-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Dbg8kkwWmEorvvrQo3QyaZVlbajA5ZLSiIDMSlDXiRXDjFsa9/qJ1jeyg29TMuHA gtTfTTWKJ/xaoo7dIsVm5A== 0000950152-98-009068.txt : 19981123 0000950152-98-009068.hdr.sgml : 19981123 ACCESSION NUMBER: 0000950152-98-009068 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19980930 FILED AS OF DATE: 19981116 DATE AS OF CHANGE: 19981120 FILER: COMPANY DATA: COMPANY CONFORMED NAME: FIRST UNION REAL ESTATE EQUITY & MORTGAGE INVESTMENTS CENTRAL INDEX KEY: 0000037008 STANDARD INDUSTRIAL CLASSIFICATION: 6798 IRS NUMBER: 346513657 STATE OF INCORPORATION: OH FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 001-06249 FILM NUMBER: 98752706 BUSINESS ADDRESS: STREET 1: 55 PUBLIC SQUARE STREET 2: STE 1900 CITY: CLEVELAND STATE: OH ZIP: 44113 BUSINESS PHONE: 2167814030 MAIL ADDRESS: STREET 1: 55 PUBLIC SQUARE SUITE 1910 CITY: CLEVELAND STATE: OH ZIP: 44113 FORMER COMPANY: FORMER CONFORMED NAME: FIRST UNION REALTY DATE OF NAME CHANGE: 19691012 10-Q 1 FIRST UNION REAL ESTATE EQUITY & MORTGAGE 10-Q 1 - - -------------------------------------------------------------------------------- - - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------- FORM 10-Q QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 ------------- For Quarter Ended September 30, 1998 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 incorporation or organization) Identification No.) Suite 1900, 55 Public Square Cleveland, Ohio 44113-1937 - - --------------------------------------- ------------------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (216) 781-4030 ----------------- - - -------------------------------------------------------------------------------- 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 the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable date. 31,416,326 Shares of Beneficial Interest outstanding as of September 30, 1998 - - ------------------------------------------------------------------------------- ================================================================================ Total number of pages contained in this report: 13 ---- 2 PART I - FINANCIAL INFORMATION - - ------------------------------ Item 1. Financial Statements. - - ------- --------------------- The combined financial statements included herein have been prepared by the registrant, 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 generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations, although the registrant believes that the disclosures contained herein are adequate to make the information presented not misleading. It is suggested that these combined financial statements be read in conjunction with the combined financial statements and the notes thereto included in the registrant's latest annual report on Form 10-K. The "Combined Balance Sheets" as of September 30, 1998 (unaudited) and December 31, 1997 (audited) and "Combined Statements of Income and Combined Statements of Changes in Cash" for the periods ended September 30, 1998 (unaudited) and 1997 (unaudited), of the registrant, and "Notes to Combined Financial Statements," are included herein. These financial statements reflect, in the opinion of the registrant, all adjustments (consisting of normal recurring accruals) necessary to present fairly the combined financial position and results of operations for the respective periods in conformity with generally accepted accounting principles consistently applied. Item 2. Management's Discussion and Analysis of Financial Condition and - - ------- --------------------------------------------------------------- Results of Operations. ---------------------- Financial Condition - - ------------------- In January 1998, the registrant acquired two parking garages for $44.8 million in cash, the assumption of $.7 million in mortgage debt and the issuance of a $.9 million mortgage note payable. The parking garages are located in Chicago, IL, and Columbus, OH. Additionally, in February 1998, the registrant acquired a parking garage in Richmond, VA for $9.1 million in cash and a development site in Cleveland, OH for $3.3 million in cash. The development site is leased on a short-term basis to the former owner until construction of a parking garage commences. In March 1998, the registrant acquired a surface parking lot adjacent to the Ballpark at Arlington in Arlington, TX for $3 million in cash. In July 1998, the registrant acquired a parking garage in Nashville, TN for $2.1 million in cash and the assumption of a $4.5 million mortgage. The cash required for these acquisitions was funded with proceeds from the registrant's bank credit facilities. The registrant in January 1998 received $6.2 million in cash as full repayment of a mortgage investment secured by a property in Middletown, WV. In May 1998, the registrant received $18.8 million in cash as full repayment of a mortgage investment secured by an office building in Cleveland, OH. The proceeds were used to repay bank loans under the registrant's bank credit facilities. In February 1998, 951,000 preferred shares of beneficial interest were converted into approximately 3,144,000 shares of beneficial interest. The registrant in May 1998, sold its investment in the land beneath an office building in Cleveland for $6 million resulting in a capital gain of $1.7 million. The proceeds were used to reduce short-term borrowings. In May 1998, the registrant obtained a $30 million non-recourse mortgage secured by its parking garage in Chicago, IL. The mortgage is for three years at an interest rate of LIBOR plus 175 basis points and is interest only. On June 1, 1998, the registrant's affiliated management company purchased the remaining non-voting common shares of Impark for $11.2 million from Impark's former owner. 2 3 The non-voting common stock was recorded as an Other Liability in the Combined Financial Statements. The registrant, for a fee from the former owner of Impark, had provided a financial guarantee that the shares would be redeemed. Upon completion of the redemption, the registrant sold $11.5 million of U.S. Treasury bills which had collateralized the financial guarantee. In July 1998, the registrant commenced a tender offer to purchase for cash all $100 million principal amount of its 8 7/8% Senior Notes due 2003 at $970 per $1,000 principal amount of Senior Notes, plus accrued and unpaid interest. Concurrently with the tender offer, the registrant conducted a consent solicitation and offered a consent payment of $30 per $1,000 principal amount of Senior Notes to amend the indenture governing the Senior Notes and to terminate listing of the Senior Notes on the New York Stock Exchange (the "NYSE"). The purpose of the tender offer and consent solicitation was (i) to prevent the possibility that the registrant would be required to purchase the Senior Notes at 101% of their principal amount, an obligation which the registrant would not have had the financial resources to satisfy, and (ii) to provide the registrant with additional financial and operating flexibility. Prior to its amendment, the Senior Note indenture required the registrant to offer to purchase the Senior Notes at 101% of their principal amount if within 90 days following the date of a "change of control," the rating of the Senior Notes by both Standard & Poor's Corporation ("S&P") and Moody's Investors Services, Inc. declined by one or more rating gradations. During April 1998, S&P placed the registrant on Credit Watch and in June 1998, Moody's placed the Senior Notes under review for possible downgrade. In August 1998, pursuant to the tender offer and consent solicitation, holders of approximately 88% of the outstanding Senior Notes consented to the indenture amendments and delisting and the registrant purchased approximately $88 million principal amount of Senior Notes. The purchase of the Senior Notes was financed with the proceeds of a $90 million loan that has a term of six months (subject to two three-month extension periods) and bears interest at 9 7/8% (the "Bridge Loan"). The lenders under the Bridge Loan are Bankers Trust, as agent, and BankBoston, N.A., Blackacre Bridge Capital, Elliott Associates, Gotham Partners, L.P. and Gotham Partners III, L.P., and Wellsford Capital, each as an equal participant. As a result of legal fees for several unusual, one-time matters, accrued severance expenses for anticipated employee terminations, a new accounting pronouncement requiring the deferral of percentage rent from tenants, and foreign currency mark-to-market losses, the registrant was not in compliance with debt service coverage, interest coverage, the leverage ratio and funds from operations covenants under its bank credit facility for the third quarter of 1998. Additionally, Impark was not in compliance with covenants relating to the leverage ratio and interest coverage under its bank credit agreement for the third quarter of 1998. Further, the lenders under the facilities determined that a change of control of the registrant occurred on May 19, 1998. Such change of control would have breached change of control covenants under both credit facilities, but the lenders waived these breaches. If the lenders under the bank credit facility and the Impark credit agreement decline to extend the change of control waivers or declare defaults relating to the other covenants, these credit facilities may be terminated and the balances outstanding may become due immediately. If the registrant is not in compliance with certain covenants or otherwise defaults under its credit facility, the Bridge Loan lenders may accelerate repayment of the Bridge Loan. The registrant and Impark have approximately $192 million outstanding at September 30, 1998 under the bank facilities and Bridge Loan. Both the registrant and Impark are presently negotiating the extension of waivers for the breach of the change of control covenants, which were previously granted until November 26, 1998 and December 31, 1998, respectively, and are negotiating with the lenders of their credit facilities and the Bridge Loan to waive the financial covenants non-compliance and to modify the financial covenants going forward. If the registrant and Impark cannot obtain the necessary waivers and modifications, the lenders under the credit facilities and the Bridge Loan may declare a default under their respective loans and the liquidity of the registrant and Impark will be impaired. In the event of a default under such agreements the lenders generally will be able to declare all such indebtedness, together with accrued interest thereon, due and payable immediately, and in the case of collateralized indebtedness, to proceed against their collateral. If the registrant were unable to refinance the indebtedness on acceptable terms, or at all, the registrant might be forced to dispose of one or more of its properties at disadvantageous terms, which might result in losses to the registrant or seek bankruptcy relief. These losses could have a material adverse effect on the registrant and its ability to pay amounts due on its indebtedness. Furthermore, if a property is mortgaged to secure payment of indebtedness and the registrant is unable to meet mortgage payments, the mortgagee could foreclose on the property, appoint a receiver and receive an assignment of rents and leases or pursue other remedies, all with a consequent loss of revenues and asset value to the registrant. Foreclosures could also create taxable income without accompanying cash proceeds, thereby hindering the registrant's ability to meet the REIT distribution requirements under the Internal Revenue Code. Accordingly, the occurrence of a default under any of the aforementioned loan agreements could have a material adverse effect on the registrant. In June 1998, the registrant implemented a multi-step Year 2000 Compliance Project (the "Project"). The Project is addressing the issue of computer systems and embedded computer chips that may not be able to properly recognize dates prior to, on, or after January 1, 2000. The general phases of the Project are as follows: (1) inventorying systems and equipment that may be affected by the Year 2000 issue; (2) assigning priorities to the items identified; (3) evaluating the Year 2000 compliance of items deemed to be critical 3 4 to the registrant's operations; (4) testing critical items; (5) repairing or replacing critical items that are determined not to be Year 2000 compliant and (6) developing and implementing contingency plans for each location. As of September 30, 1998, the inventory and priority assessment phases of the Project were completed. Critical items are those believed by the registrant to involve a risk to the safety of individuals, or that may cause damage to property, or affect revenues. Testing of critical items is being performed and is expected to be completed in 1998. The Project addresses three main sections: (a) Information Technology Systems; (b) Process Control and Instrumentation; and (c) Third Party Tenants, Suppliers and Customers. The Information Technology Systems section consists of all computer hardware and software. These systems are primarily used for accounting and financial reporting as well as property management purposes throughout the registrant's operations. Impark uses other systems, mainly for revenue control purposes at the parking facility level. The testing phase is ongoing as hardware and software are remediated, upgraded or replaced. Currently, Impark's accounting and financial reporting systems are not Year 2000 compliant; these systems will be replaced by a new general-purpose financial reporting and general ledger package by September 30, 1999. Additionally, new hardware and software are being installed at various properties and subsidiaries, which is anticipated to be completed by June 30, 1999. The Process Control and Instrumentation section includes the hardware, software and associated embedded computer chips that are used in the operations of certain facilities owned by the registrant. Testing and repair of this equipment is in process. The registrant's evaluation of these items and communications with manufacturers and suppliers revealed that the majority of this equipment is mechanical in nature and is not date-sensitive, and accordingly will not require remediation or replacement to function properly in the Year 2000. Contingency planning is in process, and all repair and testing is expected to be completed by March 31, 1999. The Third Party Tenants, Suppliers and Customers section includes the process of identifying critical suppliers and customers and obtaining information from them regarding their plans and progress in addressing the Year 2000 problem. A written notice regarding the Year 2000 problem was sent to all tenants occupying space at properties owned by the registrant and to landlords of parking facilities operated by Impark. Additionally, inquiries have been forwarded to critical third parties (primarily financial institutions and utility service providers), and responses are currently being obtained and evaluated. These evaluations will be followed by the development of contingency plans. All activities for this section are expected to be completed by June 30, 1999. The total cost of required modifications to achieve Year 2000 compliance is not expected to be material to the registrant's financial position. Estimated total costs are expected to be between $1.0 million and $2.0 million, including enhancements to software programs and upgrades to hardware, some portion of which would have been done irrespective of the Year 2000 issue. The failure to correct a material Year 2000 problem could result in the interruption or failure of certain normal business activities or operations. Such failures could have a material adverse affect on the registrant's results of operations, liquidity and financial condition. Due to the inherent uncertainty of the Year 2000 problem, resulting in part from the uncertainty of the Year 2000 readiness of third-party tenants, suppliers and customers, the registrant is unable to determine whether the consequences of Year 2000 failures will have a material impact on its results of operations, liquidity or financial condition. The Project is expected to reduce the registrant's level of uncertainty regarding the Year 2000 problem. 4 5 Liquidity and Capital Resources - - ------------------------------- Net cash provided by operations was $4.3 million as compared to cash provided by operations of $20.8 million when comparing the first nine months of 1998 to the same period of 1997. The decrease in cash provided from operations is primarily the result of a net loss of $23.2 million offset by an increase in accrued liabilities in the first nine months of 1998. The net loss was primarily caused by several one-time charges relating to the Proxy contest and change in the board of trustees' composition as detailed in the following section "Results of Operations". Dividends to shares of beneficial interest paid in 1998 of $6.6 million represented 152% of net cash from operations. The registrant received $25 million in full repayment of two mortgage investments secured by a mall in Middletown, WV and an office building in Cleveland, OH during the first nine months of 1998. The proceeds were used to repay borrowings under the registrant's bank credit facilities. Additionally, the registrant in May 1998 sold land in Cleveland, OH for $6 million which was also used to repay bank credit facilities. As noted previously, the registrant acquired five parking facilities and a development site for $62.3 million in cash. The properties were acquired by borrowing under the bank credit facilities, assumption of two mortgages totaling $5.2 million and the issuance of a $.9 million second mortgage. The registrant invested $19.2 million in its existing portfolio primarily to construct the first phase of a shopping center in Abilene, TX and continue to tenant the former retail center in Denver, CO, which has been converted into an office technology center. As noted previously, the registrant's affiliated management company purchased the remaining non-voting common stock of Impark that it did not own in June 1998 for $11.2 million. During the second quarter of 1998, the registrant sold $2.1 million of stock of another REIT and $11.5 in U.S. Treasury bills. The U.S. Treasury bills were collateral for a financial guarantee that the registrant had made in conjunction with the registrant's affiliated management company's acquisition of Impark. In May 1998, the registrant obtained a $30 million mortgage loan on its Chicago, IL parking garage. The proceeds were used to repay bank lines of credit. In June 1998, the registrant suspended its quarterly dividend to shareholders of beneficial interest and adopted a policy of making only the minimum required distributions to maintain its tax status as a REIT. Additionally, the registrant has adopted a policy of making dividend distributions on an annual basis. Based on current estimates of 1998 taxable income, the registrant does not anticipate additional dividends for shareholders of beneficial interest for 1998. As noted previously, the registrant obtained a $90 million Bridge Loan which was utilized to repurchase approximately $88 million in Senior Notes. To fund the repayment of the Bridge Loan, the registrant intends to, first, sell certain assets, second, if necessary, conduct a rights offering. To facilitate the rights offering, the registrant, in September 1998, filed a registration statement on Form S-3 with the Securities and Exchange Commission (SEC). 5 6 Results of Operations - - --------------------- Net loss applicable to shares of beneficial interest for the third quarter of 1998 was $11.7 million as compared to $.7 million in net income for the same period of 1997. The net loss for the third quarter of 1998 included $3.6 million in severance for current and future employee terminations, legal fees of $1.6 million incurred to complete due diligence for possible corporate and financial transactions of the registrant and $1.1 million for foreign currency loss from the registrant's subordinated notes to Impark that it had made in conjunction with its affiliated management company's acquisition of voting control of Impark. Prior to the third quarter of 1998, the registrant had hedged these notes to protect from the risk of currency fluctuations. The hedge was sold in June 1998 requiring subsequent currency movements be recorded in the results of operations. Additionally, in conjunction with the registrant's adoption of the Financial Accounting Standards Board's Emerging Issues Task Force bulletin 98-9 ("EITF 98-9"), "Accounting for Contingent Rent in Interim Financial Periods", no percentage rent revenue was recorded in the third quarter of 1998 as compared to $1 million in the same period of 1997. The new accounting standard requires the accrual of percentage rent only when the tenant has exceeded its defined sales breakpoint level. Consequently, instead of recording participation rents throughout the year, the majority of this rent now will be recorded in the fourth quarter of each year resulting in less percentage rent being accrued during the first three quarters of the year. Net loss applicable to shares of beneficial interest for the nine months ended September 30, 1998 was $25.5 million as compared to net income of $2.4 million for the nine-month period ended September 30, 1997. The net loss for the nine month period ending September 30, 1998 included a $2.3 million reserve on a property acquisition deposit, a $3.4 million payment to the registrant's former chairman and chief executive officer, a $5.1 million expense due to lifting of restrictions on restricted shares which followed the change of control of the registrant, $2.5 million in other professional fees relating to the change of control, and $4.8 million in proxy and litigation expenses. Additionally, as noted in the preceding paragraph, the registrant incurred $1.1 million in foreign currency declines and a decline in participation rent of $1 million due to the adoption of EITF 98-9 during the third quarter of 1998, $3.6 million in severance for anticipated employee terminations and $1.6 million in legal fees. Net income applicable to shares of beneficial interest for 1997 included $.7 million of income from the repayment of a wraparound mortgage investment, as the proceeds of $18 million exceeded the registrant's basis in the wraparound mortgage investment and $.5 million resulting from a casualty loss at one of the registrant's shopping centers. In February 1998, 951,000 preferred shares of beneficial interest were converted into common shares of beneficial interest resulting in a decreased accrued preferred dividend when comparing 1998 to 1997. Net loss for the first nine months of 1998 included $8.6 million of capital gains. The registrant sold its land beneath a building in Cleveland, Ohio resulting in a capital gain of $1.7 million. An additional capital gain of $7.7 million was recognized when a mortgage investment was repaid. This capital gain had been deferred from a property sale in 1982 since the registrant received the mortgage note as purchase consideration. The registrant also realized a capital loss from the sale of a forward exchange contract of $.8 million in the second quarter of 1998. Additionally, net loss for the first nine months of 1998 included $1.6 million of unamortized Senior Note issue costs and professional fees which were expensed in the third quarter of 1998 when the registrant repaid $88 million of the Senior Notes prior to their maturity. Mortgage loan interest income declined by $.5 million and $1.1 million, respectively, when comparing the third quarter and nine months of 1998 to the same periods of 1997. The decline in interest income when comparing the third quarter of 1998 to 1997 was caused by the repayment of a mortgage investment secured by a shopping mall in Middletown, WV in January 1998 and the repayment of a mortgage investment secured by an 6 7 office building in Cleveland, OH in May 1998. The decline in interest income when comparing the nine months of 1998 to that of 1997 was caused by the aforementioned mortgage repayments and the repayment of a wraparound mortgage investment secured by an apartment complex in Atlanta, GA in February 1997. The registrant had approximately $11.5 million invested in U.S. Treasury bills and approximately $2.1 million invested in the stock of another REIT for the first five months of 1998. The U.S. Treasury bills were purchased in April 1997 to secure the registrant's obligation under an agreement with the former owners of Impark to collateralize the $10.5 million in non-voting stock and accrued interest which the former owners of Impark received when the registrant's affiliated management registrant purchased voting control of Impark in April 1997. The REIT stock was acquired in the third and fourth quarter of 1997 as a long term investment. As noted previously, the non-voting common stock of Impark was purchased in June 1998 allowing the registrant to liquidate the investment. The registrant liquidated its holdings in the REIT stock as a result of its change in investment strategy. In September 1996, the registrant invested in a joint venture that owned eight shopping malls and 50% of another mall. The registrant in September 1997 purchased the interests of its joint venture partners. Consequently, the registrant's investment income and management fees for the registrant's affiliated management declined when comparing 1998 to 1997. Property net operating income, which is rental and parking revenues less property operating expenses and real estate taxes was $4.5 million greater when comparing the three months ended September 30, 1998 to the same period of 1997, on a non-comparable basis. Property net operating income for the comparable portfolio and Impark declined by $1 million when comparing the third quarter of 1998 to 1997. The decline in property net operating income was caused primarily by the adoption of EITF 98-9, resulting in a reduction of $1 million in participation rent accrued in the third quarter of 1998 as compared to the same period of the prior year and a $.2 million decline in net operating income from Impark primarily due to decreased sales at its equipment subsidiaries. These declines were partially offset by the increased property net operating income resulting from the continued retenanting of the North Valley Technical Center. The acquisition of the former joint venture properties in September 1997 produced $4.5 million of increased property net operating income when comparing the third quarter of 1998 to that of 1997. The registrant's acquisition of five parking garages and a development site in the first half of 1998 resulted in $1.1 million in additional property net operating income which was partially offset by the loss of $.4 million in property net operating income from the sale of an office complex and apartment complex in the last four months of 1997. Property net operating income for the nine months of 1998 increased $23 million when comparing the first nine months of 1998 to 1997 on a non-comparable basis. The acquisition of Impark in April 1997 and the acquisition of the former joint venture properties in September 1997 produced $.8 million and $21 million, respectively of increased property net operating income when comparing the first nine months of 1998 to the same period of 1997. Property net operating income for the comparable portfolio was consistent when comparing the first nine months of 1998 to the same period of 1997. However, after removing the effect of EITF 98-9 from the property operating results for the nine months ended September 30, 1998, comparable property net operating income increased by $1 million. The increase was attributable to the continued lease-up of the North Valley Technical Center and increased rental rates in the apartment portfolio. The acquisition of five parking facilities, a development site and the Canadian parking facilities produced $2.7 million in property net operating income which was partially offset by the loss of $1.4 million in property operating income from the sale of an office complex and an apartment complex in the last four months of 1997. Mortgage interest expense increased when comparing the third quarter and nine months of 1998 to that of 1997 primarily due to the $203 million in mortgage debt assumed in 7 8 September 1997 in conjunction with the purchase of the remaining interest in the registrant's joint venture and the $30 million mortgage obtained in May 1998. Bank loan interest expense increased when comparing the third quarter and nine months of 1998 to the same period of the prior year, exclusive of the bank debt assumed in the April 1997 acquisition of Impark due to increased borrowing. The average balance outstanding exclusive of Impark's bank debt for the third quarter and nine months of 1998 was $77.3 million and $87 million, respectively. The average balance outstanding for the third quarter and nine months of 1997 was approximately $11 million. The bank loans increased when comparing 1998 to 1997 primarily due to borrowings to fund the parking garage acquisitions and development site, partially fund the purchase of the registrant's partners' interest in a joint venture and to fund tenant and capital improvements during 1997 and 1998. Additionally, the bank covenant waiver fees of $.7 million for the second quarter covenant violations were recorded as bank loan interest expense in June 1998. Offsetting the increase in the bank credit facilities was the proceeds from property sales during the last four months of 1997 and in May 1998, the repayment of mortgage investments in the first and third quarters of 1998 and the $30 million mortgage obtained in May 1998. Additionally, the inclusion of Impark for a full nine months in 1998, as opposed to five and a half months in 1997, in the results of the registrant results in bank interest expense increasing by $.9 million when comparing 1998 to 1997. Depreciation and amortization expense for 1998 increased over 1997 primarily due to the amortization of goodwill and management contracts associated with the acquisition of Impark in April 1997, the depreciation from the eight shopping malls acquired in September 1997 when the registrant acquired its joint venture partners' interest in the malls and the depreciation from the four parking facilities which were acquired in the first quarter of 1998. General and administrative expenses for the third quarter of 1998 increased by $5.3 million when compared to the same period of 1997. The increase was caused primarily due to a $3.6 million accrual for severance for current and future employee terminations and $1.6 million of legal fees principally relating to the proxy contest, the tender offer and consent solicitation, the Bridge Loan, the rights offering and certain corporate restructuring matters. General and administrative expenses increased when comparing the nine months of 1998 to the same period of 1997 primarily related to certain one-time items. As noted earlier, in the second quarter of 1998, the registrant recorded several one-time charges as a result of the change in control and professional fees resulting from the proxy contest prior to the change in control. The one-time charges in the second quarter of 1998 included $3.4 million resulting from the termination of the former chairman and chief executive officer, $5.1 million for the vesting of restricted shares which occurred upon the change in control, and $2.5 million in additional professional fees resulting from the proxy contest. Additionally, in the third quarter of 1998, the registrant incurred $3.6 of severance expense and $1.6 million in legal expense as discussed in the preceding paragraph. Impark's general and administrative expenses increased over 1997 due to its inclusion in results for a full nine months in 1998 versus five and a half months in 1997, approximately $1.2 million in expansion costs into U.S. markets incurred in 1998 and a $.4 million reserve for the termination of a contract to replace its computer system. The registrant also recorded a $2.3 million provision for the potential loss of an earnest money deposit relating to a property acquisition which may not be consummated. The registrant during 1998 incurred $4.8 million in proxy and litigation expenses, including $3.1 million for the proxy - expenses of Gotham Partners L.P. 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 uncertanties 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 registrant's Annual Report filed by the company with the SEC on Form 10K. 8 9 PART II - OTHER INFORMATION - - --------------------------- Item 1. Legal Proceedings. - - ------- ------------------ Registrant vs. Gotham Partners, L.P. Cuyahoga County Court of Common Pleas, Case No. 347063 On September 16, 1998, pursuant to motion of the registrant, the court issued a Temporary Restraining Order prohibiting payments to be made pursuant to a certain Escrow Agreement between the registrant, First Union Management, Inc. and National City Bank dated May 22, 1998. Service of such order was made on National City Bank. A hearing on registrant's motion for preliminary injunction was scheduled for September 30, 1998. Prior to such hearing, the specific matter giving rise to the issuance of the Temporary Restraining Order was settled by agreement and the Order dissolved. Item 2. Changes in Securities. - - ------- ---------------------- In July 1998, the registrant commenced a tender offer to purchase for cash all of its outstanding Senior Notes and concurrently conducted a consent solicitation to amend the indenture governing the Senior Notes and to terminate the listing of the Senior Notes on the New York Stock Exchange. In August 1998, pursuant to the tender offer and consent solicitation, holders of approximately 88% of the outstanding Senior Notes consented to the indenture amendments and delisting and registrant purchased approximately $88 million principal amount of Senior Notes. The indenture amendments eliminated covenants relating to (i) limitation of indebtedness, (ii) limitation on certain liens, (iii) maintenance of a specified minimum tangible net worth, (iv) transactions with affiliates, (v) maintenance of corporate existence, (vi) maintenance of properties, (vii) maintenance of certain insurance, (viii) payment of taxes and other claims, (ix) statements as to compliance with covenants and conditions under the indenture, and (x) repurchase of the Senior Notes upon a change of control. In addition, the indenture amendments modified provisions in the indenture relating to when the registrant may merge, consolidate or sell its assets, eliminated certain events of default in the indenture, and made certain conforming and other changes to the indenture. As a result of the indenture amendments, holders of Senior Notes that were not purchased pursuant to the tender offer no longer are entitled to the benefits of substantially all of the restrictive covenants and certain events of default contained in the indenture. The elimination of substantially all of these restrictive covenants permit the registrant to take actions that could increase the credit risks of the registrant. These increased credit risks may adversely affect the market prices of the Senior Notes or otherwise be adverse to the interests of the holders of the remaining Senior Notes. Elimination of certain events of default removed the right of holders of Senior Notes to pursue certain remedies. The indenture amendments do not relieve the registrant from any of its obligations to make payments of principal and interest on Senior Notes not purchased pursuant to the tender offer. Item 3. Defaults Upon Senior Securities. - - ------- -------------------------------- None. 9 10 Item 4. Submission of Matters to a Vote of Security Holders. - - ------- ---------------------------------------------------- As discussed above, in July 1998, the registrant commenced a tender offer to purchase for cash all of its outstanding Senior Notes and conducted a consent solicitation to amend the indenture governing the Senior Notes and to terminate the listing of the Senior Notes on the New York Stock Exchange. The consent of more than a majority in aggregate principal amount of the holders of Senior Notes registered holders was required to approve the indenture amendments and the consent of more than 66 2/3% in aggregate principal amount of the holders of Senior Notes was required to approve the delisting. In August 1998, pursuant to the tender offer and consent solicitation, holders of approximately 88% of the outstanding principal amount of Senior Notes consented to the indenture amendments and delisting. Item 5. Other Information. - - ------- ------------------ In November 1998, the registrant hired Daniel P. Friedman as Chief Executive Officer, and David Schonberger and Anne Zahner as Executive Vice Presidents. Mr. Friedman, Mr. Schonberger and Ms. Zahner were previously employed by Enterprise Asset Management Inc. ("Enterprise"), a New York City based real estate investment firm. Mr. Friedman was also elected to fill one of the two vacant seats on the registrants board of trustees At Enterprise, beginning in 1991, Mr. Friedman, age 41, served as President and Chief Operating Officer and directed Enterprise's opportunistic investment program which included the acquisition of Class B enclosed malls, Class B office buildings, tax-exempt financed apartments, non-performing loans, public and private real estate and real-estate-related securities, various development opportunities, underlying co-op loans and unsold co-op shares, as well as co-venture investments in a number of early-and later-stage real estate and real-estate-related investment programs. At Enterprise, Mr. Friedman was also responsible for the day-to-day asset management of the firm's $500 million real estate portfolio and for sourcing equity capital for co-investment opportunities from partners including university endowments, investment banks, and various opportunity funds. Mr. Friedman received an MBA from the Harvard Business School and a BS in Chemistry from Stanford University. As Executive Vice President of Enterprise, Ms. Zahner, age 42, was responsible for asset management and new business development. Prior to joining Enterprise, Ms. Zahner was a regional director of real estate asset management and sales and vice president of investment management and recovery for the Travelers Insurance Registrant ("Travelers"), where she managed the workout of a $750 million loan and property portfolio. Prior to Travelers, Ms. Zahner was a real estate investment officer at Riverbank America and the ADCO Group. Ms. Zahner received an MBA from the Harvard Business School and a BA in Political Economy from the University of California at Berkley. As Vice President of Development at Enterprise, Mr. Schonberger, age 44, was responsible for all development activities including major sub-division, pre-development planning, and construction of leased and build-to-suit properties. For 15 years, Mr. Schonberger has acted as a private developer of major retail and commercial properties in the New York metropolitan area. He also founded, managed, and later sold a property management and leasing company specializing in the third party management of institutional office properties. Mr. Schonberger received a BS in Life Sciences from Connecticut College. In October 1998, William Scully was elected to fill one of three vacant seats on registrant's board of trustees. Mr. Scully has been with Apollo Real Estate Advisors, L.P. ("Apollo") since 1996 and is responsible for new investments and investment management for Apollo. 10 11 Item 6. Exhibits and Reports on Form 8-K. - - ------- ---------------------------------
(a) Exhibits: --------- Exhibit (20) - Financial Statements Combined Balance Sheets as of September 30, 1998 (unaudited) and December 31, 1997 (audited) Combined Statements of Income for the Nine Months ended September 30, 1998 and 1997 (unaudited) Combined Statements of Changes in Cash for the Nine Months ended September 30, 1998 and 1997 (unaudited) Notes to Combined Financial Statements Exhibit (27.1) - Nine months ended September 30, 1998 Exhibit (27.2) - Nine months ended September 30, 1997 (restated) (b) Reports on Form 8-K: -------------------- July 21, 1998 - Registrant's announcement of tender offer for its 8 7/8% Senior Notes and bank waiver of certain violations under existing credit facilities.
11 12 SIGNATURES ---------- Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. First Union Real Estate Equity and Mortgage Investments ---------------------------------- (Registrant) Date: November 13, 1998 By: /s/ Steven M. Edelman --------------------------------- Steven M. Edelman, Executive Vice President, Chief Financial Officer Date: November 13, 1998 By: /s/ Gregory C. Scott --------------------------------- Gregory C. Scott Controller 12 13 Index to Exhibits -----------------
Page Number ------ Exhibit (20) - Financial Statements Combined Balance Sheets as of September 30, 1998 (unaudited) and December 31, 1997 (audited)................................................. 14 ---- Combined Statements of Income for the Nine Months ended September 30, 1998 and 1997 (unaudited)............................ 14 ---- Combined Statements of Changes in Cash for the Nine Months ended September 30, 1998 and 1997 (unaudited)....................... 14 ---- Notes to Combined Financial Statements.......................................... 14 ---- Exhibit (27) - Financial Data Schedule 15 ----
13 EX-20 2 EXHIBIT 20 1 Exhibit 20 FIRST UNION REAL ESTATE EQUITY and MORTGAGE INVESTMENTS - - ------------------------------------------------------- Combined Balance Sheets
(In thousands, except shares) September 30, December 31, 1998 1997 (unaudited) (audited) --------------- ------------- ASSETS Investments in real estate Land $ 139,488 $ 109,308 Buildings and improvements 702,277 648,571 --------- --------- 841,765 757,879 Less - Accumulated depreciation (127,409) (113,858) --------- --------- Total investments in real estate 714,356 644,021 Investment in joint venture 1,598 1,575 Mortgage loans and notes receivable 5,521 30,686 Other assets Cash and cash equivalents - unrestricted 5,327 2,582 - restricted 17,873 14,282 Accounts receivable and prepayments 18,513 20,070 Investments 13,103 Inventory 3,214 3,374 Goodwill, net 61,183 66,560 Management and lease agreements, net 2,200 4,113 Deferred charges and other, net 6,182 6,300 Unamortized debt issue costs 7,199 7,445 Other 6,415 5,910 --------- --------- Total assets $ 849,581 $ 820,021 ========= ========= LIABILITIES AND SHAREHOLDERS' EQUITY Liabilities Bank loans $ 101,995 $ 69,922 Mortgage loans 346,065 313,391 Notes payable 94,998 146 Senior notes 12,538 100,000 Accounts payable and accrued liabilities 38,249 38,000 Deferred obligations 10,608 10,807 Deferred capital gains and other deferred income 2,370 10,646 Other 10,957 --------- --------- Total liabilities 606,823 553,869 --------- --------- Minority interest 1,047 1,047 Shareholders' equity Preferred shares of beneficial interest, $25 liquidation preference, 2,300,000 shares authorized and 1,349,000 outstanding 31,737 54,109 Shares of beneficial interest, $1 par, unlimited authorization, outstanding 31,416 28,179 Paid-in capital 180,007 189,272 Deferred compensation (5,643) Foreign currency translation adjustment (1,449) (812) --------- --------- Total shareholders' equity 241,711 265,105 --------- --------- $ 849,581 $ 820,021 ========= =========
2 Exhibit 20 FIRST UNION REAL ESTATE EQUITY and MORTGAGE INVESTMENTS - - ------------------------------------------------------- Combined Statements of Income
(In thousands, except per share data) Three Months Ended Nine Months Ended September 30, September 30, (unaudited) (unaudited) ------------------------ ------------------------- 1998 1997 1998 1997 -------- --------- --------- --------- Revenues Rents $ 78,057 $ 70,440 $ 237,839 $ 145,643 Interest - Mortgage loans 118 648 1,093 2,221 - Short-term investments 227 635 911 1,319 - Investments 2 177 302 301 Equity in (loss) income from joint venture (12) (172) 23 412 Management fees 84 1,099 262 2,706 Other income 194 308 441 1,601 -------- --------- --------- --------- 78,670 73,135 240,871 154,203 -------- --------- --------- --------- Expenses Property operating 55,323 52,989 168,615 101,695 Real estate taxes 3,269 2,490 9,335 7,106 Depreciation and amortization 7,508 5,276 20,365 12,724 Interest - Mortgage loans 7,471 3,799 21,463 8,489 - Senior notes 1,141 2,219 5,578 6,656 - Bank loans and other 2,439 1,307 9,259 3,338 - Notes payable 1,267 1,267 General and administrative 8,443 3,110 29,271 8,138 Litigation and proxy expenses 4,848 Foreign currency loss 1,125 1,125 -------- --------- --------- --------- 87,986 71,190 271,126 148,146 -------- --------- --------- --------- Income (loss) before capital gains and extraordinary loss (9,316) 1,945 (30,255) 6,057 from early extinguishment of debt Capital gains 8,648 Extraordinary loss from early extinguishment of debt (1,633) (1,633) -------- --------- --------- --------- Net income (loss) before preferred dividend (10,949) 1,945 (23,240) 6,057 Preferred dividend (708) (1,207) (2,291) (3,622) -------- --------- --------- --------- Net income (loss) applicable to shares of beneficial interest $(11,657) $ 738 $ (25,531) $ 2,435 ======== ========= ========= ========= Per share data Basic weighted average shares 31,431 27,337 30,561 23,522 Stock options, treasury method -- 444 -- 444 Restricted shares, treasury method -- 225 2 225 -------- --------- --------- --------- Diluted weighted average shares 31,431 28,006 30,563 24,191 ======== ========= ========= ========= Income (loss) applicable to shares of beneficial interest before capital gains and extraordinary loss from early extinguishment of debt, basic and diluted $ (.32) $ .03 $ (1.06) $ .10 ======== ========= ========= ========= Net income (loss) applicable to shares of beneficial interest, basic and diluted $ (.37) $ .03 $ (.84) $ .10 ======== ========= ========= =========
Statement of Comprehensive Income
Unaudited (In thousands) Three Months Ended Nine Months Ended September 30, September 30, ------------------------- ------------------------- 1998 1997 1998 1997 -------- --------- --------- --------- Net Income (loss) $(11,657) $ 738 $ (25,531) $ 2,435 Available for sale securities 66 Foreign currency translation adjustment (337) (86) (637) 15 -------- --------- --------- --------- Comprehensive income $(11,994) $ 652 $ (26,102) $ 2,450 ======== ========= ========= =========
3 Exhibit 20 Combined Statements of Changes in Cash
Unaudited (In thousands) Three Months Nine Months Ended September 30, Ended September 30, ------------------------ --------------------------- 1998 1997 1998 1997 ----------- ----------- ----------- ----------- Cash provided by operations Net income (loss) before preferred dividend $(10,949) $ 1,945 $(23,240) $ 6,057 Adjustments to reconcile net income (loss) to net cash provided by (used for) operations -- Depreciation and amortization 7,508 5,276 20,365 12,724 Capital gains (8,648) Extraordinary loss from early extinguishment of debt 1,633 1,633 Foreign currency loss 1,125 1,125 Vesting of restricted shares 5,068 Decrease (increase) in deferred charges and other, net 195 (1,084) (1,039) (4,631) Increase (decrease) in deferred income 738 207 (558) 996 Increase in deferred interest on mortgage investments (19) (6) (102) Decrease in deferred obligations (5) (4) (15) (13) Net changes in other assets and liabilities (980) 1,452 9,647 5,798 -------- -------- -------- --------- Net cash provided by (used for) operations (735) 7,773 4,332 20,829 -------- -------- -------- --------- Cash provided by (used for) investing Repayment of mortgage investment and note payable 25,045 16,200 Investment in short-term investments (12,651) (12,651) Principal received from mortgage investments 13 57 126 159 Proceeds from sale of properties 4,023 6,042 13,011 Purchase of investments (1,771) Investments in properties (2,208) (63,022) Investments in capital and tenant improvements (4,929) (7,857) (19,167) (16,946) Acquisition of joint venture interests, net of cash aquired (72,900) (72,900) Investment in Impark (11,195) (36,574) Deposit for property acquisitions (2,000) (70) (2,000) Sale of investments 1,621 15,141 -------- -------- -------- --------- Net cash used for investing (5,503) (91,328) (48,871) (111,701) -------- -------- -------- --------- Cash provided by (used for) financing (Decrease) increase in short-term loans 6,701 38,975 32,072 13,175 Increase in note payable 90,000 90,000 Increase in mortgage loans 30,000 2,737 Repayment of mortgage loans - Normal payments (1,001) (632) (2,928) (1,839) - Balloon payments (468) (468) (13,835) Sale of hedge agreement 825 Purchase of senior notes (87,462) (87,462) Purchase of First Union shares (1,829) Sale of First Union shares 51 2,995 121,049 Debt issue costs paid (2,003) (202) (3,129) (1,013) Dividends paid to shares of beneficial interest (3,076) (6,577) (7,378) Dividends paid to preferred shares of beneficial interest (708) (1,208) (2,624) (3,663) -------- -------- -------- --------- Net cash provided by financing 5,059 33,908 50,875 109,233 -------- -------- -------- --------- Decrease in cash and cash equivalents (1,179) (49,647) 6,336 18,361 Cash and cash equivalents at beginning of period 24,379 70,959 16,864 2,951 -------- -------- -------- --------- Cash and cash equivalents at end of period $ 23,200 $ 21,312 $ 23,200 $ 21,312 ======== ======== ======== =========
Income per share of beneficial interest has been computed in accordance with SFAS 128 (Earnings Per Share). SFAS 128 requires that common share equivalents be excluded from the weighted average shares outstanding for the calculation of basic earnings per share. Shares and per share amounts for 1997 have been restated accordingly. In May 1998, the registrant sold its investment in the land beneath the Huntington Building in Cleveland, Ohio for $6.0 million resulting in a capital gain of $1.7 million. Additionally, an $18.9 million mortgage investment secured by the Huntington Building was repaid in 1998 resulting in the recognition of a $7.7 million capital gain which was deferred when the building was sold in 1982 since the registrant received the mortgage note as consideration. In June 1998, the registrant sold a forward exchange agreement resulting in a loss of $.8 million. The forward exchange contract was purchased to protect the registrant from foreign currency fluctuations resulting from notes issued in conjunction with the acquisition of Impark. In August 1998, the registrant repaid $87.5 million of its 8 7/8% senior notes resulting in $1.6 million of issue costs and solicitation fees being expensed. The registrant, in July 1998, adopted the Financial Accounting Standards Board's Emerging Issues Task Force Bulletin 98-9 (EITF-98-9), "Accounting for Contingent Rent in Interim Financial Periods" on a prospective basis. EITF-98-9 requires that contingent rental income, such as percentage rent which is dependent on sales of retail tenants, be recognized in the period that a tenant exceeds its specified sales breakpoint. Consequently, the registrant will accrue the majority of percentage rent income in the fourth quarter of each year after the adoption of EITF-98-9. As a result, no percentage rent income was recorded by the registrant in the third quarter of 1998. In the third quarter of 1997, $1.0 million of percentage rental income was recorded. EX-27.1 3 EXHIBIT 27.1
5 0000037008 FIRST UNION REAL ESTATE EQUITY AND MORTGAGE INVESTMENTS 9-MOS DEC-31-1998 JAN-01-1998 SEP-30-1998 23,200,000 0 18,513,000 0 3,214,000 44,927,000 841,765,000 127,409,000 849,581,000 38,249,000 448,060,000 31,416,000 0 31,737,000 178,588,000 849,581,000 0 240,871,000 0 177,950,000 55,609,000 0 37,567,000 0 0 (30,255,000) 0 0 0 (25,531,000) (.84) (.84)
EX-27.2 4 EXHIBIT 27.2
5 0000037008 FIRST UNION REAL ESTATE EQUITY AND MORTGAGE INVESTMENTS 9-MOS DEC-31-1997 JAN-01-1997 SEP-30-1997 21,312,000 12,651,000 20,008,000 0 0 53,971,000 769,436,000 (115,174,000) 816,079,000 46,326,000 422,114,000 0 54,109,000 28,137,000 168,574,000 816,079,000 0 154,203,000 0 108,801,000 20,862,000 0 18,483,000 0 0 2,435,000 0 0 0 2,435,000 .10 .10
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