a variety of risks and factors, including, without limitation, international, national and local economic conditions and real estate risks and financing risks and acts of terror or war. Many of the risks and factors that will determine these results and values are beyond the Company's ability to control or predict. These statements are necessarily based upon various assumptions involving judgment with respect to the future. All such forward-looking statements speak only as of the date of this Report. The Company expressly disclaims any obligation or undertaking to release publicly any updates of revisions to any forward-looking statements contained herein to reflect any change in the Company's expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based. Factors that could adversely affect the Company's ability to obtain these results and value include, among other things: (i) the volume of transactions and prices for real estate in the real estate markets generally, (ii) a general or regional economic downturn that could create a recession in the real estate markets, (iii) the Company's debt level and its ability to make interest and principal payments, (iv) an increase in expenses related to new initiatives, investments in people, technology, and service improvements, (v) the Company's ability to implement, and the success of, new initiatives and investments, including expansion into new specialty areas and integration of the Company's business units, (vi) the ability of the Company to consummate acquisitions and integrate acquired companies and assets, and (vii) other factors described in the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 2002, filed on October 15, 2002. RESULTS OF OPERATIONS REVENUE The Company's revenue is derived principally from transaction services fees related to commercial real estate, which include commissions from leasing, acquisition and disposition, and agency leasing assignments as well as fees from appraisal and consulting services. Management services fees comprise the remainder of the Company's revenues, and include fees related to both property and facilities management outsourcing and business services. Revenue in any given quarter during the three fiscal year period ended June 30, 2002, as a percentage of total annual revenue, ranged from a high of 34.4% to a low of 18.6%, with revenue earned in the second quarters of each of the last three fiscal years ranging from 28.4% to 34.4%. The Company has typically experienced its lowest quarterly revenue in the quarter ending March 31 of each year with higher and more consistent revenue in the quarters ending June 30 and September 30, and its highest quarterly revenue in the quarter ending December 31, due to increased activity caused by the desire of clients to complete transactions by calendar year-end. Total revenue of $165.0 million was recognized for the six months ended December 31, 2002 as compared to revenue of $178.1 million for the same period last year. Transaction services fees decreased by $12.2 13 million in the current fiscal period over the same period in 2001 due to the weakening general economy and its impact on the real estate industry through negative absorption and higher vacancy rates, while management services fees decreased by $1.0 million or 3.9% during that same period. Total revenue for the quarter ended December 31, 2002 was $88.1 million, a decrease of 13.1% over revenue of $101.4 for the same period last year. Transaction services fees decreased $13.2 million or 15.0% over the prior year period, while management services fees decreased by $37,000 or 0.3%. COSTS AND EXPENSES Services commissions expense is the Company's largest expense and is a direct function of gross transaction services revenue levels, which include transaction services commissions and other fees. Professionals receive services commissions at rates that increase upon achievement of certain levels of production. As a percentage of gross transaction revenue, related commission expense increased slightly to 59.6% for the six months ended December 31, 2002 as compared to 59.3% for the same period in 2001 and decreased slightly to 60.2% from 60.4% for the respective quarters ended December 31 in the same periods. Salaries, wages and benefits decreased by $10.1 million or 19.8% during the six months ended December 31, 2002 as compared to December 31, 2001. Please see Note 11 of Notes to Condensed Consolidated Financial Statements for additional information. Selling, general and administrative expenses were relatively flat, increasing by $1.1 million, or 3.3%, for the same period. The net decrease in operating costs of $9.0 million resulted primarily from the Company tightening its expenditures through a reduction in workforce in March 2002, along with the reduction of bonus payments and the elimination of the company match to the 401(k) Plan for qualified employees for calendar year 2002. Depreciation and amortization expense for the six months ended December 31, 2002 decreased to $4.1 million from $5.6 million in the comparable period last year. The Company holds multi-year service contracts with certain key professionals, the costs of which are amortized over the lives of the respective contracts, which are generally two to three years. Amortization expense relating to these contracts of $761,000 was recognized in the six months ended December 31, 2002 compared to $1.3 million for the same period in the prior year. In June 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets," effective for fiscal years beginning after December 15, 2001. Under the new rules, goodwill is no longer amortized but is subject to annual impairment tests in accordance with the Statement. Other intangible assets will continue to be amortized over their useful lives. The Company applied the new rules on accounting for goodwill and other intangible assets beginning in the quarter ended September 30, 2002 and completed the transitional impairment tests of goodwill as of July 1, 2002. The Company has determined that no goodwill impairment will impact the earnings and financial position of the Company as of that date. Application of the non-amortization provisions of the Statement resulted in a decrease in depreciation and amortization expense and a corresponding increase in net operating income of approximately $391,000 and $783,000 for the three and six month periods ended December 31, 2002 as compared to the same periods in 2001, or $0.03 and $0.05 per share, respectively. It is expected to result in an increase in net operating income of approximately $1.6 million for the fiscal year. A non-recurring expense consisting of severance and other costs totaling $900,000 was incurred during the quarter ended September 30, 2002 in connection with the termination of employment of the Company's former chief operating officer. During the quarter ended December 31, 2002, additional non- recurring expenses totaling $884,000 were incurred, consisting of severance of $150,000 and other costs totaling $734,000 related to office closure costs. 14 During the quarter ended December 31, 2001, the Company concluded long standing litigation proceedings on the JOHN W. MATTHEWS, ET AL. V KIDDER, PEABODY & CO., ET AL. AND HSM INC., ET AL. ("Matthews") case for which it had previously recorded loss reserves. In addition, during this period, loss reserves were recorded as a result of the liquidation proceedings surrounding one of the Company's insurance carriers ("Reliance" liquidation). (See Note 9 of Notes to Condensed Consolidated Financial Statements in Item 1 of this Report for additional information.) The positive outcome of the Matthews case, partially offset by the additional exposure on the Reliance liquidation, resulted in $2.2 million of net income from claim related reserves. The Company also incurred other non-recurring expense in the quarter ended December 31 2001 totaling $500,000 related to a write-down of the carrying basis of an investment in a commercial real estate services internet venture. The Company's decision to write-down its interest in the venture was due to a dilution in the Company's ownership position, as well as uncertainty in the venture's ability to achieve its business plan. As a result of these events, the Company recognized net non-recurring income of $1.7 million for the quarter and six months ended December 31, 2001. Interest income decreased during the three and six month periods ended December 31, 2002 as compared to the same periods in the prior year as a result of lower available invested cash. Interest expense incurred during the six months ended December 31, 2002 and 2001 was due primarily to the Company's term loan borrowings under the credit facility. Interest expense was also incurred during the six months ended December 31, 2002 due to the note payable-affiliate funded in March 2002 and subsequently converted to preferred stock in September 2002. See Note 5 of Notes to Condensed Consolidated Financial Statements. NET INCOME (LOSS) The net loss for the six months ended December 31, 2002 was $922,000, or $0.06 per common share on a diluted basis, as compared to $972,000, or $0.07 per common share, for the same period in the prior fiscal year. For the quarter ended December 31, 2002, net income was $1,354,000, or $0.09 per common share on a diluted basis, as compared to net income of $1,294,000, or $0.09 per common share for the same period in fiscal year 2002. The number of common shares outstanding at December 31, 2002 represented an increase over the previous year's number of outstanding common shares primarily due to the exercise of warrants in January 2002 to purchase 1,337,358 shares. LIQUIDITY AND CAPITAL RESOURCES For the six months ended December 31, 2002, the Company generated cash flow from operations of $8.4 million, used $2.2 million in investing activities for purchases of equipment, software and leasehold improvements, and used $2.7 million in financing activities primarily for the repayment of credit facility borrowings. The Company has historically experienced the highest use of operating cash in the quarter ended March 31, primarily related to the payment of incentive and deferred commission payable balances which attain peak levels during the quarter ended December 31. Deferred commission balances of approximately $7.6 million, related to revenues earned in calendar year 2002, were paid in January 2003, and incentive bonuses of approximately $2.0 million are expected to be paid in mid March 2003. In the event of adverse economic conditions or other unfavorable events, and to the extent that the Company's cash requirements are not met by operating cash flow or available debt or equity proceeds, the Company may find it necessary to reduce expenditure levels or undertake other actions as may be appropriate under the circumstances. See Note 8 of Notes to Condensed Consolidated Financial Statements in Item 1 of this Report for information concerning earnings before interest, taxes, depreciation and amortization. 15 On September 19, 2002, Kojaian Ventures, L.L.C. ("KV"), a related party, exercised its right to convert a subordinated promissory note it held into preferred stock of the Company. As a result of this conversion, 11,725 shares of the Company's Series A Preferred Stock were issued, with a stated value of $1,000 per share. The outstanding related party principal and interest obligations totaling $11,725,000 were reclassified to stockholders' equity on the date of conversion. Issuance costs of $783,000, previously offset against the note obligations, were also reclassified as a reduction of additional paid in capital. The preferred stock carries a dividend coupon of 12%, compounded quarterly on a cumulative basis. Accrued dividends at December 31, 2002 totaled approximately $398,000. The preferred stock contains liquidation preference and voting rights equal to 990 common shares for each share of preferred stock, or a total of 11,607,750 common share equivalents, subject to adjustment. As a consequence of the conversion, there has been a change in the voting control of the Company, as these equivalents, along with 3,762,884 shares of outstanding common stock owned by KV and its affiliates (approximately 25% of the outstanding common stock of the Company), represent approximately 57% of the total voting power of the Company. The preferred stock is not convertible into any other securities of the Company or subject to redemption. Warburg Pincus Investors, L.P., which currently owns approximately 39% of the outstanding common stock of the Company, has approximately 22% of the total voting power. The Company's common stock was listed on the New York Stock Exchange ("NYSE") pursuant to a listing agreement. As previously disclosed by the Company, the NYSE had accepted the Company's proposed business plan to attain compliance with the NYSE's listing standards on or before July 4, 2003. This plan had been submitted in response to a notification received by the Company on January 4, 2002 regarding non-compliance with such listing standards. As a result of the business plan's acceptance, the Company's common stock continued to be traded on the exchange, subject to the Company maintaining compliance with the plan and periodic review by the NYSE. Upon completion of a recent review, the NYSE announced on October 8, 2002 that the Company's common stock was being de-listed from the NYSE, due primarily to the Company's book value and market capitalization value being below minimum levels required by their listing standards. The Company's common stock commenced trading on the over-the-counter market ("OTC") effective October 17, 2002, under the symbol GBEL.OB, and ceased trading on the NYSE prior to the opening that day. The Company has principal payment obligations under the term portion of its credit facility of $29.0 million as of December 31, 2002, of which $8.7 million becomes due over the twelve months ending December 31, 2003. The Company is subject to certain financial covenants pursuant to the terms of its credit agreement, including minimum EBITDA (as defined in the credit agreement) levels it must achieve. On December 20, 2002, the Company received a waiver through March 31, 2003 with respect to any default regarding the minimum EBITDA levels for the quarter ended December 31, 2002 which levels were not achieved. The waiver also provided for an increase in interest rates of 50 basis points on borrowings until such time as the outstanding principal falls below $24.0 million, and accelerated principal repayments of $1.7 million. Prior to the expiration of the EBITDA waiver at March 31, 2003 the Company will seek to reach an amendment agreement with its lenders establishing new EBITDA thresholds to avoid future defaults under the credit agreement. The Company remains current on its debt service payments under the credit agreement, and has initiated discussions with the lenders to achieve appropriate amended terms. The Company also has continued to provide additional historical and forecasted financial information to the lenders to support efforts to accomplish these amended terms. There can be no assurance that the Company will conclude an amendment with its lending group by March 31, 2003. 16 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company's bank debt obligations are floating rate obligations whose interest rate and related monthly interest payments vary with the movement in LIBOR. As of December 31, 2002 the outstanding principal balances on these debt obligations totaled $29.0 million, of which $8.7 million is due over the next twelve months. Since interest payments on these obligations will increase if interest rate markets rise, or decrease if interest rate markets decline, the Company is subject to cash flow risk related to these debt instruments. In order to mitigate this risk, terms of the credit agreement required the Company to enter into interest rate swap agreements to effectively convert a portion of its floating rate term debt obligations to fixed rate debt obligations through March, 2004. Interest rate swaps generally involve the exchange of fixed and floating rate interest payments on an underlying notional amount. As of December 31, 2002 the Company had $12.0 million in notional amount interest rate swaps outstanding in which the Company pays a fixed rate of 5.18% and receives a three-month LIBOR based rate from the counter-parties. The notional amount of the interest rate swap agreements is scheduled to decline as follows: Notional Amount Date ----------------------- ------------------ $10,500,000 June 30, 2003 8,000,000 March 31, 2004 When interest rates rise the interest rate swap agreements increase in fair value to the Company and when interest rates fall the interest rate swap agreements decline in value to the Company. As of December 31, 2002, there was a net decline in interest rates since the Company had entered into the agreements, and the interest rate swap agreements were in an unrealized loss position to the Company of approximately $288,000, net of taxes. To highlight the sensitivity of the interest rate swap agreements to changes in interest rates, the following summary shows the effects of a hypothetical instantaneous change of 100 basis points (BPS) in interest rates as of December 31, 2002 (in thousands): Notional Amount $12,000 Fair Value to the Company (288) Change in Fair Value to the Company Reflecting Change in Interest Rates - 100 BPS (62) + 100 BPS 61 The Company does not utilize financial instruments for trading or other speculative purposes, nor does it utilize leveraged financial instruments. ITEM 4. CONTROLS AND PROCEDURES Within the 90-day period prior to the filing of this Quarterly Report on Form 10-Q, the Company carried out an evaluation, under the supervision and with the participation of management, including the Chief Executive Officer and the Chief Financial Officer, of the effectiveness of the Company's disclosure controls and procedures. Based upon the evaluation, the Company's Chief Executive Officer and Chief Financial Officer have concluded that the Company's disclosure controls and procedures are effective to timely alert them to material information required to be included in Company's Exchange Act filings. In addition, there have been no significant changes in the internal controls, or in other factors that could significantly affect internal controls, subsequent to the date that the Chief Executive Officer and Chief Financial Officer completed their evaluation. 17 PART II OTHER INFORMATION (ITEMS 2, 3 AND 5 ARE NOT APPLICABLE FOR THE QUARTER ENDED DECEMBER 31, 2002) 18 ITEM 1. LEGAL PROCEEDINGS The disclosure called for by Item 1 is incorporated by reference to Note 9 of Notes to Condensed Consolidated Financial Statements. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS The 2002 annual meeting of stockholders of the Company was held on November 19, 2002. The Company submitted to a vote of stockholders, through the solicitation of proxies, the election of eight directors, representing the entire Board of Directors. The votes cast for and withheld with respect to each nominee for election as director were as follows: VOTES WITHHOLDING NOMINEE VOTES FOR AUTHORITY ------- --------- ------------------ R. David Anacker 26,588,887 44,489 Anthony G. Antone 26,596,235 37,141 Barry M. Barovick 26,582,960 50,410 C. Michael Kojaian 26,591,561 41,815 Reuben S. Leibowitz 26,581,514 51,862 Ian C. Morgan 26,587,423 45,953 Steven H. Shepsman 26,594,930 38,446 Todd A. Williams 26,490,747 142,629 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (A) EXHIBITS (3) ARTICLES OF INCORPORATION AND BYLAWS 3.1 Certificate of Incorporation of the Registrant, as restated November 1, 1994, incorporated herein by reference to Exhibit 3.2 to the Registrant's Annual Report on Form 10-K filed on March 31, 1995. 3.2 Amendment to the Restated Certificate of Incorporation of the Registrant as filed with the Delaware Secretary of State on December 9, 1997, incorporated herein by reference to Exhibit 4.4 to the Registrant's Statement on Form S-8 filed on December 19, 1997 (File No. 333-42741). 3.3 Certificate of Retirement with Respect to 130,233 Shares of Junior Convertible Preferred Stock of Grubb & Ellis Company, filed with the Delaware Secretary of State on January 22, 1997, incorporated herein by reference to Exhibit 3.3 to the Registrant's Quarterly Report on Form 10-Q filed on February 13, 1997. 3.4 Certificate of Retirement with Respect to 8,894 Shares of Series A Senior Convertible Preferred Stock, 128,266 shares of Series B Senior Convertible Preferred Stock, and 19,767 Shares of Junior Convertible Preferred Stock of Grubb & Ellis Company, filed with the Delaware Secretary of State on January 22, 1997, incorporated herein by reference to Exhibit 3.4 to the Registrant's Quarterly Report on Form 10-Q filed on February 13, 1997. 19 3.5 Bylaws of the Registrant, as amended and restated effective May 31, 2000, incorporated herein by reference to Exhibit 3.5 to the Registrant's Annual Report on Form 10-K filed on September 28, 2000. (4) INSTRUMENTS DEFINING THE RIGHTS OF SECURITY HOLDERS, INCLUDING INDENTURES. 4.1 Amended and Restated Certificate of Designations, Number, Voting Powers, Preferences and Rights of Series A Preferred Stock of Grubb & Ellis Company, as filed with the Secretary of State of Delaware on September 13, 2002, incorporated herein by reference to Exhibit 3.8 to the Registrant's Annual Report on Form 10-K filed on October 15, 2002. 4.2 Securities Purchase Agreement dated May 13, 2002 by and between Grubb & Ellis Company and Kojaian Ventures, L.L.C., incorporated herein by reference to Exhibit 2 to the Registrant's Current Report on Form 8-K filed on May 14, 2002. 4.3 Copy of Convertible Subordinated Promissory Note and Security Agreement in the principal amount of $11,237,500 dated May 13, 2002 issued by the Registrant to Kojaian Ventures, L.L.C., incorporated herein by reference to Exhibit 3 to the Registrant's Current Report on Form 8-K filed on May 14, 2002. 4.4 Form of Waiver executed by Bank of America, N.A., LaSalle Bank National Association and Bank One, N.A., and the Company, dated December 20, 2002, incorporated herein by reference to Exhibit 1 to the Registrant's Current Report on Form 8-K filed on January 10, 2003. (99) OTHER INFORMATION 99.1 SARBANES-OXLEY ACT, SECTION 906 CERTIFICATION (B) REPORTS ON FORM 8-K A Current Report on Form 8-K dated December 2, 2002, was filed with the Securities and Exchange Commission on January 10, 2003, reporting under Item 5 (a) a summary of the terms of a waiver to the Company's amended and restated term loan and revolving credit facility dated as of December 31, 2000 and (b) a lawsuit filed by an executive officer of the Company in December 2002 where the Company was named as a defendant. 20 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. GRUBB & ELLIS COMPANY ----------------------- (Registrant) Date: February 14, 2003 /s/ IAN Y. BRESS ----------------------- Ian Y. Bress Chief Financial Officer 21 CERTIFICATIONS I, Barry M. Barovick, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Grubb & Ellis Company; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a. designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b. evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c. presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent function): a. all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b. any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: February 14, 2003 /s/ BARRY M. BAROVICK --------------------- Barry M. Barovick President, Chief Executive Officer and a director 22 CERTIFICATIONS I, Ian Y. Bress, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Grubb & Ellis Company; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a. designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b. evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c. presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent function): a. all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b. any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: February 14, 2003 /s/ IAN Y. BRESS ---------------- Ian Y. Bress Chief Financial Officer 23 GRUBB & ELLIS COMPANY EXHIBIT INDEX FOR THE QUARTER ENDED DECEMBER 31, 2002 EXHIBIT ------- (99) OTHER INFORMATION 99.1 Sarbanes-Oxley Act, Section 906 Certification 24