10-Q 1 y91851e10vq.txt FIRST UNION REAL ESTATE EQUITY AND MORTGAGE INV. ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2003 Commission File Number 1-6249 First Union Real Estate Equity and Mortgage Investments ------------------------------------------------------- (Exact name of registrant as specified in its charter) Ohio 34-6513657 ------------------------------- ------------------------------------ (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 125 Park Avenue, 14th Floor New York, New York 10017 ---------------------------------------- ---------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (212) 949-1373 -------------------------------------------------------------------------------- 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] Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable date. 26,058,913 Common Shares of Beneficial Interest outstanding as of November 1, 2003 -------------------------------------------------------------------------------- ================================================================================ Total number of pages contained in this report: 29 PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS. FIRST UNION REAL ESTATE EQUITY and MORTGAGE INVESTMENTS Combined Balance Sheets
September 30, 2003 December 31, (In thousands, except share data) (Unaudited) 2002 --------- --------- ASSETS Investments in real estate, at cost Land $ 6,086 $ 6,086 Buildings and improvements 65,494 64,867 --------- --------- 71,580 70,953 Less - Accumulated depreciation (13,584) (12,057) --------- --------- Investments in real estate, net 57,996 58,896 Other assets Cash and cash equivalents - unrestricted 16,328 3,897 - restricted 1,862 1,968 Accounts receivable and prepayments, net of allowances of $263 and $601, respectively 1,344 1,625 Investments 68,937 103,974 Inventory, net of reserve 371 1,033 Unamortized debt issue costs, net 223 278 Other 143 154 --------- --------- Total assets $ 147,204 $ 171,825 ========= ========= LIABILITIES AND SHAREHOLDERS' EQUITY Liabilities Mortgage loan $ 41,533 $ 41,781 Note payable 68 80 Senior notes 12,538 12,538 Accounts payable and accrued liabilities 6,908 8,332 Dividends payable 516 516 Deferred items 386 471 --------- --------- Total liabilities 61,949 63,718 --------- --------- Shareholders' equity Convertible preferred shares of beneficial interest, $25 per share liquidation preference, 2,300,000 shares authorized, 983,082 shares outstanding at September 30, 2003 and December 31, 2002 23,131 23,131 Shares of beneficial interest, $1 par, unlimited authorized, 26,058,913 and 34,814,361 outstanding at September 30, 2003 and December 31, 2002 26,059 34,814 Additional paid-in capital 199,968 207,634 Accumulated distributions in excess of net income (163,903) (157,472) --------- --------- Total shareholders' equity 85,255 108,107 --------- --------- Total liabilities and shareholders' equity $ 147,204 $ 171,825 ========= =========
See Notes to Combined Financial Statements. 2 FIRST UNION REAL ESTATE EQUITY and MORTGAGE INVESTMENTS Combined Statements of Operations
Three Months Ended Nine Months Ended Unaudited (In thousands, except per share data) September 30, September 30, --------------------- --------------------- 2003 2002 2003 2002 -------- -------- -------- -------- Revenues Rents $ 3,476 $ 3,309 $ 10,256 $ 10,013 Sales 372 602 1,816 2,194 Interest 172 421 682 1,318 Other income - 475 - 475 -------- -------- -------- -------- 4,020 4,807 12,754 14,000 -------- -------- -------- -------- Expenses Property operating 1,239 1,489 3,762 3,946 Cost of goods sold 788 1,049 2,754 3,538 Real estate taxes 225 213 674 674 Depreciation and amortization 552 512 1,612 1,540 Interest 1,237 1,480 3,608 3,885 General and administrative 762 1,079 5,281 4,220 -------- -------- -------- -------- 4,803 5,822 17,691 17,803 -------- -------- -------- -------- Loss before gain on sale (783) (1,015) (4,937) (3,803) Gain on sale 54 - 54 - -------- -------- -------- -------- Net loss (729) (1,015) (4,883) (3,803) Preferred dividend (516) (517) (1,548) (1,551) -------- -------- -------- -------- Net loss applicable to shares of beneficial interest $ (1,245) $ (1,532) $ (6,431) $ (5,354) ======== ======== ======== ======== Per share data Basic: Net loss applicable to shares of beneficial interest $ (0.04) $ (0.04) $ (0.20) $ (0.15) ======== ======== ======== ======== Diluted: Net loss applicable to shares of beneficial interest $ (0.04) $ (0.04) $ (0.20) $ (0.15) ======== ======== ======== ======== Basic weighted average shares 28,141 34,806 32,474 34,806 ======== ======== ======== ======== Diluted weighted average shares 28,141 34,806 32,474 34,806 ======== ======== ======== ========
See Notes to Combined Financial Statements. 3 FIRST UNION REAL ESTATE EQUITY and MORTGAGE INVESTMENTS Combined Statements of Cash Flows
Nine Months Unaudited (In thousands) Ended September 30, --------------------------- 2003 2002 ----------- ----------- Cash used for operating activities Net loss $ (4,883) $ (3,803) Adjustments to reconcile net loss to net cash used in operating activities Depreciation and amortization 1,612 1,540 Gain on sale of VenTek parking business (54) - Decrease in deferred items (85) (338) Net changes in other operating assets and liabilities (487) 126 ----------- ----------- Net cash used in operating activities (3,897) (2,475) ----------- ----------- Cash provided by investing activities Purchase of investments (1,134,273) (1,146,175) Proceeds from maturity of investments 1,169,310 1,159,202 Net proceeds from sale of VenTek parking business 60 - Investments in building and tenant improvements (646) (482) ----------- ----------- Net cash provided by investing activities 34,451 12,545 ----------- ----------- Cash used in financing activities Decrease in note payable (12) (12) Repayment of mortgage loan - principal payments (248) (228) Repurchase of shares of beneficial interest (16,421) - Dividends paid on shares of beneficial interest - (6,962) Dividends paid on preferred shares of beneficial interest (1,548) (1,551) ----------- ----------- Net cash used in financing activities (18,229) (8,753) ----------- ----------- Increase in cash and cash equivalents 12,325 1,317 Cash and cash equivalents at beginning of period 5,865 4,724 ----------- ----------- Cash and cash equivalents at end of period $ 18,190 $ 6,041 =========== =========== Supplemental Disclosure of Cash Flow Information Interest Paid $ 3,329 $ 4,163 =========== =========== Supplemental Disclosure of Non-Cash Investing and Financing Activities Dividends accrued on preferred shares of beneficial interest $ 516 $ 517 =========== =========== Loan receivable in connection with the sale of VenTek parking business $ 133 $ - =========== =========== Transfer of inventory in connection with the sale of VenTek parking business $ 158 $ - =========== =========== Net transfer of receivables and payables in connection with the sale of VenTek parking business $ 19 $ - =========== ===========
See Notes to Combined Financial Statements. 4 FIRST UNION REAL ESTATE EQUITY AND MORTGAGE INVESTMENTS FORM 10-Q SEPTEMBER 30, 2003 NOTES TO COMBINED FINANCIAL STATEMENTS General The accompanying financial statements represent the combined results of the registrant, First Union Real Estate Equity and Mortgage Investments (the "Trust") and First Union Management Inc. (the "Company"). Under a trust agreement, the common shares of the Company are held for the benefit of the shareholders of the Trust. Accordingly, the financial statements of the Company and the Trust have been combined. The combined financial statements included herein have been prepared by the Trust, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations, although the Trust believes that the disclosures contained herein are adequate to make the information presented not misleading. These combined financial statements should be read in conjunction with the combined financial statements and the notes thereto included in the Trust's latest annual report on Form 10-K. The combined financial statements reflect, in the opinion of the Trust, all adjustments (consisting of normal recurring adjustments) necessary to present fairly the combined financial position and results of operations for the respective periods in conformity with accounting principles generally accepted in the United States of America consistently applied. Accounting Policies In April 2002, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13 and Technical Corrections," which updates, clarifies and simplifies existing accounting pronouncements. In part, this statement rescinds SFAS No. 4, "Reporting Gains and Losses from Extinguishment of Debt." FASB No. 145 is effective for fiscal years beginning after May 15, 2002. Upon adoption, enterprises must reclassify prior period items that do not meet the extraordinary item classification criteria in Accounting Principles Board ("APB") No. 30. The adoption of this statement on January 1, 2003 had no impact on the Trust's combined financial statements. In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." SFAS No. 146 requires companies to recognize costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal plan. Examples of costs covered by the standard include lease termination costs and certain employee severance costs that are associated with a restructuring, discontinued operation, plant closing or other exit or disposal activity. SFAS No. 146 is effective prospectively for exit and disposal activities initiated after December 31, 2002. In November 2002, the FASB issued Interpretation No. 45, "Guarantors' Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others." The Interpretation elaborates on the disclosures to be made by a guarantor in its financial statements about its obligations under 5 certain guarantees that it has issued. It also clarifies that a guarantor is required to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. This Interpretation does not prescribe a specific approach for subsequently measuring the guarantor's recognized liability over the term of the related guarantee. The disclosure provisions of this Interpretation were effective for the Trust's December 31, 2002 combined financial statements. The initial recognition and initial measurement provisions of this Interpretation are applicable on a prospective basis to guarantees issued or modified after December 31, 2002. This Interpretation had no effect on the Trust's combined financial statements. The Trust's guarantees are disclosed in the combined financial statements. In January 2003, the FASB issued Interpretation No. 46, "Consolidation of Variable Interest Entities." This Interpretation clarifies the application of existing accounting pronouncements to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. The provisions of the Interpretation are immediately effective for all variable interests in variable interest entities created after January 31, 2003, and the Trust will need to apply its provisions to any existing variable interests in variable interest entities no later than the first reporting period beginning after December 15, 2003. The Trust does not anticipate that this Interpretation will have any effect on the combined financial statements. In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." The statement improves the accounting for certain financial instruments that under previous guidance, issuers could account for as equity. The new statement requires that those instruments be classified as liabilities in statements of financial position. SFAS No. 150 affects the issuer's accounting for three types of freestanding financial instruments. One type is mandatorily redeemable shares, which the issuing company is obligated to buy back in exchange for cash or other assets. A second type, which includes put options and forward purchase contracts, involves instruments that do or may require the issuer to buy back some of its shares in exchange for cash or other assets. The third type of instruments that are liabilities under this statement is obligations that can be settled with shares, the monetary value of which is fixed, tied solely or predominantly to a variable such as a market index, or varies inversely with the value of the issuers' shares. SFAS No. 150 does not apply to features embedded in a financial instrument that is not a derivative in its entirety. In addition to its requirements for the classification and measurement of financial instruments in its scope, SFAS No. 150 also requires disclosures about alternative ways of settling the instruments and the capital structure of entities, all of whose shares are mandatorily redeemable. Most of the guidance in SFAS No. 150 is effective for all financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. This statement had no effect on the Trust's combined financial statements. 6 Earnings Per Share The computation of basic and diluted earnings per share is as follows (in thousands, except per share data):
Three Months Ended Nine Months Ended September 30, September 30, --------------------- --------------------- 2003 2002 2003 2002 -------- -------- -------- -------- Basic Net loss $ (729) $ (1,015) $ (4,883) $ (3,803) Preferred dividend (516) (517) (1,548) (1,551) -------- -------- -------- -------- Net loss applicable to shares of beneficial interest $ (1,245) $ (1,532) $ (6,431) (5,354) ======== ======== ======== ======== Basic weighted average shares 28,141 34,806 32,474 34,806 ======== ======== ======== ======== Net loss per share $ (0.04) $ (0.04) $ (0.20) $ (0.15) ======== ======== ======== ======== Diluted Net loss $ (729) $ (1,015) $ (4,883) $ (3,803) Preferred dividend (516) (517) (1,548) (1,551) -------- -------- -------- -------- Net loss applicable to shares of beneficial interest $ (1,245) $ (1,532) $ (6,431) $ (5,354) ======== ======== ======== ======== Basic weighted average shares 28,141 34,806 32,474 34,806 Convertible preferred shares - - - - -------- -------- -------- -------- Diluted weighted average shares 28,141 34,806 32,474 34,806 ======== ======== ======== ======== Net loss per share $ (0.04) $ (0.04) $ (0.20) $ (0.15) ======== ======== ======== ========
The preferred shares are not included in the diluted earnings per share calculation for the three and nine months ended September 30, 2003 and 2002, because they are anti-dilutive. Share Options The Trust accounts for stock option awards in accordance with APB No. 25, "Accounting for Stock Issued to Employees" and has adopted the disclosure-only provisions of SFAS No. 123, "Accounting for Stock-Based Compensation." Consequently, compensation cost has not been recognized for the share option plans except for the options granted in 1999 which had an exercise price that was less than the grant date per share market price. Had the Trust applied the expense recognition provisions of SFAS No. 123, there would have been no impact on the results of operations for the periods ended September 30, 2003 and 2002. Dividends The Trust declared a dividend of $0.5 million ($0.525 per share) to Series A Cumulative Preferred Shareholders in both the first, second and third quarters of 2003. The first quarter dividends were paid April 30, 2003 to shareholders of record at the close of business on March 31, 2003. The second quarter dividends were paid July 31, 2003 to shareholders of record at the close of business on June 30, 2003. The third quarter dividends were paid October 31, 2003 to shareholders of record at the close of business on September 30, 2003. 7 Termination of Proposed Transaction On February 13, 2002, the Trust entered into a definitive agreement of merger and contribution with, among others, Gotham Partners, L.P. ("Gotham Partners"), a shareholder of the Trust that is controlled by affiliates of William A. Ackman, who was at the time Chairman of the Board of Trustees of the Trust, and Gotham Golf Corp. ("Gotham Golf"), a Delaware corporation controlled by Gotham Partners, pursuant to which the Trust agreed to merge with and into Gotham Golf. The parties subsequently adopted Amendment No. 1 to the merger agreement on April 24, 2002, Amendment No. 2 to the merger agreement on September 24, 2002 and Amendment No. 3 to the merger agreement on October 24, 2002. The proposed transaction was approved by the Trust's common shareholders at a special meeting held on November 27, 2002. In November 2002, the plaintiff in the preferred shareholder litigation (see "Legal Proceedings") filed with the New York Supreme Court for New York County an Order to Show Cause why the transaction should not be enjoined. The court held a hearing on that issue on November 20. On November 21, 2002, the court issued an order denying the defendants' motion to dismiss the complaint and granting plaintiff's motions for preliminary injunction and expedited discovery in connection with the proposed merger. Following hearings with respect to the plaintiff's motions, the court issued an order in December 2002 granting a preliminary injunction barring the proposed merger of the Trust with and into Gotham Golf. The Trust appealed the court's order barring the transaction in the Appellate Division of the New York Supreme Court. Oral argument on the appeal was heard by the Appellate Division on March 11, 2003. On June 25, 2003 the Trust entered into a Settlement, Termination and Standstill Agreement (the "Agreement") with, among others, Gotham Partners. The Agreement provided for the termination of the merger agreement regarding the merger of the Trust with Gotham Golf, the purchase by the Trust of 5,841,233 common shares of the Trust owned by Gotham Partners and its affiliates for approximately $11.1 million and a termination payment to Gotham Partners of $2.4 million. The Agreement also provides that neither Gotham Partners nor any affiliate will enter into or agree to enter into any form of business combination, acquisition or other transaction involving the Trust or any majority-owned affiliate for a period of five years from the date of the Agreement. The termination payment was recognized as a general and administrative expense during the three months ended June 30, 2003. On September 4, 2003, the Appellate Division, First Department of the New York Supreme Court, issued its ruling on the appeal by the Trust and the other defendants of the trial court's order barring the merger transaction. The five-member Appellate Division panel unanimously found that the legal standard for the granting of the injunction had not been satisfied and, accordingly, the order of the trial court granting the injunction was reversed and the injunction vacated. Plaintiff preferred shareholders have not sought to appeal from this decision. As the transaction had already been terminated prior to the issuance of the opinion, the opinion had no effect on the terminated transaction. The Trust is pursuing the goal of obtaining dismissal with prejudice by order of the court or, in the alternative, to settle by dismissal with prejudice for outside of court and, thus, terminate the proceedings. To that end, the Trust has filed a motion for summary judgment in the Kimeldorf case. 8 The Board of Trustees has continued to operate the Trust as an ongoing enterprise since the termination of the merger transaction with a focus on reducing operating expenses whenever possible. The Board of Trustees continues to examine other suitable operating and investment alternatives with respect to the Trust. Share Repurchase The Trust authorized a share repurchase plan in July 2003. The plan allows for the Trust to purchase up to $10.0 million of its common and preferred shares in the market or through private transactions. Through November 14, 2003, the Trust repurchased 2,914,215 common shares for $5,323,348. Legal Proceedings Preferred Shareholder Lawsuit Kimeldorf v. First Union, et al. On April 15, 2002, the Trust was served with a complaint filed in the Supreme Court of New York in New York County on behalf of a purported holder of the Trust's convertible preferred shares. Among the allegations made by the plaintiff is that the proposed transaction with Gotham Golf was approved by the Trust's Board of Trustees in violation of fiduciary duties owed to the holders of the Trust's convertible preferred shares. The suit seeks, among other things, unspecified damages, an injunction of the proposed transaction and the court's certification of the lawsuit as a class action. Named as defendants in the lawsuit were the Trust, its then five trustees and Gotham Partners. (For a summary of the proceedings in this suit to date, see "Termination of Proposed Transaction," above). In November 2002, First Carolina Investors, Inc. ("First Carolina") a holder of preferred shares, filed a separate lawsuit in New York Supreme Court for New York County, naming the same defendants as in the Kimeldorf case. In December 2002, plaintiffs Kimeldorf and First Carolina filed a consolidated amended complaint, styled Kimeldorf et al. v. First Union, et al, alleging, among others, breach of contract; aiding and abetting breach of contract; tortious interference with the contract; breach of fiduciary duties; aiding and abetting of breach of fiduciary duties; and unconscionability against the defendants. This consolidated amended complaint essentially consolidated the separate First Carolina complaint, filed in November 2002, with the complaint of Mr. Kimeldorf, filed in April 2002. On April 30, 2003, the trial court granted the plaintiff's motion to certify the litigation as a class action. However, plaintiff never submitted an order identifying the certified class, and the court has issued an order nullifying the grant of class certification. In July 2003, plaintiffs Kimeldorf and First Carolina each filed separate motions with the trial court seeking to hold the defendants in contempt as a result of the execution and performance of the Termination Agreement (see "Termination of Proposed Transaction", above). The plaintiffs contend that these actions violated the trial court's injunction against the consummation of the merger between the Trust and Gotham Golf. Defendants filed a brief in opposition to the motions. The trial court heard oral argument with respect to these motions in July 2003 and has taken them under advisement. In September 2003, the Appellate Division, First Department of the New York Supreme Court vacated the preliminary injunction, the violation of which was the subject of plaintiff's motions for contempt. Although not dispositive of the matter, the Trust believes but cannot assure that there is a reasonable likelihood that the 9 plaintiff preferred shareholders will not prevail on motions seeking the trial court to hold the Trust and the other defendants in contempt of a vacated preliminary injunction. The Trust is pursuing the goal of obtaining dismissal with prejudice by order of the court or, in the alternative, to settle by dismissal with prejudice outside of court and, thus, terminate the proceedings. To that end, the Trust has filed a motion for summary judgment in the Kimeldorf case. The Trust regards the lawsuit as being without merit and will vigorously defend against the asserted claims. Common Shareholders Lawsuits Fink v. First Union. On or about January 24, 2003, the Trust was served with a complaint filed in the Supreme Court of New York, New York County on behalf of a purported holder of the Trust's common shares, on behalf of himself and the common shareholders as a class. The lawsuit seeks a declaration that the lawsuit is maintainable as a class action and a certification that the plaintiff, Robert Fink, is the representative of the class. Named as defendants in the lawsuit are the Trust, Gotham Partners, the companies affiliated with Gotham Partners and the Trust that are parties to the Merger Agreement, William Ackman and the four current Trustees of the Trust. Among the allegations asserted are breach of fiduciary duty and aiding and abetting thereof in connection with the transactions contemplated by the Merger Agreement. The relief requested by the plaintiff includes an injunction preventing the defendants from proceeding with consummation of the merger, rescission of the merger if it occurs, an accounting for any profits realized by the defendants as a result of the actions complained of, an order permitting the creation of a shareholders' committee composed of the Trust common shareholders and their representatives to manage the affairs of the Trust, compensatory damages and the costs and disbursements of plaintiff's counsel. On or about February 14, 2003, the parties to this lawsuit stipulated that the defendants need not answer or otherwise respond to the complaint for an indefinite period of time. The stipulation is revocable by the plaintiff at any time. The Trust believes that the purpose of the stipulation was to delay court proceedings in this lawsuit until the outcome of the appeal of the injunction entered in the Kimeldorf case (see "Termination of Proposed Transaction," above) is decided by the Appellate Division. On or about July 3, 2003, the Plaintiff filed an amended complaint which seeks additional relief based upon the termination agreement, including a request that the defendants be required to return to the Trust the termination fee paid to Gotham Partners as well as the consideration paid for Gotham Partners' shares in the Trust. As with the original complaint, the parties have stipulated that the defendants need not answer or otherwise respond to the amended complaint for an indefinite period of time. The stipulation is revocable by the plaintiff at any time. Following the decision of the Appellate Division, First Department of the New York Supreme Court in the Kimeldorf case, counsel for the Trust and the other defendants have requested that the plaintiff voluntarily dismiss its suit with prejudice. If the plaintiff common shareholder does not voluntarily dismiss the Fink case with prejudice, the Trust and the other defendants intend to file a motion with the trial court to dismiss the case. The Trust regards the lawsuit as without merit and plans to vigorously defend against the allegations. 10 K-A & Company, LTD. v. First Union. On or about February 12, 2003, a complaint was filed in the Court of Common Pleas, Cuyahoga County, Ohio, by a purported holder of the Trust's common shares, on behalf of itself and the Trust common shareholders as a class. Named as defendants in the lawsuit are the Trust, Gotham Partners, William Ackman and four of the current Trustees of the Trust. The allegations made and the relief requested in the K-A suit are substantially identical to those of the Fink suit referenced above. This lawsuit was removed by notice filed by defendants to the United States District Court, Northern District of Ohio, Eastern Division (Case No. 1:03 CV 0460). On April 10, 2003, the plaintiff filed a motion for a preliminary injunction seeking an order preventing the defendants from consummation of the merger. The defendants filed a motion requesting the court to stay consideration of the plaintiff's motion pending a decision on the appeal of the preliminary injunction entered by the New York Supreme Court for New York County in Kimeldorf, described above. Following the issuance of the Appellate Division, First Department of the New York Supreme Court of its reversal of the order granting the injunction, and the vacating of the injunction, granted in the Kimeldorf case, the plaintiffs in the K-A & Company, LTD. case have voluntarily dismissed their complaint with prejudice; accordingly, that case has been disposed of. Peach Tree Mall Litigation The Trust, as one Plaintiff in a class action composed of numerous businesses and individuals, has pursued legal action against the State of California associated with the 1986 flood of Sutter Buttes Center, formerly Peach Tree Mall. In September 1991, the court ruled in favor of the plaintiffs on the liability portion of the inverse condemnation suit, which the State of California appealed. In the third quarter of 1999, the 1991 ruling in favor of the Trust and the other plaintiffs was reversed by the State of California Appeals Court, which remanded the case to the trial court for further proceedings. After the remand to the trial court, the Trust and the other plaintiffs determined to pursue a retrial before the court. The retrial of the litigation commenced February 2001 and was completed July 2001. In November 2001, the trial court issued a decision that generally held in favor of the State of California. In February 2002, the Plaintiffs in the case filed a notice of appeal of the ruling of the trial court in the California Court of Appeals. The appellate briefing was completed in May 2003. The Trust is unable to predict at this time whether or not it will recover any amount of its damage claims in this legal proceeding. Indemnity to Imperial Parking Corporation In 1999, Newcourt Financial Ltd. ("Newcourt") brought a claim in Ontario against an affiliate of the Trust and Imperial Parking Limited alleging a breach of a contract between the Trust affiliate and Newcourt's predecessor-in-interest, Oracle Credit Corporation and Oracle Corporation Canada, Inc. The Trust affiliate and Imperial Parking Limited brought a separate action in British Columbia against Newcourt, Oracle Credit Corporation and Oracle Corporation Canada claiming, among other things, that the contract at issue was not properly authorized by the Trust's board of trustees and the Imperial Parking Limited board of directors. On March 27, 2000, in connection with the spinoff of Imperial Parking Corporation (the successor in interest to Imperial Parking Limited) to the Trust's shareholders, the Trust granted a full indemnity to Imperial Parking Corporation in respect of all damages arising from the outstanding actions. Numerous attempts to settle this matter have not been successful. The Trust has reserved $600,000 in its combined financial statements for this claim. The reserved amount consists of the face amount of the contract 11 of $425,000 and estimated costs of $175,000. The amount of the claim, $825,000, includes Newcourt's calculation of interest on the amount due at the default rate under the contract. The Trust believes that, due to the failure of attempted settlement negotiations, discovery will commence, and the matter will become more actively litigated. The Trust intends to defend vigorously against the claims brought against the parties that it has indemnified and to pursue their separate claims with respect to this matter. Mountaineer Mall Claim The Trust was named as a defendant in a lawsuit filed in connection with a contractor's claim relative to the construction of a portion of the Mountaineer Mall, located in Morgantown, West Virginia. The construction of the mall commenced in 1993 and was completed in 1995. The mall was sold in July 1999. A trial on the merits of the lawsuit was held in 1997. In October 2002, the court issued findings of fact and conclusions of law providing that the claimant was entitled to recover from the Trust the principal amount of $266,076 in damages plus various interest amounts, which, when added to the principal amount, would result in an aggregate damage award of $494,382 against the Trust. The court's order provided, however, that the amount of the damage award was subject to offset by the amount of legal fees and expenses reasonably and necessarily incurred by the Trust in defending a certain mechanic's lien claim asserted by the plaintiff in the lawsuit. The court further directed that the plaintiff and the Trust negotiate in good faith as to the amount of such expense and that, if the parties were unable to agree as to the appropriate offset, the court would schedule an evidentiary hearing for the purpose of resolving the issue. In July 2003, the Trust and the plaintiff entered into a settlement agreement and paid $350,000 to the plaintiff in full settlement of the claim. Contingencies VenTek The Company's subsidiary, VenTek International, Inc. ("VenTek"), a manufacturer of transit ticketing equipment, continues to incur significant operating losses. The Trust has provided performance bond guarantees entered into with respect to two contracts of VenTek with transit authorities, which contracts are in the amounts of $6.2 million and $5.3 million. These contracts are for the manufacture, installation and maintenance of transit ticket vending equipment by VenTek. The guarantees are expected to expire within the next fifteen months based on the commencement of contractual warranty and maintenance periods now in effect under both contracts. As of November 1, 2003, no amounts have been drawn against these guarantees. If VenTek is unable to perform in accordance with these contracts, the Trust may be responsible for payment under these guarantees. In connection with one of the contracts, VenTek settled a claim for liquidated damages for approximately $0.1 million during the nine months ended September 30, 2003. During the third quarter, VenTek entered into a new contract for $2.2 million with one of the transit authorities to manufacture additional ticket vending machines. In connection with the contract, the Trust provided cash collateral equal to 50 percent of the contract value to secure a Letter of Credit required by the bonding company. 12 Park Plaza Mall Two department stores owned and operated by Dillard's Department Stores, Inc. ("Dillard's") are the anchor stores at Park Plaza Mall. Dillard's owns its facilities in Park Plaza Mall and has a Construction, Operation and Reciprocal Easement Agreement with a subsidiary of the Trust that contains an operating covenant requiring Dillard's to operate these facilities continuously as retail department stores until July 2003. Dillard's and its partner, Simon Property Group, own a parcel of land of nearly 100 acres in the western part of Little Rock, Arkansas and have announced, at various times over the last several years, their intention to build in this new location. During the first quarter of 2001, the Little Rock board of directors approved a change in zoning that would allow the construction of an approximately 1.3 million square foot regional enclosed mall on this site. The zoning on this site reverted to its prior status as a residential use property pursuant to a court order in 2002; however, the proponents of the regional enclosed mall have filed a notice of appeal of this ruling in the Supreme Court of Arkansas. A hearing of the appeal was held on October 30, 2003, with no decision expected before December 2003. In the event that a large-scale retail facility is built on this site, Dillard's may cease operating its stores at Park Plaza Mall. In the event Dillard's closes one or both of its stores at Park Plaza Mall, it is unlikely that it would sell or lease its two stores to comparable anchor tenants. Accordingly, the value of Park Plaza Mall would be materially and adversely affected due to the decline in traffic and sales volume at Park Plaza Mall, and the rights of many of the tenants to terminate their leases or to pay less rent triggered by the closure of one or both of the anchor stores. The Park Plaza Mall property is financed by a mortgage loan. The loss of an anchor tenant or a significant number of other mall tenants could result in an event of default under this mortgage. Regardless of whether the proposed new mall is built at the site in question, under the terms of the operating covenant, Dillard's has no obligation to maintain its operations at Park Plaza Mall beyond July 2003. Dillard's has been approached to extend the operating covenant at the Park Plaza Mall. To date, it has declined to do so, however, under the terms of the operating covenant, Dillard's is permitted to continue operations at Park Plaza Mall through 2031. If Dillard's does not maintain its presence as an anchor store at Park Plaza Mall, the Park Plaza Mall would experience a loss of revenue and likely an event of default under the mortgage, thereby causing the value of the Park Plaza Mall to be materially and adversely affected. In such circumstances, there would be an impairment of the value of the property and a loss could be recognized. There can be no assurance that Dillard's will maintain its presence as an anchor store at Park Plaza Mall. Other Contingency Revenue Canada has commenced a tax audit of the Trust's March 2000 spin off of Imperial Parking Corp. of Canada (IPK, Amex). The Trust cannot determine at this time what effect, if any, the tax audit will have on the financial position or results of operations of the Trust. The Trust does not anticipate that the liability, if any, would exceed $0.7 million. Sale of VenTek Parking Business On August 1, 2003, VenTek sold substantially all the assets of its parking ticketing equipment business to an unrelated third party for approximately $0.4 million. VenTek received approximately $0.1 million in cash, a note receivable for approximately $0.1 million and transferred approximately $0.2 million in liabilities. The Trust recognized a gain of $54,000. 13 Business Segments The Trust's and Company's business segments include ownership of a shopping center, an office building, and a parking and transit ticket equipment manufacturing company. Management evaluates performance based upon net operating income. With respect to property assets, net operating income is property rent less property operating expense, and real estate taxes. With respect to VenTek, a manufacturer of transit and parking ticketing equipment, net operating income is sales revenue less cost of goods sold. Corporate assets consist primarily of cash and cash equivalents, investments and deferred issue costs for senior notes. The parking ticket equipment business was sold on August 1, 2003. All intercompany transactions between segments have been eliminated (see table of business segments). 14 Business Segments (in thousands)
Three Months Ended September 30, Nine Months Ended September 30, -------------------------------- ------------------------------- 2003 2002 2003 2002 -------- -------- -------- -------- Rents and Sales Shopping Centers $ 3,097 $ 2,934 $ 9,074 $ 8,824 Office Buildings 367 342 1,070 1,026 VenTek 372 602 1,816 2,194 Corporate 12 33 112 163 -------- -------- -------- -------- 3,848 3,911 12,072 12,207 Less - Operating Expenses and Costs of Goods Sold Shopping Centers 1,065 1,163 3,134 3,232 Office Buildings 174 185 562 546 VenTek 788 1,049 2,754 3,538 Corporate - 141 66 168 -------- -------- -------- -------- 2,027 2,538 6,516 7,484 Less - Real Estate Taxes Shopping Centers 203 203 607 619 Office Buildings 22 22 67 67 Corporate - (12) - (12) -------- -------- -------- -------- 225 213 674 674 Net Operating Income (Loss) Shopping Centers 1,829 1,568 5,333 4,973 Office Buildings 171 135 441 413 VenTek (416) (447) (938) (1,344) Corporate 12 (96) 46 7 -------- -------- -------- -------- 1,596 1,160 4,882 4,049 Less - Depreciation and Amortization 552 512 1,612 1,540 Less - Interest Expense 1,237 1,480 3,608 3,885 Corporate Income (Expense) Interest 172 421 682 1,318 Other income (VenTek) - 475 - 475 General and administrative (762) (1,079) (5,281) (4,220) -------- -------- -------- -------- Net Loss before Gain on Sale and Preferred Dividend $ (783) $ (1,015) $ (4,937) $ (3,803) ======== ======== ======== ========
15 Business Segments (Continued)
Three Months Ended September 30, Nine Months Ended September 30, ------------------------------- ------------------------------ 2003 2002 2003 2002 --------------- -------------- --------------- ------------- Capital Expenditures Shopping Centers $448 $240 $499 $256 Office Buildings 55 73 129 219 VenTek 16 3 18 7 ---- ---- ---- ---- $519 $316 $646 $482 ==== ==== ==== ====
September 30, ------------------------ 2003 2002 -------- -------- Identifiable Assets Shopping Centers $ 57,505 $ 57,841 Office Buildings 2,185 2,358 VenTek 1,091 2,904 Corporate 86,423 109,076 -------- -------- Total Assets $147,204 $172,179 ======== ========
16 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. 2002 TRANSACTION THE PROPOSED TRANSACTION On February 13, 2002, the Trust entered into a definitive agreement of merger and contribution with, among others, Gotham Partners, L.P., ("Gotham Partners") a shareholder of the Trust that is controlled by affiliates of William A. Ackman, who was at the time Chairman of the Board of Trustees of the Trust, and Gotham Golf Corp. ("Gotham Golf"), a Delaware corporation controlled by Gotham Partners, pursuant to which the Trust agreed to merge with and into Gotham Golf. On October 24, 2002, the parties adopted the last of three amendments to the merger agreement. The proposed transaction was approved by the Trust's common shareholders at a special meeting held on November 27, 2002. In November 2002, the plaintiff in the preferred shareholder litigation (see "Legal Proceedings") filed with the New York Supreme Court for New York County an Order to Show Cause why the transaction should not be enjoined. The court held a hearing on that issue on November 20. On November 21, 2002, the court issued an order denying the defendants' motion to dismiss the complaint and granting plaintiff's motions for preliminary injunction and expedited discovery in connection with the proposed merger. Following hearings with respect to the plaintiff's motions, the court issued an order in December 2002 granting a preliminary injunction barring the proposed merger of the Trust with and into Gotham Golf. The Trust appealed the court's order barring the transaction in the Appellate Division of the New York Supreme Court. Oral argument on the appeal was heard by the Appellate Division on March 11, 2003. On June 25, 2003 the Trust entered into a Settlement, Termination and Standstill Agreement (the "Agreement") with, among others, Gotham Partners. The Agreement provided for the termination of the merger agreement regarding the merger of the Trust with Gotham Golf, the purchase by the Trust of 5,841,233 common shares of the Trust owned by Gotham Partners and its affiliates for approximately $11.1 million and a termination payment to Gotham Partners of $2.4 million. The Agreement also provides that neither Gotham Partners nor any affiliate will enter into or agree to enter into any form of business combination, acquisition or other transaction involving the Trust or any majority-owned affiliate for a period of five years from the date of the Agreement. The termination payment was recognized as a general and administrative expense during the three months ended June 30, 2003. On September 4, 2003, the Appellate Division, First Department of the New York Supreme Court, issued its ruling on the appeal by the Company and the other defendants of the trial court's order barring the merger transaction. The five-member Appellate Division panel unanimously found that the legal standard for the granting of the injunction had not been satisfied and, accordingly, the order of the trial court granting the injunction was reversed and the injunction vacated. Plaintiff preferred shareholders have not sought to appeal from this decision. As the transaction had already been terminated prior to the issuance of the opinion, the opinion had no effect on the terminated transaction. 17 The Board of Trustees has continued to operate the Trust as an ongoing enterprise since the termination of the merger transaction with a focus on reducing operating expenses whenever possible. The Board of Trustees continues to examine other suitable operating and investment alternatives with respect to the Trust. OTHER MATTERS The Trust could be affected by declining economic conditions as a result of various factors that affect the real estate business including the financial condition of tenants, competition, and increased operating costs. The Trust expects that its insurance costs will increase when its policies are renewed at the end of November 2003. The Trust's Directors' and Officers' insurance was renewed in June 2003. The rates increased in excess of 100% upon renewal. The Trust authorized a share repurchase plan in July 2003. The plan allows for the Trust to purchase up to $10.0 million of its common and preferred shares in the market or private transactions. The Trust's most critical accounting policy relates to the evaluation of the carrying value of real estate. The Trust evaluates the need for an impairment loss on its real estate assets when indicators of impairment are present and the undiscounted cash flows are not sufficient to recover the asset's carrying amount. The impairment loss is measured by comparing the fair value of the asset to its carrying amount. In addition, estimates are used when accounting for the allowance for doubtful accounts, potentially excess and obsolete inventory, product warranty reserves, the percentage of completion method of recognizing revenue and contingent liabilities, among others. These estimates are susceptible to change and actual results could differ from these estimates. The effects of changes in these estimates are recognized in the period they are determined. SHAREHOLDER LITIGATION Three separate lawsuits were filed, and one has since been dismissed with prejudice, with respect to the proposed transactions between the Trust and Gotham Partners relative to the Merger Agreement of February 13, 2002, which Merger Agreement was terminated effective June 25, 2003. (See "Part II, Item 1. Legal Proceedings"). PARK PLAZA MALL Two Dillard's department stores are the anchor stores at Park Plaza Mall. Dillard's owns its facilities in Park Plaza Mall and has a Construction, Operation and Reciprocal Easement Agreement with a subsidiary of the Trust that contains an operating covenant requiring Dillard's to operate these facilities continuously as retail department stores until July 2003. Dillard's and its partner, Simon Property Group, own a parcel of land of nearly 100 acres in the western part of Little Rock, Arkansas and have announced, at various times over the last several years, their intention to build in this new location. During the first quarter of 2001, the Little Rock board of directors approved a change in zoning that would allow the construction of an approximately 1.3 million square foot regional enclosed mall on this site. The zoning on this site reverted to its prior status as a residential use property pursuant to a court order in 2002; however, the proponents of the regional enclosed mall have filed a notice of appeal of this ruling in the Supreme Court of Arkansas. A hearing of the appeal was held on October 30, 2003, with no decision expected before December 2003. In the event that a large-scale retail facility is built on this site, Dillard's may cease operating its stores at Park Plaza Mall. In the event Dillard's closes one or both of its stores at Park Plaza Mall, it is unlikely that it would sell or lease its two stores to 18 comparable anchor tenants. Accordingly, the value of Park Plaza Mall would be materially and adversely affected due to the decline in traffic and sales volume at Park Plaza Mall, and the rights of many of the tenants to terminate their leases or to pay less rent triggered by the closure of one or both of the anchor stores. The Park Plaza Mall property is financed by a mortgage loan. The loss of an anchor tenant or a significant number of other mall tenants could result in an event of default under this mortgage. Regardless of whether the proposed new mall is built at the site in question, under the terms of the operating covenant, Dillard's has no obligation to maintain its operations at Park Plaza Mall beyond July 2003. Dillard's has been approached to extend the operating covenant at the Park Plaza Mall. To date, it has declined to do so, however, under the terms of the operating covenant, Dillard's is permitted to continue operations at Park Plaza Mall through 2031. If Dillard's does not maintain its presence as an anchor store at Park Plaza Mall, the Park Plaza Mall would experience a loss of revenue and likely an event of default under the mortgage, thereby causing the value of the Park Plaza Mall to be materially and adversely affected. In such circumstances, there would be an impairment of the value of the property and a loss could be recognized. There can be no assurance that Dillard's will maintain its presence as an anchor store at Park Plaza Mall. With respect to capital improvements, the Trust has completed the repair of Park Plaza Mall's roof at a cost of approximately $0.6 million during the first quarter of 2003. VENTEK The Company's subsidiary, VenTek, a manufacturer of transit ticketing equipment, continues to incur significant operating losses. The Trust has provided performance bond guarantees entered into with respect to two contracts of VenTek with transit authorities, which contracts are in the amounts of $6.2 million and $5.3 million. These contracts are for the manufacture, installation and maintenance of transit ticket vending equipment by VenTek. The guarantees are expected to expire within the next fifteen months based on the commencement of contractual warranty and maintenance periods now in effect under both contracts. As of November 1, 2003, no amounts have been drawn against these guarantees. If VenTek is unable to perform in accordance with these contracts, the Trust may be responsible for payment under these guarantees. In connection with one of the contracts, VenTek settled a claim for liquidated damages for approximately $0.1 million during the nine months ended September 30, 2003. During the third quarter, VenTek entered into a new contract for $2.2 million with one of the transit authorities to manufacture additional ticket vending machines. In connection with the contract, the Trust provided cash collateral equal to 50 percent of the contract value to secure a Letter of Credit required by the bonding company. In August 2003, VenTek sold substantially all the assets of its parking ticket equipment business to an unrelated third party for approximately $0.4 million. VenTek received approximately $0.1 million in cash, a note receivable for approximately $0.1 million and transferred approximately $0.2 million in liabilities. The Trust recognized a gain of $54,000 on the transaction. The sale of the parking ticket equipment business is not expected to have a significant impact on operations or cash flows of the Trust. Other Contingency Revenue Canada has commenced a tax audit of the Trust's March 2000 spin off of Imperial Parking Corp. of Canada (IPK, Amex). The Trust cannot determine at this time what effect, if any, the tax audit will have on the financial position or results of operations of the Trust. The Trust does not anticipate that the liability, if any, would exceed $0.7 million. 19 LIQUIDITY AND CAPITAL RESOURCES GENERAL Unrestricted and restricted cash and cash equivalents increased by approximately $12.3 million (to $18.2 million from $5.9 million) when comparing the balance at September 30, 2003 to the balance at December 31, 2002. The Trust's net cash provided by investing activities of $34.4 million was partially offset by net cash used for operating activities of $3.9 million and net cash used for financing activities of $18.2 million. Cash used for financing activities included $16.4 million for the repurchase of shares of beneficial interest, $1.5 million in cash dividends to preferred shareholders and $0.3 million of mortgage amortization. Cash provided by investing activities consisted of the excess of maturities over purchases of U.S. Treasury Bills and Federal Home Loan Bank Discount Notes of $35.0 million. Cash used for investing activities consisted of $0.6 million of improvements to properties. The Trust declared a dividend of $0.5 million ($0.525 per share) to Series A Cumulative Preferred Shareholders (the "Preferred Shareholders") in the third quarter of 2003. The dividend was paid October 31, 2003 to shareholders of record at the close of business on September 30, 2003. In addition, the Trust paid a dividend of $0.5 million ($0.525 per share) to the Preferred Shareholders in the first and second quarters. No cash dividend for the first, second or third quarters was declared with respect to the Common Shares. At September 30, 2003, the Trust owned $48.950 million in face value of U.S. Treasury Bills and Federal Home Loan Bank Discount Notes. The U.S. Treasury Bills and Federal Home Loan Bank Discount Notes are of maturities of less than 90 days and classified as held to maturity. The average yields for the nine months ended September 30, 2003 and 2002 were 1.06% and 1.67%, respectively. At September 30, 2003, the Trust owned $20.0 million in interest bearing commercial paper. The average yield for the three months ended September 30, 2003 was 1.28%. A summary of the Trust's borrowings and repayment timing is as follows (in millions):
Payments Due by Period ---------------------- Less than 1-3 4-5 After 5 Contractual Obligations Total 1 Year Years Years Years --------------------------------------------------------------------------------------------------------------------- Mortgage loan payable $ 41.5 $ 0.3 $ 0.8 $ 0.9 $ 39.5 Senior notes 12.5 12.5 - - - -------------------------------------------------------------------------------- Total $ 54.0 $ 12.8 $ 0.8 $ 0.9 $ 39.5 ================================================================================
The only lease with respect to which the Trust has an obligation for payment of rent for is for VenTek, which is month to month. The senior notes were paid in full on October 1, 2003. 20 RESULTS OF OPERATIONS Net loss applicable to shares of beneficial interest for the nine months ended September 30, 2003 was $6.4 million as compared to a net loss of $5.4 million for the nine months ended September 30, 2002. Net loss applicable to shares of beneficial interest for the three months ended September 30, 2003 was $1.2 million as compared to a net loss of $1.5 million in the comparable period in 2002. Interest income decreased by $0.2 million and $0.6 million during the three and nine months ended September 30, 2003, as compared to the comparable periods in 2002. The decrease is a result of lower amounts invested and lower interest rates between the periods. Property net operating income, which is rent less property operating expenses and real estate taxes, increased for the nine months ended September 30, 2003 to $5.8 million from $5.4 million. There was an increase in revenues of $0.2 million and a decrease in operating expenses of $0.2 million. Revenues increased by $0.2 million for the nine months ended September 30, 2003, due to lease termination fees received of $0.3 million at Park Plaza. A decrease in occupancy at Park Plaza was partially offset by an increase in rental rates when comparing the nine months ended September 30, 2003 to September 30, 2002. Occupancy and rental rates both increased at Circle Tower when comparing the periods. Included in operating expenses are $0.2 million in 2002 of costs incurred in connection with the matters described above in the Park Plaza Mall section. Property net operating income increased for the three months ended September 30, 2003 to $2.0 million from $1.6 million in 2002. The increase was attributed to an increase in revenues of approximately $0.2 million and a decrease in operating expenses of approximately $0.2 million. The increase of $0.2 million in revenues was primarily due to a lease termination fee received of $0.2 million at Park Plaza. Depreciation and amortization increased for the three and nine months ended September 30, 2003 when compared to the comparable period in 2002 due to an increase in building and improvements. Interest expense decreased when comparing the three and nine months ended September 30, 2003 due to the payment of principal on the mortgage loan. General and administrative expenses increased by approximately $1.1 million when comparing the nine months ended September 30, 2003 to the comparable period in 2002. The increase was due to a $2.4 million termination fee paid to Gotham Partners to terminate the Gotham Proposal. The termination fee was partially offset by a decrease in legal fees and professional fees. Included in general and administrative expenses for the nine months ended September 30, 2003 and 2002 are approximately $2.9 million and $1.9 million, respectively, of the Trust's transaction costs related to the Gotham Proposal. During the nine months ended September 30, 2003 and 2002, $0.4 million of costs related to the preferred shareholder lawsuit were included in general and administrative expenses. Also included in general and administrative expenses are $0.3 million and $0.6 million in 2003 and 2002, respectively, to a firm providing management services to VenTek. Otherwise, general and administrative expenses remained relatively constant when comparing the nine months ended September 30, 2003 to the comparable period in 2002. 21 General and administrative expenses decreased by $0.3 million when comparing the three months ended September 30, 2003 to the comparable period in 2002. The decrease was primarily due to the termination of the Gotham Proposal. In addition, an increase in insurance expense was offset by a decrease in professional fees. Included in general and administrative expenses for the three months ended September 30, 2002 are $0.4 million of transaction costs related to the Gotham Proposal. Also included in general and administrative expenses are $0.1 million and $0.2 million for the three months ended September 30, 2003 and 2002, respectively, to a firm providing management services to VenTek. Also included in general and administrative expenses for the 2003 and 2002 periods is a $0.1 million tax refund. The Company's manufacturing facility, VenTek, incurred a net loss of $1.1 million for the nine months ended September 30, 2003 and 2002. Revenue decreased for the nine months ended September 30, 2003 to $1.8 million from $2.2 million in 2002 and cost of goods sold decreased to $2.8 million from $3.5 million for the same period. For the three months ended September 30, 2003, VenTek incurred a net loss of $0.4 million as compared to a net loss of $0.1 million for the three months ended September 30, 2002. Revenues decreased to $0.4 million from $0.6 million for the three months ended September 30, 2003 and 2002 and costs of goods sold decreased to $0.8 million from $1.0 million for the same period. The decrease in both revenues and cost of goods sold is due to the winding down of current contracts. During the third quarter VenTek entered into a new contract for $2.2 million with one of the transit authorities to manufacture additional ticket vending machines. In addition in October 2003, VenTek received a change order on an existing contract to manufacture additional ticket vending machines for $0.8 million. There was no backlog for VenTek at September 30, 2003 besides the new contract. Backlog represents products or services that VenTek's customers have committed by contract to purchase. VenTek's backlog is subject to fluctuations and is not necessarily indicative of future sales. A failure to replace backlog has resulted in lower revenues. Certain statements contained in this Form 10-Q that are forward-looking are based on current expectations that are subject to a number of uncertainties and risks, and actual results may differ materially. The uncertainties and risks include, but are not limited to, changes in market activity, changes in local real estate conditions and markets, actions by competitors, interest rate movements and general economic conditions. Further information about these matters can be found in the Trust's Annual Report filed with the SEC on Form 10-K. 22 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES OF MARKET RISK Interest Rate Risk All of the Trust's loans outstanding at September 30, 2003 have fixed interest rates. The Trust's investments in U.S. Treasury Bills, Federal Home Loan Bank Discount Notes, and commercial paper mature in less than 90 days and therefore are not subject to significant interest rate risk. ITEM 4. CONTROLS AND PROCEDURES The registrant's principal executive and financial officer has, within 90 days of the filing date of this quarterly report, evaluated the effectiveness of the registrant's disclosure controls and procedures (as defined in Exchange Act Rules 13a - 14(c)) and has determined that such disclosure controls and procedures are adequate to ensure that information required to be disclosed by the registrant in the reports filed or submitted under the Exchange Act is recorded, processed and summarized and reported within the time periods specified by the Securities and Exchange Commission. There have been no significant changes in the registrant's internal controls or in other factors that could significantly affect such internal controls since the date of evaluation. Accordingly, no corrective actions have been taken with regard to significant deficiencies or material weaknesses. 23 PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS. PREFERRED SHAREHOLDER LAWSUIT KIMELDORF V. FIRST UNION REAL ESTATE EQUITY AND MORTGAGE INVESTMENTS, ET AL., SUPREME COURT OF THE STATE OF NEW YORK, COUNTY OF NEW YORK (INDEX NO. 107176/02). On April 15, 2002, the Trust was served with a complaint filed in the Supreme Court of New York in New York County on behalf of a purported holder of the Trust's convertible preferred shares. Among the allegations made by the plaintiff is that the proposed transaction with Gotham Golf was approved by the Trust's Board of Trustees in violation of fiduciary duties owed to the holders of the Trust's convertible preferred shares. The suit seeks, among other things, unspecified damages, an injunction of the proposed transaction and the court's certification of the lawsuit as a class action. Named as defendants in the lawsuit were the Trust, its then five trustees and Gotham Partners. (For a summary of the proceedings in this suit to date, see "Termination of Proposed Transaction," above). In November 2002, First Carolina Investors, Inc. ("First Carolina") a holder of preferred shares, filed a separate lawsuit in New York Supreme Court for New York County, naming the same defendants as in the Kimeldorf case. In December 2002, plaintiffs Kimeldorf and First Carolina filed a consolidated amended complaint, styled Kimeldorf et al. v. First Union, et al, alleging, among others, breach of contract; aiding and abetting breach of contract; tortious interference with the contract; breach of fiduciary duties; aiding and abetting of breach of fiduciary duties; and unconscionability against the defendants. This consolidated amended complaint essentially consolidated the separate First Carolina complaint, filed in November 2002, with the complaint of Mr. Kimeldorf, filed in April 2002. On April 30, 2003, the trial court granted the plaintiff's motion to certify the litigation as a class action. However, plaintiff never submitted an order identifying the certified class, and the court has issued an order nullifying the grant of class certification. In July 2003, Plaintiff Kimeldorf and First Carolina each filed separate motions with the trial court seeking to hold the defendants in contempt as a result of the execution and performance of the Termination Agreement (see "Termination of Proposed Transaction", above). The plaintiffs contend that these actions violated the trial court's injunction against the consummation of the merger between the Trust and Gotham Golf. Defendants filed a brief in opposition to the motions. The trial court heard oral argument with respect to these motions in July 2003 and has taken them under advisement. In September 2003, the Appellate Division, First Department of the New York Supreme Court vacated the preliminary injunction, the violation of which was the subject of plaintiff's motions for contempt. Although not dispositive of the matter, the Trust believes but cannot assure that there is a reasonable likelihood that the plaintiff preferred shareholders will not prevail on motions seeking the trial court to hold the Trust and the other defendants in contempt of a vacated preliminary injunction. The Trust is pursuing the goal of obtaining dismissal with prejudice by order of the court or, in the alternative, to settle by dismissal with prejudice outside of court and, thus, terminate the proceedings. To that end, the Trust has filed a motion for summary judgment in the Kimeldorf case. 24 The Trust regards the lawsuit as being without merit and will vigorously defend against the asserted claims. COMMON SHAREHOLDER LAWSUITS FINK V. FIRST UNION REAL ESTATE EQUITY AND MORTGAGE INVESTMENTS, ET AL., SUPREME COURT OF THE STATE OF NEW YORK, COUNTY OF NEW YORK (INDEX NO. 03600265) On or about January 24, 2003, the Trust was served with a complaint filed in the Supreme Court of New York, New York County on behalf of a purported holder of the Trust's common shares, on behalf of himself and the common shareholders as a class. The lawsuit seeks a declaration that the lawsuit is maintainable as a class action and a certification that the plaintiff, Robert Fink, is the representative of the class. Named as defendants in the lawsuit are the Trust, Gotham Partners, the companies affiliated with Gotham Partners and the Trust that are parties to the Merger Agreement, William Ackman and the four current Trustees of the Trust. Among the allegations asserted are breach of fiduciary duty and aiding and abetting thereof in connection with the transactions contemplated by the Merger Agreement. The relief requested by the plaintiff includes an injunction preventing the defendants from proceeding with consummation of the merger, rescission of the merger if it occurs, an accounting for any profits realized by the defendants as a result of the actions complained of, an order permitting the creation of a shareholders' committee composed of the Trust common shareholders and their representatives to manage the affairs of the Trust, compensatory damages and the costs and disbursements of plaintiff's counsel. On or about February 14, 2003, the parties to this lawsuit stipulated that the defendants need not answer or otherwise respond to the complaint for an indefinite period of time. The stipulation is revocable by the plaintiff at any time. The Trust believes that the purpose of the stipulation was to delay court proceedings in this lawsuit until the outcome of the appeal of the injunction entered in the Kimeldorf case (see "Termination of Proposed Transaction," above) is decided by the Appellate Division. On or about July 3, 2003, the Plaintiff filed an amended complaint which seeks additional relief based upon the termination agreement, including a request that the defendants be required to return to the Trust the termination fee paid to Gotham Partners as well as the consideration paid for Gotham Partners' shares in the Trust. As with the original complaint, the parties have stipulated that the defendants need not answer or otherwise respond to the amended complaint for an indefinite period of time. The stipulation is revocable by the plaintiff at any time. Following the decision of the Appellate Division, First Department of the New York Supreme Court in the Kimeldorf case, counsel for the Trust and the other defendants have requested that the plaintiff voluntarily dismiss its suit with prejudice. If the plaintiff common shareholder does not voluntarily dismiss the Fink case with prejudice, the Trust and the other defendants intend to file a motion with the trial court to dismiss the case. The Trust regards the lawsuit as without merit and plans to vigorously defend against the allegations. K-A & COMPANY, LTD. V. FIRST UNION REAL ESTATE EQUITY AND MORTGAGE INVESTMENTS, ET AL., UNITED STATES DISTRICT COURT, NORTHERN DISTRICT OF OHIO, EASTERN DIVISION (CASE NO. 1:03 CV 0460) On or about February 12, 2003, a complaint was filed in the Court of Common Pleas, Cuyahoga County, Ohio, by a purported holder of the Trust's common shares, on behalf of itself and the Trust common shareholders as a class. Named as defendants in the lawsuit are the Trust, Gotham Partners, William Ackman and four of the current Trustees of the Trust. The allegations made and the relief requested in the K-A suit are substantially 25 identical to those of the Fink suit referenced above. This lawsuit was removed by notice filed by defendants to the United States District Court, Northern District of Ohio, Eastern Division (Case No. 1:03 CV 0460). On April 10, 2003, the plaintiff filed a motion for a preliminary injunction seeking an order preventing the defendants from consummation of the merger. The defendants filed a motion requesting the court to stay consideration of the plaintiff's motion pending a decision on the appeal of the preliminary injunction entered by the New York Supreme Court for New York County in Kimeldorf, described above. Following the issuance of the Appellate Division, First Department of the New York Supreme Court of its reversal of the order granting the injunction, and the vacating of the injunction, granted in the Kimeldorf case, the plaintiffs in the K-A & Company, LTD. case have voluntarily dismissed their complaint with prejudice; accordingly, that case has been disposed of. OTHER LITIGATION PEACH TREE MALL LITIGATION The Trust, as one Plaintiff in a class action composed of numerous businesses and individuals, has pursued legal action against the State of California associated with the 1986 flood of Sutter Buttes Center, formerly Peach Tree Mall. In September 1991, the court ruled in favor of the plaintiffs on the liability portion of the inverse condemnation suit, which the State of California appealed. In the third quarter of 1999, the 1991 ruling in favor of the Trust and the other plaintiffs was reversed by the State of California Appeals Court, which remanded the case to the trial court for further proceedings. After the remand to the trial court, the Trust and the other plaintiffs determined to pursue a retrial before the court. The retrial of the litigation commenced February 2001 and was completed July 2001. In November 2001, the trial court issued a decision that generally held in favor of the State of California. In February 2002, the Plaintiffs in the case filed a notice of appeal of the ruling of the trial court in the California Court of Appeals. The appellate briefing was completed in May 2003. The Trust is unable to predict at this time whether or not it will recover any amount of its damage claims in this legal proceeding. INDEMNITY TO IMPERIAL PARKING CORPORATION In 1999, Newcourt Financial Ltd. ("Newcourt") brought a claim in Ontario against an affiliate of the Trust and Imperial Parking Limited alleging a breach of a contract between the Trust affiliate and Newcourt's predecessor-in-interest, Oracle Credit Corporation and Oracle Corporation Canada, Inc. The Trust affiliate and Imperial Parking Limited brought a separate action in British Columbia against Newcourt, Oracle Credit Corporation and Oracle Corporation Canada claiming, among other things, that the contract at issue was not properly authorized by the Trust's board of trustees and the Imperial Parking Limited board of directors. In March 2000, in connection with the spinoff of Imperial Parking Corporation (the successor in interest to Imperial Parking Limited) to the Trust's shareholders, the Trust granted a full indemnity to Imperial Parking Corporation in respect of all damages arising from the outstanding actions. Numerous attempts to settle this matter have not been successful. The Trust has reserved $600,000 in its combined financial statements for this claim. The reserved amount consists of the face amount of the contract of $425,000 and estimated costs of $175,000. The amount of the claim, $825,000, includes Newcourt's calculation of interest on the amount due at the default rate under the contract. The Trust believes that, due to 26 the failure of attempted settlement negotiations, discovery will commence, and the matter will become more actively litigated. The Trust intends to defend vigorously against the claims brought against the parties that it has indemnified and to pursue their separate claims with respect to this matter. MOUNTAINEER MALL CLAIM The Trust was named as a defendant in a lawsuit filed in connection with a contractor's claim relative to the construction of a portion of the Mountaineer Mall, located in Morgantown, West Virginia. The construction of the mall commenced in 1993 and was completed in 1995. The mall was sold in July 1999. A trial on the merits of the lawsuit was held in 1997. In October 2002, the court issued findings of fact and conclusions of law providing that the claimant was entitled to recover from the Trust the principal amount of $266,076 in damages plus various interest amounts, which, when added to the principal amount, would result in an aggregate damage award of $494,382 against the Trust. The court's order provided, however, that the amount of the damage award is subject to offset by the amount of legal fees and expenses reasonably and necessarily incurred by the Trust in defending a certain mechanic's lien claim asserted by the plaintiff in the lawsuit. The court further directed that the plaintiff and the Trust negotiate in good faith as to the amount of such expense and that, if the parties are unable to agree as to the appropriate offset, the court would schedule an evidentiary hearing for the purpose of resolving the issue. In July 2003, the Trust and the plaintiff entered into a settlement agreement and paid $350,000 to the plaintiff in full settlement of the claim. 27 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. (a) Exhibits 31 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 32 Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (b) Reports on Form 8-K: The Registrant has filed a Form 8-K dated August 14, 2003, reporting under Items 7 and 12 thereof the release of its second quarter earnings information and attaching thereto as an exhibit its earnings release dated August 14, 2003. 28 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Trust has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. First Union Real Estate Equity and Mortgage Investments ---------------------------------- (Trust) Date: November 14, 2003 By: /s/ Neil H. Koenig ---------------------------------- Neil H. Koenig Interim Chief Executive Officer and Interim Chief Financial Officer 29