-----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, CM6J6h/dpHktaSeptYMOjBS4oaZXfr9Fi/FKm6LHHNV5SDWUvFjXfpW5hPPZvXKN O5aXYLrfBeIdukzEOZLl9w== 0000950152-99-003217.txt : 19990414 0000950152-99-003217.hdr.sgml : 19990414 ACCESSION NUMBER: 0000950152-99-003217 CONFORMED SUBMISSION TYPE: 10-K405/A PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990413 FILER: COMPANY DATA: COMPANY CONFORMED NAME: FIRST UNION REAL ESTATE EQUITY & MORTGAGE INVESTMENTS CENTRAL INDEX KEY: 0000037008 STANDARD INDUSTRIAL CLASSIFICATION: REAL ESTATE INVESTMENT TRUSTS [6798] IRS NUMBER: 346513657 STATE OF INCORPORATION: OH FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405/A SEC ACT: SEC FILE NUMBER: 001-06249 FILM NUMBER: 99592910 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-K405/A 1 FIRST UNION REAL ESTATE EQUITY & MORT. 10-K405/A 1 , SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K/A ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED 12-31-98 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 -------------- SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NAME OF EACH EXCHANGE ON TITLE OF EACH CLASS WHICH REGISTERED ------------------- ---------------- SHARES OF BENEFICIAL INTEREST (PAR VALUE $1 PER SHARE) NEW YORK STOCK EXCHANGE - ------------------------ ----------------------- SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: NONE (Title of class) 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. Yes [X] No [ ] State the aggregate market value of the voting stock held by non-affiliates of the registrant. The aggregate market value shall be computed by reference to the price at which the stock was sold, or the average bid and asked prices of such stock, as of a specified date within 60 days prior to the date of filing. As of January 31, 1999, 26,069,303 Shares of Beneficial Interest were held by non-affiliates, and the aggregate market value of such shares was approximately $130,346,515. (APPLICABLE ONLY TO CORPORATE REGISTRANTS) Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable date. 31,376,105 SHARES OF BENEFICIAL INTEREST WERE OUTSTANDING AS OF JANUARY 31, 1999 - -------------------------------------------------------------------------------- DOCUMENTS INCORPORATED BY REFERENCE List hereunder the following documents if incorporated by reference and the Part of the Form 10-K into which the document is incorporated: (1) Any annual report to security holders; (2) Any proxy or information statement; and (3) Any prospectus filed pursuant to Rule 424(b) or (c) under the Securities Act of 1933. The listed documents should be clearly described for identification purposes. 1999 Proxy Statement 2 FIRST UNION REAL ESTATE EQUITY AND MORTGAGE INVESTMENTS CROSS REFERENCE SHEET PURSUANT TO ITEM G, GENERAL INSTRUCTIONS TO FORM 10-K
ITEM OF FORM 10-K LOCATION - ----------------- -------- (PAGE OR PAGES) PART I 1. Business 3 through 6 2. Properties 7 through 12 3. Legal Proceedings 13 4. Submission of Matters to a Vote of Security Holders 13 PART II 5. Market for Registrant's Common Equity and Related Stockholder Matters 13; Exhibit 13, page 1 6. Selected Financial Data 13; Exhibit 13, page 2 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 13; Exhibit 13, pages 25 through 31 7A. Quantitative and Qualitative Disclosures Regarding Market Risk 13, Exhibit 13, page 28 --- 8. Financial Statements 13; Exhibit 13, pages 4 through 7 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 13 PART III 10. Directors and Executive Officers of the Registrant 14; 1999 Proxy Statement 11. Executive Compensation 14; 1999 Proxy Statement 12. Security Ownership of Certain Beneficial Owners and Management 14; 1999 Proxy Statement 13. Certain Relationships and Related Transactions 14; 1999 Proxy Statement PART IV 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K (a) Financial Statements and Financial Statement Schedules 14 and 22 through 28; Exhibit 13, pages 4 through 7 (b) Exhibits 15 through 20; Exhibit Index, pages 29 through 34 (c) Reports on Form 8-K 28
2 3 PART I ITEM 1. BUSINESS. The registrant is an unincorporated association in the form of a business trust organized in Ohio under a Declaration of Trust dated August 1, 1961, as amended from time to time through July 25, 1986 (the "Declaration of Trust"), which has as its principal business activity the ownership and management of real estate investments. The registrant qualifies as a real estate investment trust ("REIT") under Sections 856 through 860 of the Internal Revenue Code (the "Code"). To encourage efficient operation and management of its property, and after receiving a ruling from the Internal Revenue Service with respect to the proposed form of organization and operation, the registrant, in 1971, caused a management company to be organized pursuant to the laws of the State of Delaware under the name First Union Management, Inc. (the "Management Company"), to lease property from the registrant and to operate such property for its own account as a separate taxable entity. At December 31, 1998, the registrant net leased 47 of its properties to the Management Company. The shares of the Management Company are held in trust, with the shareholders of the registrant, as exist from time to time, as contingent beneficiaries. The Management Company, in April 1997, acquired voting control of Imperial Parking Limited and its affiliates ("Impark") which is primarily a parking management and transit ticketing manufacturing company based in Canada. Because the Management Company owns voting control of Impark, the financial statements of Impark are consolidated with the Management Company. Additionally, for financial reporting purposes, the financial statements of the Management Company are combined with those of the registrant. On July 22, 1998, tax legislation was enacted limiting the "grandfathering rules" applicable to stapled REITS, such as the registrant (the "Stapled REIT Legislation"). As a result, the income and activities of the Management Company with respect to any real property interests acquired by the registrant and the Management Company after March 26, 1998, for which there was no binding written agreement, public announcement or filing with the Securities and Exchange Commission on or before March 26, 1998, will be attributed to the registrant for purposes of determining whether the registrant qualifies as a REIT under the Code. The registrant terminated its management arrangements with the Management Company in March 1999, and self-manages its retail, apartment and office portfolios. The registrant entered into third-party management arrangements for the parking facilities it owns. Accordingly, the registrant no longer receives any rents from the Management Company. The registrant owns regional enclosed shopping malls, apartment complexes, large downtown office buildings and parking facilities. The registrant's portfolio is diversified by type of property, geographical location, tenant mix and rental market. As of December 31, 1998, the registrant owned (in fee or pursuant to long-term ground leases under which the registrant is lessee) 21 shopping malls, 8 apartment complexes, 5 office properties, 7 parking garages and 2 surface parking lots in the United States and 1 parking garage and 10 surface parking lots in Canada. The registrant also owns 50% of another mall in a joint venture with an unrelated party. All of the registrant's shopping malls compete for tenants on the basis of the rent charged and location, and encounter competition from other retail properties in their respective market areas. Some of the registrant's shopping malls compete with other shopping malls in the environs. However, the principal competition for the registrant's shopping malls may come from future shopping malls locating in their market areas. Additionally, the overall economic health of retail tenants impacts the registrant's shopping malls. Due to the overbuilding of retail space and a demand for large, open area, administrative service space in Denver, CO, in 1995, the registrant has repositioned a former retail mall into an office property and released approximately 64% of the former mall. Additionally, due to excess mall space in Abilene, TX in 1997, the registrant demolished its enclosed mall and constructed the first phase of a strip shopping center which opened in 1998. In February 1999, the registrant sold its shopping center in Buffalo Grove, IL and signed contracts to sell 8 shopping malls and 1 shopping center. The registrant's apartment complexes compete with other apartments and residential housing in the immediate areas in which they are located and may compete with apartments and residential housing constructed in the same areas in the future. The registrant's office properties compete for tenants principally with office buildings throughout the respective areas in which they are located. In most areas where the registrant's office buildings are located, competition for tenants has been and continues to be intense on the basis of rent, location and age of the building. The registrant sold its office building in Shreveport, LA in March 1999. The registrant currently has its Indianapolis, IN and Marysville, CA office properties under contract with closings scheduled to occur in April 1999. The registrant plans to hold and redevelop its Cleveland, OH office building. The registrant's parking facilities compete with other parking facilities in the immediate areas in which they are located and may compete with new parking facilities constructed in the same areas in the future. The registrant's mortgage investments are collateralized by an apartment complex and the management contract of another apartment complex. The risks inherent with the registrant's mortgage portfolio relate to the performance and the value of the apartment complexes that secure the mortgage investments. These risks may impair the realizability of the mortgage investments. The registrant's segment data may be found in footnote 23 to the Combined Financial Statements on page 19 to Exhibit 13. The registrant has approximately $206 million in debt due in 1999. The registrant intends to fund the repayment by using cash available at December 31, 1998, a rights offering to shareholders, mortgage financing and the net proceeds from property sales. The registrant's credit rating, leverage, share price and liquidity limit the flexibility of the registrant to avail itself of other types of capital markets transactions at this time. Impark operations consist primarily of parking management in Canada. Impark also has a market presence in Buffalo, NY, Minneapolis, MN, and Milwaukee, WI. Currently, Impark derives 87%, 12% and 1% of revenue from its management of facilities in Canada, the United States and Asia, respectively. Impark's Canadian operations are not hedged against currency fluctuations. Impark faces competition from local and national parking operators in procuring management contracts from third party parking lot and garage owners. Transit ticketing products, manufactured by a wholly-owned subsidiary of Impark, are targeted to be sold to predominantly U.S. mass transit operators, and the sales of these products represent approximately 3% of Impark's gross revenues. RISK FACTORS An investment in the registrant's securities involves various risks. The following factors should be carefully considered in addition to the other information set forth in this report. NEW SENIOR MANAGEMENT LACKS PRIOR EXPERIENCE WITH THE REGISTRANT AND IN OPERATING PUBLIC COMPANIES OR REITS In June 1998, William A. Ackman was elected as Chairman of the Board. In October 1998, William A. Scully was appointed Vice Chairman of the Board. In November 1998, the registrant appointed Daniel P. Friedman as its President and Chief Executive Officer, and David Schonberger and Anne N. Zahner, each as Executive Vice Presidents. Until their appointments, these individuals had little, if any, previous working experience or relationships with the registrant or with the Management Company or with either of their senior management or other personnel. The failure of the new management team to work effectively with the registrant's or the Management Company's other senior management could result in the departure of key personnel or disruptions in the operations of the registrant, which in turn could have a material adverse effect on the registrant's or the Management Company's business, financial condition or results of operations. In addition, none of the members of the new management team has ever operated or served as an executive officer, director or trustee of a public company or a REIT. The lack of experience with or knowledge of issues that confront public companies or REITs could have an adverse effect on the ability of such individuals to effectively manage the operations of the registrant and thereby could have an adverse effect on the registrant's business, financial condition or results of operations. PROPOSED DEPARTURE OF SOME MEMBERS OF SENIOR MANAGEMENT Some members of the senior management team that was in place prior to Mr. Friedman's appointment have expressed a desire to leave the registrant and are in discussions with the registrant regarding the timing and terms of their departure. The departure of these individuals could result in the departure of additional key personnel or disruptions in the operations of the registrant, which in turn could have a material adverse effect on the registrant's business, financial condition or results of operations. DIFFICULTIES IN SERVICING DEBT The registrant recently negotiated amendments to its principal credit facilities, including its senior credit facility (the "FUR Credit Facility"), the Cdn.$38.8 million credit facility of Impark, an affiliate of the registrant and subsidiary of the Management Company (the "Impark Credit Facility" and, together with the FUR Credit Facility, the "Credit Facilities"), and a loan to the registrant from a syndicate of lenders led by BT Alex.Brown (the "Bridge Loan") in an original principal amount of $90 million. Among other things, the amendments, in principle, require the registrant to make significant principal prepayments in April, May and June 1999. As of March 26, 1999, the registrant had $167.6 million in principal outstanding under the FUR Credit Facility and the Bridge Loan and Cdn.$35.4 million in principal outstanding under the Impark Credit Facility. The upcoming amortization payments require the registrant to reduce the principal amounts outstanding under the FUR Credit Facility and the Bridge Loan to $158.9 million in the aggregate in April 1999, $130.0 million in the aggregate in May 1999 and $100.0 million in the aggregate in June 1999. All remaining principal under the FUR Credit Facility and the Bridge Loan is due on August 11, 1999. The registrant is relying on its cash reserves, cash flow from operations, net proceeds from assets sales, financing assets and net proceeds from offerings 3 4 to make these principal payments, but there can be no assurance that these sources will provide sufficient funds to enable the registrant to make these payments. DEFAULT UNDER THE FUR CREDIT FACILITY, THE IMPARK CREDIT FACILITY AND THE BRIDGE LOAN The registrant and Impark recently negotiated amendments to, and waivers of any defaults under, the Credit Facilities and the Bridge Loan. The defaults resulted primarily from the failure to comply with various financial covenants. Although the defaults have been waived and the debt instruments have been amended, there can be no assurance that either the registrant or Impark will satisfy their respective financial covenants or their respective obligations, including principal and interest repayment obligations, under the FUR Credit Facility, the Bridge Loan or the Impark Credit Facility. If the registrant or Impark is unable to satisfy its obligations under either of these facilities or the Bridge Loan, the lenders may declare all indebtedness outstanding thereunder, together with any accrued interest thereon, due and payable immediately and by such action trigger cross-defaults under other debt instruments. There can be no assurance that the registrant or Impark will be able to refinance any of such indebtedness. DEBT COVENANTS RESTRICT OPERATING FLEXIBILITY; FAILURE TO COMPLY WITH DEBT INSTRUMENTS COULD CAUSE ACCELERATION OF DEBT Debt instruments, including the Credit Facilities and the Bridge Loan, to which either of the registrant or the Management Company is currently a party, and to which either may become a party in the future, contain and may contain a number of significant covenants that, among other things, restrict in varying degrees either of the registrant or the Management Company from selling assets, incurring additional indebtedness, repaying other indebtedness, paying dividends, creating liens on assets, entering into leases, making investments, loans or advances, making acquisitions, engaging in mergers or consolidations, engaging in certain transactions with affiliates and certain other corporate activities. Each of the registrant's and the Management Company's ability to remain in compliance with certain such covenants will depend upon, among other things, its results of operations and may be affected by events beyond its control, including economic, financial and industry conditions. Accordingly, there can be no assurance that either of the registrant or the Management Company will remain in compliance with such agreements and covenants. In the event of a default under such instruments or agreements relating to any indebtedness of either of the registrant or the Management Company, the holders of such indebtedness generally will be able to declare all such indebtedness, together with accrued interest thereon, to be due and payable immediately and, in the case of collateralized indebtedness, to proceed against their collateral. In addition, default under one debt instrument could in turn permit lenders under other debt instruments to declare borrowings outstanding thereunder to be due and payable pursuant to cross-default clauses. Accordingly, the occurrence of a default under any debt instrument could have a material adverse effect on the registrant or the Management Company and may cause the registrant or the Management Company to seek protection or relief under applicable bankruptcy laws. CONTEMPLATED ASSET SALES WILL SHRINK PORTFOLIO AND RETURNS TO SHAREHOLDERS; REPLACEMENT ASSETS RESULTING FROM OTHER ASSET SALES MAY NOT PROVIDE GREATER SHAREHOLDER VALUE The registrant is in the process of selling various of its residential, retail, office and parking properties. Because the registrant intends to apply the net proceeds of these asset sales to repay outstanding indebtedness, its portfolio of properties will be smaller, less diverse and less valuable and will generate less revenue for ultimate distribution to its shareholders. In addition, the registrant may elect in the future to sell other assets. To the extent that the net proceeds of any of those asset sales are not used to acquire replacement assets or assets of at least equivalent value, the registrant's portfolio of properties will be similarly affected. There can be no assurance that the registrant will be able to sell the properties described above on advantageous terms, expeditiously or at all. Moreover, if any of these assets are sold and their net proceeds are applied towards the purchase of replacement assets, there can be no assurance that the registrant will be able to acquire replacement assets that will be as valuable as the assets they replace or provide greater returns to the registrant and its shareholders. INCOME AND ACTIVITIES OF MANAGEMENT COMPANY MAY BE ATTRIBUTED TO THE REGISTRANT UNDER RECENT ANTI-STAPLING LEGISLATION AND MAY THREATEN REIT STATUS Under the Stapled REIT Legislation, the anti-stapling rules provided in the Code apply to real property interests acquired or substantially improved after March 26, 1998 by the registrant or the Management Company, or a subsidiary or partnership in which a 10% or greater interest is owned by either the registrant or the Management Company unless: - the real property interests are acquired pursuant to a written agreement that was binding on March 26, 1998 and at all times thereafter or - the acquisition of such real property interests was described in a public announcement or in a filing with the Securities and Exchange Commission on or before March 26, 1998. Consequently, the income and activities of the Management Company with respect to any property acquired by the registrant or the Management Company after March 26, 1998, for which there was no binding written agreement, public announcement or filing with the Securities and Exchange Commission on or before March 26, 1998, will be attributed to the registrant for purposes of determining whether the registrant qualifies as a REIT under the Code. These attribution rules may make it more difficult for the registrant to qualify as a REIT and may subject the registrant to various additional taxes. IMPROVED PROPERTIES MAY BECOME SUBJECT TO ANTI-STAPLING LEGISLATION UNDER CERTAIN CIRCUMSTANCES AND MAY THREATEN REIT STATUS The Stapled REIT Legislation also provides that a property held by a stapled REIT but not subject to the anti-stapling rules would become subject to such rules in the event of either - an improvement placed in service after December 31, 1999 that changes the use of the property and the cost of which is greater than 200% of (1) the undepreciated cost of the property (prior to the improvement) or (2) in the case of property acquired where there is a substituted basis, the fair market value of the property on the date it was acquired by the stapled REIT or - an addition or improvement that expands beyond the boundaries of the land included in such property. The Stapled REIT Legislation contains an exception for improvements placed in service before January 1, 2004 pursuant to a binding contract in effect on December 31, 1999 and at all times thereafter. If previously exempt property of the registrant or the Management Company becomes subject to the anti-stapling rules upon the occurrence of any of the events described above, any income generated by, and activities conducted by the registrant and the Management Company through, such properties would be attributed to the registrant for purposes of determining whether the registrant qualifies as a REIT under the Code. These attribution rules may make it more difficult for the registrant to qualify as a REIT and may subject the registrant to various additional taxes. OTHER LEGISLATION COULD ADVERSELY AFFECT THE REGISTRANT'S REIT QUALIFICATION Other legislation (including legislation previously introduced, but not yet passed), as well as regulations, administrative interpretations or court decisions, also could change the tax law with respect to the registrant's qualification as a REIT and the federal income tax consequence of such qualification. The adoption of any such legislation, regulations or administrative interpretations or court decisions could have a material adverse effect on the results of operations, financial condition and prospects of the registrant and could restrict the registrant's ability to grow. DEPENDENCE ON QUALIFICATION AS A REIT; TAX AND OTHER CONSEQUENCES IF REIT QUALIFICATION LOST There can be no assurance that the registrant has operated in a manner to qualify as a REIT for federal income tax purposes in the past or that it will so qualify in the future. Qualification as a REIT involves the application of highly technical and complex provisions of the Code, for which there are only limited judicial or administrative interpretations. The complexity of these provisions is greater in the case of a stapled REIT such as the registrant. Qualification as a REIT also involves the determination of various factual matters and circumstances not entirely within the registrant's control. In addition, the registrant's ability to qualify as a REIT is dependent upon its continued exemption from the anti-stapling rules of Section 269B(a)(3) of the Code, which, if they were to apply, would prevent the registrant from qualifying as a REIT. The "grandfathering" rules governing Section 269B generally provide, however, that Section 269B(a)(3) does not apply to a stapled REIT (except with respect to new real property interests as described above "--Income and Activities of Management Company May Be Attributable to the Registrant Under Recent Anti-Stapling Legislation and May Threaten REIT Status.") if the REIT and its stapled operating company were stapled on June 30, 1983. On June 30, 1983, the registrant was stapled with the Management Company. There are, however, no judicial or administrative authorities interpreting this "grandfathering" rule. Moreover, if for any reason the registrant failed to qualify as a REIT in 1983, the benefit of the "grandfathering" rule would not be available to the registrant, in which case the registrant would not qualify as a REIT for any taxable year from and after 1983. The failure of the registrant to qualify as a REIT would have a material adverse effect on the registrant's ability to make dividends to its shareholders and to pay amounts due on its indebtedness. If it is determined that the registrant did not qualify as a REIT during any of the preceding five fiscal years, the registrant potentially could incur corporate tax with respect to a year that is still open to adjustment by the Internal Revenue Service ("IRS"). If the registrant were to fail to qualify as a REIT, it would be subject to federal income tax (including any applicable alternative minimum tax) on its taxable 4 5 income at corporate rates. In addition, unless entitled to relief under certain statutory provisions and subject to the discussion above regarding the impact if the registrant failed to qualify as a REIT in 1983, the registrant also would be disqualified from re-electing REIT status for the four taxable years following the year during which qualification is lost. Failure to qualify as a REIT would result in additional tax liability to the registrant for the year or years involved. In addition, the registrant would no longer be required by the Code to make dividends to its shareholders. To the extent that dividends to shareholders would have been made in anticipation of the registrant's qualifying as a REIT, the registrant might be required to borrow funds or to liquidate certain of its investments on disadvantageous terms to pay the applicable tax. The failure to qualify as a REIT would also constitute a default under certain debt obligations of the registrant, which would generally allow the holders thereof to demand the immediate repayment of such indebtedness. Any acceleration of this indebtedness (including through cross-defaults) could have a material adverse effect on the registrant and its ability to make dividends to shareholders and to pay amounts due on this and other indebtedness. ADVERSE EFFECTS OF REIT MINIMUM DIVIDEND REQUIREMENTS In order to qualify as a REIT, the registrant is generally required each year to distribute to its shareholders at least 95% of its taxable income (excluding any net capital gain). In addition, if the registrant were to dispose of assets acquired in certain acquisitions during the ten-year period following the acquisitions, the registrant would be required to distribute at least 95% of the amount of any "built-in gain" attributable to such assets that the registrant recognizes in the disposition, less the amount of any tax paid with respect to such recognized built-in gain. The registrant generally is subject to a 4% nondeductible excise tax on the amount, if any, by which certain distributions paid by it with respect to any calendar year are less than the sum of: - 85% of its ordinary income for that year, - 95% of its capital gain net income for that year, and - 100% of its undistributed income from prior years. The registrant intends to make distributions to its shareholders to comply with the 95% distribution requirement and to avoid the nondeductible excise tax. Differences in timing between the recognition of taxable income and the receipt of cash available for distribution could require the registrant to borrow funds on a short-term basis on disadvantageous terms to meet the 95% distribution requirement and to avoid the nondeductible excise tax. Distributions to shareholders by the registrant are determined by the registrant's board of trustees ("Board of Trustees") and depend on a number of factors, including the amount of cash available for distribution, financial condition, results of operations, any decision by the Board of Trustees to reinvest funds rather than to distribute such funds, capital expenditures, the annual distribution requirements under the REIT provisions of the Code and such other factors as the Board of Trustees deems relevant. For federal income tax purposes, distributions paid to shareholders may consist of ordinary income, capital gains, return of capital, or a combination thereof. The registrant will provide shareholders with annual statements as to the taxability of distributions. ABILITY TO OPERATE PROPERTIES DIRECTLY AFFECTS THE REGISTRANT'S FINANCIAL CONDITION The registrant's investments will be subject to the risks inherent in owning real estate. The underlying value of the registrant's real estate investments, the results of its operations and its ability to make distributions to its shareholders and to pay amounts due on its indebtedness will depend on its ability to operate the registrant's properties in a manner sufficient to maintain or increase revenues and to generate sufficient revenues in excess of its operating and other expenses. ILLIQUIDITY OF REAL ESTATE Real estate investments are relatively illiquid. The registrant's ability to vary its portfolio in response to changes in economic and other conditions will therefore be limited. If the registrant decides to sell an investment, no assurance can be given that the registrant will be able to dispose of it in the time period it desires or that the sales price of any investment will recoup or exceed the amount of the registrant's investment. INCREASES IN PROPERTY TAXES COULD AFFECT ABILITY TO MAKE EXPECTED SHAREHOLDER DISTRIBUTIONS The registrant's real estate investments are all subject to real property taxes. The real property taxes on properties in which the registrant invests may increase or decrease as property tax rates change and as the value of the properties are assessed or reassessed by taxing authorities. Increases in property taxes may have an adverse effect on the registrant and its ability to make distributions to shareholders and to pay amounts due on its indebtedness. ENVIRONMENTAL LIABILITIES The obligation to pay for the cost of complying with existing environmental laws, ordinances and regulations, as well as the cost of complying with future legislation, may affect the operating costs of the registrant. Under various federal, state and local environmental laws, ordinances and regulations, a current or previous owner or operator of real property may be liable for the costs of removal or remediation of hazardous or toxic substances on or under the property. Environmental laws often impose liability whether or not the owner or operator knew of, or was responsible for, the presence of such hazardous or toxic substances and whether or not such substances originated from the property. In addition, the presence of hazardous or toxic substances, or the failure to remediate such property properly, may adversely affect the registrant's ability to borrow by using such real property as collateral. Certain environmental laws and common law principles could be used to impose liability for releases of hazardous materials, including asbestos-containing materials or "ACMs," into the environment. In addition, third parties may seek recovery from owners or operators of real properties for personal injury associated with exposure to released ACMs or other hazardous materials. Environmental laws may also impose restrictions on the use or transfer of property, and these restrictions may require expenditures. In connection with the ownership and operation of any of the registrant's properties, the registrant, the Management Company and the other lessees of these properties may be liable for any such costs. The cost of defending against claims of liability or remediating contaminated property and the cost of complying with environmental laws could materially adversely affect the registrant and the Management Company and their ability to pay amounts due on their indebtedness and with respect to the registrant, to make distributions to its shareholders. Prior to undertaking major transactions, the registrant has hired independent environmental experts to review specific properties. Thirty-six properties have been reviewed and no significant environmental hazards have been uncovered. The registrant has no reason to believe that any environmental contamination or violation of any applicable law, statute, regulation or ordinance governing hazardous or toxic substances has occurred or is occurring. However, no assurance can be given that hazardous or toxic substances are not located on any of the properties. The registrant will also endeavor to protect itself from acquiring contaminated properties or properties with significant compliance problems by obtaining site assessments and property reports at the time of acquisition when it deems such investigations to be appropriate. There is no guarantee, however, that these measures will successfully insulate the registrant from all such liabilities. COMPLIANCE WITH THE ADA MAY AFFECT EXPECTED DISTRIBUTIONS TO THE REGISTRANT'S SHAREHOLDERS Under the Americans with Disabilities Act of 1990 (the "ADA"), all public accommodations are required to meet certain federal requirements related to access and use by disabled persons. A determination that the registrant is not in compliance with the ADA could also result in the imposition of fines and/or an award of damages to private litigants. If the registrant were required to make modifications to comply with the ADA, there could be a material adverse effect on its ability to pay amounts due on its indebtedness or to make distributions to its shareholders. UNINSURED AND UNDERINSURED LOSSES The registrant may not be able to insure its properties against losses of a catastrophic nature, such as earthquakes and floods, because such losses are uninsurable or not economically insurable. The registrant will use its discretion in determining amounts, coverage limits and deductibility provisions of insurance, with a view to maintaining appropriate insurance coverage on its investments at a reasonable cost and on suitable terms. This may result in insurance coverage that, in the event of a substantial loss, would not be sufficient to pay the full current market value or current replacement cost of the lost investment and also may result in certain losses being totally uninsured. Inflation, changes in building codes, zoning or other land use ordinances, environmental considerations, lender imposed restrictions and other factors also might make it not feasible to use insurance proceeds to replace the property after such property has been damaged or destroyed. Under such circumstances, the insurance proceeds, if any, received by the registrant might not be adequate to restore its economic position with respect to such property. INABILITY TO REFINANCE The registrant is subject to the normal risks associated with debt and preferred stock financings, including the risk that the registrant's cash flow will be insufficient to meet required payments of principal and interest and distributions, the risk that indebtedness on its properties, or unsecured indebtedness, will not be able to be renewed, repaid or refinanced when due or that the terms of any renewal or refinancing will not be as favorable as the terms of such indebtedness. 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 on disadvantageous terms, which might result in losses to the registrant, which losses could have a material adverse effect on the registrant and its ability to make distributions to shareholders and 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 upon 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 5 6 the registrant. Foreclosures could also create taxable income without accompanying cash proceeds, thereby hindering the registrant's ability to meet the REIT distribution requirements of the Code. RISING INTEREST RATES The registrant has incurred and expects in the future to incur indebtedness which bears interest at variable rates. Accordingly, increases in interest rates would increase the registrant's interest costs (to the extent that the related indebtedness was not protected by interest rate protection arrangements), which could have a material adverse effect on the registrant and its ability to make distributions to shareholders and to pay amounts due on its indebtedness or cause the registrant to be in default under certain debt instruments. In addition, an increase in market interest rates may cause holders to sell their shares of beneficial interest of the registrant ("Common Shares") and reinvest the proceeds thereof in higher yielding securities, which could adversely affect the market price for the Common Shares. IMPACT OF YEAR 2000 ISSUES In June 1998, the registrant and the Management Company implemented a multi-step Year 2000 Compliance Project (the "Project") that was intended to assess the ability of their computer systems to properly recognize dates prior to, on, or after January 1, 2000. Any failure by the registrant and the Management Company to correct a material Year 2000 issue could result in the interruption or failure of certain normal business activities or operations. The most reasonable worst case scenarios for the registrant are - a significant number of tenants at shopping centers will not be able to record sales transactions using their automated equipment or accept credit card transactions, and - electric utility companies will not be able to provide power to operate shopping centers, office buildings, apartment complexes or parking facilities. The most reasonable worst case scenarios for Impark are - its financial reporting system will not work on or after January 1, 2000, and - parking equipment that has been identified as non-compliant will not accept credit cards from parking patrons at the facilities it manages. The registrant and the Management Company expect the total cost of required modifications to achieve Year 2000 compliance to be between $1.0 million and $2.0 million, including enhancements to software programs and upgrades to hardware. If these most reasonable worst case scenarios occurred, they could have a material adverse affect on the registrant's and the Management Company's results of operations, liquidity and financial condition. EXCHANGE RATE LOSSES At December 31, 1998, the Management Company had approximately $157 million of revenues attributable to Impark's Canadian operations, representing approximately 48% of the registrant's and the Management Company's total revenues. The registrant does not hedge its foreign currency exposure and does not currently intend to do so in the future. The registrant recognized a $2.2 million charge during 1998 related to unrealized exchange rate losses on loans to affiliated Canadian companies. As of December 31, 1998, the registrant also has recorded a $2.1 million loss from the translation of the Canadian operations as a separate component of shareholders' equity. There can be no assurance that foreign currency rate fluctuations will not have a material adverse effect on the registrant's business, financial condition or results of operations in the future. RESULTS OF OPERATIONS ADVERSELY AFFECTED BY FACTORS BEYOND THE REGISTRANT'S CONTROL Results of operations of the registrant's properties may also be adversely affected by, among other things: - changes in national economic conditions, changes in local market conditions due to changes in general or local economic conditions and neighborhood characteristics; - changes in interest rates and in the availability, cost and terms of financing; - the impact of present or future environmental legislation and compliance with environmental laws and other regulatory requirements; - the ongoing need for capital improvements, particularly in older structures; - changes in real estate tax rates and assessments and other operating expenses; - adverse changes in governmental rules and fiscal policies; - adverse changes in zoning and other land use laws; and - earthquakes and other natural disasters (which may result in uninsured losses) and other factors which are beyond its control. CAUTIONARY STATEMENTS CONCERNING FORWARD-LOOKING STATEMENTS Any statements in this report, including any statements in the documents that are incorporated by reference herein that are not strictly historical are forward-looking statements within the meaning of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Any such forward-looking statements contained or incorporated by reference herein should not be relied upon as predictions of future events. Certain such forward-looking statements can be identified by the use of forward-looking terminology such as "believes," "expects," "may," "will," "should," "seeks," "approximately," "intends," "plans," "pro forma," "estimates" or "anticipates" or the negative thereof or other variations thereof or comparable terminology, or by discussions of strategy, plans, intentions or anticipated or projected events, results or conditions. Such forward-looking statements are dependent on assumptions, data or methods that may be incorrect or imprecise and they may be incapable of being realized. Such forward-looking statements include statements with respect to: - the declaration or payment of distributions by the registrant or the Management Company, - the ownership, management and operation of properties, - potential acquisitions or dispositions of properties, assets or other businesses by the registrant or the Management Company, - the policies of the registrant or the Management Company regarding investments, acquisitions, dispositions, financings and other matters, - the qualification of the registrant as a REIT under the Code and the "grandfathering" rules under Section 269B of the Code, - the real estate industry and real estate markets in general, - the availability of debt and equity financing, - interest rates, - general economic conditions, - supply and customer demand, - trends affecting the registrant or the Management Company, - the effect of acquisitions or dispositions on capitalization and financial flexibility, - the anticipated performance of the registrant or the Management Company and of acquired properties and businesses, including, without limitation, statements regarding anticipated revenues, cash flows, funds from operations, earnings before interest, depreciation and amortization, property net operating income, operating or profit margins and sensitivity to economic downturns or anticipated growth or improvements in any of the foregoing, and - the ability of the registrant or the Management Company and of acquired properties and businesses to grow. Shareholders are cautioned that, while forward-looking statements reflect the respective companies' good faith beliefs, they are not guarantees of future performance and they involve known and unknown risks and uncertainties. Actual results may differ materially from those in the forward-looking statements as a result of various factors. The information contained or incorporated by reference in this prospectus and any accompanying prospectus supplement, including, without limitation, the information set forth in "Risk Factors" below or in any risk factors in documents that are incorporated by reference in this report, identifies important factors that could cause such differences. Neither the registrant nor Management Company undertakes any obligation to publicly release the results of any revisions to these forward-looking statements that may reflect any future events or circumstances. The number of persons employed by the registrant is 43. 6 7 ITEM 2. PROPERTIES - ------- ---------- The following table sets forth certain information relating to the registrant's investments at December 31, 1998:
Square Year Total Date of Ownership feet(1) Occupancy construction cost Direct equity investments Location acquisition percentage (000) rate(2) completed (000) - ------------------------- -------- ----------- ---------- ------- --------- ----------- ------- Shopping Malls: Eastern - ------- Mountaineer Morgantown, WV 1/29/78 100% 676(4) 87% 1975 $ 33,513 Fingerlakes Auburn, NY 9/28/81 100 405 60 1980 27,967 Fairgrounds Square Reading, PA 9/30/81 100 723(5) 91 1980 42,359 Crossroads St. Cloud, MN 1/01/72 100 738(9) 99 1966 35,201 Two Rivers Clarksville, TN 9/26/75 100 231(10) 45 1968 8,771 Crossroads Fort Dodge, IA 4/22/77 100 429(11) 92 1967 13,748 Kandi Willmar, MN 3/12/79 100 448 85 1973 21,009 Woodland Commons(12) Buffalo Grove, IL 4/03/95 100 170 100 1991 22,204 Westgate Towne Centre Abilene, TX 4/22/77 100 163(13) 98 1962 16,900 -------- 221,672 -------- Western - ------- Valley North Wenatchee, WA 8/30/73 100 267 87 1966 5,262 Mall 205 Portland, OR 3/01/75 100 432(14) 94 1970 14,371 Plaza 205 Portland, OR 4/26/78 100 167 100 1970 4,558 Valley Yakima, WA 5/01/80 100 390(15) 89 1972 11,737 -------- 35,928 -------- Southwestern: - ------------- Alexandria Alexandria, LA 09/01/97 100 898 95 1973 31,681 Brazos Lake Jackson, TX 09/01/97 100 707 92 1976 25,938 Killeen Killeen, TX 09/01/97 100 579 93 1981 42,625 Mesilla Valley Las Cruces, NM 09/01/97 100 593 90 1981 40,191 Park Plaza Little Rock, AR 09/01/97 100 547 100 1988 64,145 Pecanland Monroe, LA 09/01/97 100 923 99 1985 46,462 Shawnee Shawnee, OK 09/01/97 100 445 95 1989 19,717 Villa Linda Santa Fe, NM 09/01/97 100 569 92 1985 43,978 -------- 314,737 -------- 572,337 -------- Apartments: Midwestern - ---------- Somerset Lakes Indianapolis, IN 11/10/88 100 360 units 93 1975 21,135 Hunter's Creek Cincinnati, OH 12/11/96 100 146 units 98 1980 5,785 Steeplechase Cincinnati, OH 06/30/95 100 272 units 96 1987 12,246 ------- 39,166 ------- Southern - -------- Briarwood Fayetteville, NC 6/30/91 100 274 units 95 1968-70 8,425 Woodfield Gardens Charlotte, NC 6/30/91 100 132 units 90 1974 3,933 Windgate Place Charlotte, NC 6/30/91 100 196 units 94 1974-78 6,554 Walden Village Atlanta, GA 6/01/92 100 372 units 96 1973 14,376 Beech Lake Durham, NC 8/19/94 100 345 units 94 1986 20,217 ------- 53,505 ------- 92,671 ------- Mortgage Loans ---------------------------------------------------------- Balance Principal Original at repayment balance(s) 12/31/98 for 1999 Interest Year of Direct Equity Investments (000) (000) (000) rate maturity - ------------------------- --------- --------- --------- -------- -------- Shopping Malls: Eastern - ------- Mountaineer $ 4,600(3) $ 3,734 $ 236 8.250% 2009 Fingerlakes --- --- --- --- --- Fairgrounds Square --- ---(6) --- --- --- Crossroads 49,500(3) 47,528 743 7.485 2002 Two Rivers --- --- --- --- --- Crossroads --- ---(6) --- --- --- Kandi --- ---(6) --- --- --- Woodland Commons(12) 12,000(3) 11,491 256 7.750 2006 Westgate Towne Centre --- --- --- --- --- ------- ------- ------ 66,100 62,753 1,235 ------- ------- ------ Western - ------- Valley North --- --- --- --- --- Mall 205 --- ---(6) --- --- --- Plaza 205 --- ---(6) --- --- --- Valley --- ---(6) --- --- --- ------ ------ ----- --- --- --- ------ ------ ----- Southwestern: - ------------- Alexandria 21,463 21,223(7) 199 8.430 2006 Brazos 15,749 15,573(7) 146 8.430 2006 Killeen 28,319 28,002(7) 262 8.430 2006 Mesilla Valley 24,643 24,367(7) 228 8.430 2006 Park Plaza 37,511 37,091(7) 347 8.430 2006 Pecanland 39,344 38,711(8) 543 12.250 2017 Shawnee 11,576 11,447(7) 107 8.430 2006 Villa Linda 24,692 24,416(7) 228 8.430 2006 -------- ------- ------ 203,297 200,830 2,060 -------- ------- ------ 269,397 263,583 3,295 -------- ------- ------ Apartments: Midwestern - ---------- Somerset Lakes 15,000(3) 14,410 254 7.650 2006 Hunter's Creek 2,738 2,706 24 8.470 2002 Steeplechase 9,000(3) 8,632 158 7.395 2006 ------- ------- ------ 26,738 25,748 436 ------ ------ ------ Southern - -------- Briarwood --- ---(6) --- --- --- Woodfield Gardens --- ---(6) --- --- --- Windgate Place --- ---(6) --- --- --- Walden Village --- ---(6) --- --- --- Beech Lake 12,500(3) 11,984 202 6.869 2005 ------ ------ ----- 12,500 11,984 202 ------ ------ ----- 39,238 37,732 638 ------ ------ -----
8
ITEM 2. PROPERTIES - ------- ---------- -CONTINUED Square Year Total Date of Ownership feet(1) Occupancy construction cost Direct equity investments Location acquisition percentage (000) rate(2) completed (000) - ------------------------- -------- ----------- ---------- ------- --------- ------------ ----- Office Buildings: Midwestern - ---------- 55 Public Square Cleveland, OH 01/15/63 100% 396 82% 1959 $ 38,945 Circle Tower Indianapolis, IN 10/16/74 100 102 87 1930 4,919 -------- 43,864 -------- Southern - -------- Henry C. Beck(16) Shreveport, LA 08/30/74 100 185 84 1958 10,196 -------- 10,196 -------- Western Redevelopment - --------------------- North Valley Tech Center Denver, CO 12/03/69 100 484 57(17) 1967 28,392 Sutter Buttes Center Marysville, CA 12/19/79 100 427 54(18) 1972 13,868 -------- 42,260 -------- 96,320 -------- Parking Facilities: United States - ------------- Huntington Garage Cleveland, OH 12/31/75 100 1,100 spcs --- 1969 8,127 West Third St. lot Cleveland, OH 09/19/77 100 300 spcs --- --- 2,443 5th and Marshall Garage Richmond, VA 02/24/98 100 793 spcs --- 1985 9,192 Long Street Garage Columbus, OH 01/16/98 100 550 spcs --- 1978 3,928 Madison & Wells Garage Chicago, IL 01/28/98 100 1,107 spcs --- 1998 43,184 Magic Mile Lot Arlington, TX 03/26/98 100 1,000 spcs --- 1997 3,011 Printer's Alley Garage Nashville, TN 07/01/98 100 275 spcs --- 1926 6,650 -------- 76,535 -------- Canada: - ------- 10th Ave. Lot Calgary, Alberta 05/05/97 100 55 spcs --- --- 228 1009-9th Ave. Lot Calgary, Alberta 05/05/97 100 142 spcs --- --- 587 Parkade Edmonton, Alberta 05/05/97 100 562 spcs --- 1958 1,241 103 St. Lot Edmonton, Alberta 05/05/97 100 61 spcs --- --- 310 107th St. Edmonton, Alberta 05/05/97 100 -- (18) 100 1973 196 221 9th Ave. Lot Calgary, Alberta 05/05/97 100 148 (19) --- --- 1,370 Blanchard St. Victoria, Br.Columbia 05/05/97 100 -- (19) 100 1982 312 Graham Ave. Lot Winnipeg, Manitoba 05/05/97 100 175 spcs --- --- 1,124 Water Ave. Lot Winnipeg, Manitoba 05/05/97 100 235 spcs --- --- 595 Young St. Lot Winnipeg, Manitoba 05/05/97 100 40 spcs --- --- 98 Broadway Lot Winnipeg, Manitoba 05/05/97 100 67 spcs --- --- 415 Donald St. Lot Winnipeg, Manitoba 05/05/97 100 -- (20) --- --- 113 Broad St. Lot Regina, Saskatchewan 05/05/97 100 20 spcs --- --- 35 Queens Quay Toronto, Ontario 05/05/97 100 -- (19) 100 1950 1,206 351 Smith St. Winnipeg, Manitoba 09/09/97 100 110 spcs --- --- 800 -------- 8,630 -------- 85,165 -------- $846,493 Write-down for unrealized loss on carrying value of real estate (21) (39,634) Total equity investments -------- $806,859 ======== Mortgage Loans --------------------------------------------------------- Balance Principal Original at repayment balance(s) 12/31/98 for 1999 Interest Year of Direct equity investments (000) (000) (000) rate maturity - ------------------------- --------- --------- --------- -------- -------- Office Buildings: Midwestern - ---------- 55 Public Square $ --- $ ---(6) $ --- --- --- Circle Tower --- --- --- --- --- -------- ------ ------ --- --- --- -------- ------ ------ Southern - -------- Henry C. Beck --- --- --- --- --- -------- ----- ------ --- --- --- -------- ----- ------ Western Redevelopment - --------------------- North Valley Tech Center --- --- --- --- --- Sutter Buttes Center --- --- --- --- --- -------- ----- ----- --- --- --- -------- ----- ----- --- --- --- -------- ----- ----- Parking Facilities: United States - ------------- Huntington Garage 9,300(3) 8,201 282 8.550% 2014 West Third St. Garage --- --- --- --- --- 5th and Marshall Garage --- ---(6) --- --- --- Long Street Garage 1,602(3) 1,526(21) 93(21) (21) ---(21) Madison & Wells Garage 30,000(3) 30,000 --- LIBOR+1.75% 2001 Magic Mile Lot --- --- --- --- --- Printer's Alley Garage 4,468(3) 4,000 --- LIBOR+1.75% 2001 ------- ------ ------- 45,370 43,727 375 ------- ------ ------- Canada: - ------- 10th Ave. Lot --- --- --- --- --- 1009-9th Ave. Lot --- --- --- --- --- Parkade --- --- --- --- --- 103 St. Lot --- --- --- --- --- 107th St. --- --- --- --- --- 221 9th Ave. Lot --- --- --- --- --- Blanchard St. --- --- --- --- --- Graham Ave. Lot --- --- --- --- --- Water Ave. Lot --- --- --- --- --- Young St. Lot --- --- --- --- --- Broadway Lot --- --- --- --- --- Donald St. Lot --- --- --- --- --- Broad St. Lot --- --- --- --- --- Queens Quay --- --- --- --- --- 351 Smith St. --- --- --- --- --- -------- ------- ------- --- --- --- -------- ------- ------- 45,370 43,727 375 -------- ------- ------- --- --- --- --------- -------- ------- $ 354,005 $345,042 $ 4,308 ========= ======== =======
9 (1) The square footage shown represents gross leasable area for shopping malls and net rentable area for office buildings. The apartments are shown as number of units. The parking garages and parking facilities are shown as number of parking spaces. (2) Occupancy rates shown are as of December 31, 1998, and are based on the total square feet at each property, except apartments which are based on the number of units and occupied at the end of the year. (3) The registrant obtained mortgages on the following properties subsequent to acquisition: Huntington Parking Garage in the amount of $9,300,000 in 1993; Mountaineer Mall in the amount of $4,600,000 in 1994; Crossroads Shopping Center (St. Cloud, MN) in the amount of $49,500,000 in 1995; Woodland Commons in the amount of $12,000,000 in 1996; Somerset Lakes in the amount of $15,000,000 in 1996; Steeplechase in the amount of $9,000,000 in 1996; Beech Lake in the amount of $12,500,000 in 1996; Hunter's Creek in the amount of $2.7 million; Madison & Wells Garage in the amount of $30,000,000 in 1998. The registrant assumed $4,468,000 and $1,602,000 in mortgage debt upon the acquisition of the Printer's Alley Garage and the Long Street Garage, respectively. (4) The total mall contains 676,000 square feet; the registrant owns 618,000 square feet, the balance being ground leased to Giant Eagle Markets, Inc. (5) The total mall contains 723,000 square feet; the registrant owns 537,000 square feet, the balance being separately ground leased to Boscov's Department Store, Inc. (6) These properties are the collateral for the registrant's $110 million revolving line of credit. (7) The mortgage secured by these malls requires that all rents and other tenant charges be deposited into a bank account which serves as additional security for the lender. (8) The mortgage loan participates in 55% of revenues, as defined, in excess of $5,970,516. (9) The total mall contains 738,000 square feet; the registrant owns 626,000 square feet, the balance being separately owned by Target Stores. (10) The mall is currently being converted to an office complex in 1998. Approximately 58,000 square feet of office space has been leased to an office tenant opening in the second quarter of 1999. (11) The total mall contains 429,000 square feet; the registrant owns 332,000 square feet, the balance being separately owned by an unrelated third party with Sears, Roebuck and Co. as tenant. (12) This property was sold in February 1999 for $21.6 million resulting net proceeds of $9.3 million after repayment of debt. (13) The mall is currently being redeveloped as a power strip center with Winn-Dixie occupying 65,000 square feet in July 1998. Currently, 95,000 square feet is separately owned by Montgomery Ward & Co., Incorporated. (14) The total mall contains 432,000 square feet; the registrant owns 255,000 square feet, the balance being separately owned by Montgomery Ward Development 9 10 Corporation. (15) The total mall contains 390,000 square feet; the registrant owns 272,000 square feet, the balance being separately ground leased to Sears, Roebuck and Co. (16) The registrant sold this building in March 1999 for $2.1 million resulting in net proceeds of $1.8 million. (17) North Valley Technical Center was repositioned from a shopping mall to an office complex during 1995. Montgomery Ward vacated the complex in 1997 allowing the registrant to continue to retenant the former mall as an office center. (18) The property was inundated by a flood which occurred in February 1986. The mall was subsequently rebuilt and re-opened in November 1986. A temporary tenant occupied approximately 70,000 square feet as of December 31, 1998. The Trust is pursuing a mixed use strategy for this former retail facility. (19) These properties are general use buildings currently being used as regional and city offices by Impark Limited. (20) This property is currently demolished and awaiting redevelopment. (21) This property has two mortgages. Interest rates are 8.25% and 8.625%. The mortgages mature in 2003 and 2009, respectively. The 8.25% mortgage, in the principal amount of $863,000 has a principal payment for 1999 of $50,000. The 8.625% mortgage, in the principal amount of $663,000, has a principal payment for 1999 of $43,000. (22) In December 1995, the registrant recorded a $14 million unrealized loss on the carrying value of assets identified for disposition. Subsequent to the disposition of three office buildings and one shopping mall, this reserve was $3,630,000 as of December 31, 1997 after restatement due to the retroactive restatement of depreciation expense. In December 1998, the registrant recorded a $36 million unrealized loss on the carrying value of assets identified for disposition. As of December 31, 1998, the registrant owned in fee its interests in Crossroads Center (St. Cloud, MN), Woodland Commons, Mall 205, Crossroads Mall (Ft. Dodge, IA), Westgate Towne Centre, Mountaineer Mall, Plaza 205, Valley Mall, Fingerlakes Mall, Fairgrounds Square Mall, 55 Public Square Building, Henry C. Beck Building, Sutter Buttes Center, Brazos Mall, Killeen Mall, Mesilla Valley Mall, Park Plaza Mall, Pecanland Mall, Shawnee Mall, Villa Linda Mall, Somerset Lakes Apartments, Briarwood Apartments, Woodfield Gardens Apartments, Windgate Place Apartments, Walden Village Apartments, Beech Lake Apartments, Steeplechase Apartments, Hunter's Creek Apartments, Parkade, West Third Lot, 10th Avenue, 1009 9th Avenue, 103 St., 107 St., 221 9th Avenue, Graham Ave., Water Ave., Young St., Broad St., Broadway, 357 Smith St., Blanchard St., Queens Quay, Donald St., St. Clair Development Property, Madison & Wells Garage, Long Street Garage, 5th & Marshall Garage, Magic Mile Lot, Printer's Alley Garage. The registrant holds a leasehold estate or estates, or a fee interest and one or more leasehold estates in Valley North Mall, Two Rivers Mall, Kandi Mall, Alexandria Mall, Circle Tower Building and North Valley Technical Center and the Huntington Garage. 10 11 RENTALS FROM NET LEASES The registrant leases 47 of its properties to its Management Company. The Management Company operates these properties and pays the registrant a fixed based rent and participation rent based on property revenues (Percentage Rents) The following table sets forth the rentals paid to the registrant from the Management Company for the year ended December 31, 1998, under net leases of the properties indicated:
ANNUAL PROPERTY BASE RENT PERCENTAGE RENTS - -------- --------- ---------------- SHOPPING MALLS: EASTERN - ------- Mountaineer (1) $ 755,000 $ 712,000 Fingerlakes (1)(3) 780,000 174,000 Fairgrounds Square (1) 2,850,000 921,000 Crossroads (St. Cloud, MN.) (1)(4) 3,307,500 3,397,000 Two Rivers (1) --- 32,000 Crossroads (Ft. Dodge, IA) (1) 736,000 809,000 Westgate Towne Centre (1) --- 35,000 Kandi (1) 712,000 545,000 Woodland Commons (1) 1,600,000 416,000 WESTERN - ------- Valley North (1) 400,000 142,000 Mall 205 (1) 1,232,000 534,000 Plaza 205 (1) 276,000 272,000 Valley (1) 463,000 472,000 SOUTHWESTERN - ------------ Alexandria (2) Brazos (2) Killeen (2) Mesilla Valley (2) Park Plaza (2) Pecanland (2) Shawnee (2) Villa Linda (2) APARTMENTS: MIDWESTERN - ---------- Somerset Lakes (1) 971,000 1,207,000 Steeplechase (1) 800,000 595,000 Hunter's Creek (1) 500,000 36,000 SOUTHERN - -------- Briarwood (1) 435,000 232,000 Woodfield Gardens (1) 100,000 54,000
11 12
Windgate Place (1) 235,000 103,000 Walden Village (1) 850,000 568,000 Beech Lake (1) 955,000 722,000 OFFICE BUILDINGS: MIDWESTERN - ---------- 55 Public Square (1),(5) $1,650,000 1,260,000 Circle Tower (1) 209,000 134,000 SOUTHERN - -------- Henry C. Beck (1) 179,000 166,000 WESTERN - ------- North Valley Technical Center (1) 500,000 57,000 Sutter Buttes Center (1) 292,000 271,000 PARKING: UNITED STATES - ------------- Huntington Garage (1) 825,000 154,000 West Third Lot (1) 150,000 74,000 201 West Madison Garage (1) 2,400,000 1,458,000 60 East Long Street Garage (1) 400,000 --- 5th & Marshall Garage (1) 500,000 57,000 Magic Mile Lot (1) --- 92,000 Printer's Alley Garage (1) 450,000 --- CANADIAN - -------- 10th Avenue (1) 15,600 --- 1009 9th Avenue (1) 39,000 --- Parkade (1) 130,000 --- 103 St.(1) 27,000 --- 221 9th Ave. (1) 95,000 --- 245 Graham Ave. (1) 60,000 --- 168 Water Ave. (1) 65,000 --- 336 Young St. (1) 7,000 --- 304 Broadway (1) 8,000 --- 1724 Broad St. (1) 4,000 --- 351 Smith St. (1) 3,000 --- (1) Leased to the Management Company. (2) The Management Company manages these shopping malls for the registrant and receives a management fee of 4% of gross receipts as a management fee, as defined, and a leasing fee of 4.5% of base rent, as defined, over the term of the lease, for new and renewal tenants, respectively. (3) Includes a separate lease for Fingerlakes Storage. (4) Includes a separate lease for the Stearns County Building. (5) Includes a separate lease for the Illuminating Parking Garage. 12
13 ITEM 3. LEGAL PROCEEDINGS. REGISTRANT VS. THE STATE OF CALIFORNIA The registrant 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 registrant on the liability portion of this inverse condemnation suit, which the State of California appealed. The registrant is proceeding with its damage claim in Superior Court of the State of California. No recognition of potential income has been made in the December 31, 1998 Combined Financial Statements. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. None. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. "Market Price and Dividend Record" presented on page 1 of Exhibit 13. ITEM 6. SELECTED FINANCIAL DATA. "Selected Financial Data" presented on page 2 and 3 of Exhibit 13. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. "Management's Discussion and Analysis of Financial Condition and Results of Operations" presented on pages 25 through 31 of Exhibit 13. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES REGARDING MARKET RISK. Quantitative and Qualitative disclosures regarding market risk presented on page 28 of Exhibit 13. ITEM 8. FINANCIAL STATEMENTS. The "Combined Balance Sheets" as of December 31, 1998 and 1997, and the "Combined Statements of Operations, Combined Statements of Comprehensive Income, Combined Statements of Changes in Cash, Combined Statements of Shareholders' Equity" for the years ended December 31, 1998, 1997 and 1996, of the registrant, "Notes to Combined Financial Statements" and "Report of Independent Public Accountants" are presented on pages 4 through 24 of Exhibit 13. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. None. 13 14 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. (A) DIRECTORS. "Election of Trustees" presented in the registrant's 1999 Proxy Statement is incorporated herein by reference. (B) EXECUTIVE OFFICERS. Executive offices as presented in the registrant's 1999 Proxy Statement is incorporated by reference. ITEM 11. EXECUTIVE COMPENSATION. "Compensation of Trustees" and "Executive Compensation", presented in the registrant's 1999 Proxy Statement are incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. "Security Ownership of Trustees, Officers and Others" presented in the registrant's 1999 Proxy Statement is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS "Certain Transactions and Relationships" presented in the registrant's 1999 Proxy Statement is incorporated herein by reference. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K. (a) FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES. (1) FINANCIAL STATEMENTS: Combined Balance Sheets - December 31, 1998 and 1997 on page 4 of Exhibit 13. Combined Statements of Operations - For the Years Ended December 31, 1998, 1997 and 1996 on page 5 of Exhibit 13. Combined Statements of Comprehensive Income - For the Years Ended December 31, 1998, 1997 and 1996 on page 5 of Exhibit 13. Combined Statements of Changes in Cash - For the Years Ended December 31, 1998, 1997 and 1996 on page 6 of Exhibit 13. Combined Statements of Shareholders' Equity - For the Years Ended December 31, 1998, 1997 and 1996 on page 7 of Exhibit 13. Notes to Combined Financial Statements on pages 8 to 23 of Exhibit 13. Report of Independent Public Accountants on page 24 of Exhibit 13. (2) FINANCIAL STATEMENT SCHEDULES: Report of Independent Public Accountants on Financial Statement Schedules. Schedule III - Real Estate and Accumulated Depreciation. Schedule IV - Mortgage Loans on Real Estate. All Schedules, other than III and IV, are omitted, as the information is not required or is otherwise furnished. 14 15 (B) EXHIBITS.
EXHIBIT INCORPORATED HEREIN BY NUMBER DESCRIPTION REFERENCE TO PAGE - ------ ----------- ------------ ---- (3)(a) Declaration of Trust of Registrant dated August 1, 1961, Registration Statement on Form S-3 No. as amended through July 25, 1986 33-4493 ---- (3)(b) By-laws of Registrant, as amended Registration Statement on Form S-3 No. 33-4493 ---- (3)(c) By-laws of Registrant, as amended March 31, 1997 Form 10-Q ---- (3)(d) By-laws of Registrant as amended 1998 10-K X ---- (4)(a) Form of certificate for Shares of Beneficial Interest Registration Statement on Form S-3 No. 33-2818 ---- (4)(b) Form of Indenture governing Debt Securities, dated Registration Statement on Form S-3 No. February 1, 1983 between Registrant and Ameritrust 2-81605 Company ---- (4)(c) Form of Debt Security Registration Statement on Form S-3 No. 33-4493 ---- (4)(d) Form of Indenture governing Debt Securities, dated Registration Statement on Form S-3 No. October 1, 1993 between Registrant and Society National 33-68002 Bank ---- (4)(e) Form of Note Registration Statement on Form S-3 No. 33-68002 ---- (4)(f) Form of Indenture governing Debt Securities Registration Statement on Form S-3 No. 333-00953 ---- (4)(g) Rights Agreement between Registrant and National City Form 8-A dated March 30, 1990 No. 0-18411 Bank dated March 7, 1990 ---- (4)(h) Certificate of Designations relating to Registrant's Form 8-K dated October 24, 1996 Series A Cumulative Redeemable Preferred Shares of ---- Beneficial Interest (4)(i) Standby Purchase Agreement between Registrant and Gotham Schedule 13D dated August 11, 1998 Partners, L.P. dated August 11, 1998 ---- (4)(j) Standby Purchase Agreement between Registrant and Gotham Schedule 13D dated August 11, 1998 Partners III, L.P. dated August 11, 1998 ---- X (4)(l) Warrant to purchase 500,000 shares of beneficial interest ---- of Registrant
15 16
EXHIBIT INCORPORATED HEREIN BY NUMBER DESCRIPTION REFERENCE TO PAGE - ------ ----------- ------------ ---- (4)(k) Standby Purchase Agreement between Registrant and Schedule 13D dated August 11, 1998 Elliott Associates, L.P. dated August 11, 1998 ---- (10)(a) Share Purchase Agreement dated as of December 31, 1983 Registration Statement No. 2-88719 between registrant and First Union Management, Inc. ---- (10)(b) First Amendment to Share Purchase Agreement dated as of Registration Statement No. 33-2818 December 10, 1985 between registrant and First Union ---- Management, Inc. (10)(c) Second Amendment to Share Purchase Agreement dated as of Registration Statement No. 33-11524 December 9, 1986 between registrant and First Union ---- Management, Inc. (10)(d) Third Amendment to Share Purchase Agreement dated as of Registration Statement No. 33-19812 December 2, 1987 between registrant and First Union ---- Management, Inc. (10)(e) Fourth Amendment to Share Purchase Agreement dated as of Registration Statement No. 33-26758 December 7, 1988 between registrant and First Union ---- Management, Inc. (10)(f) Fifth Amendment to Share Purchase Agreement dated as of Registration Statement No. 33-33279 November 29, 1989 between registrant and First Union Management, Inc. ---- (10)(g) Sixth Amendment to Share Purchase Agreement dated as of Registration Statement No. 33-38754 November 28, 1990 between registrant and First Union Management, Inc. ---- (10)(h) Seventh Amendment to Share Purchase Agreement dated as Registration Statement No. 33-45355 of November 27, 1991 between registrant and First Union Management, Inc. ---- (10)(i) Eighth Amendment to Share Purchase Agreement dated as of Registration Statement No. 33-57756 November 30, 1992 between registrant and First Union Management, Inc. ---- (10)(j) Employment and Consulting Agreement with Donald S. 1991 Form 10-K Schofield dated September 1, 1991 ----
16 17
EXHIBIT INCORPORATED HEREIN BY NUMBER DESCRIPTION REFERENCE TO PAGE - ------ ----------- ------------ ---- (10)(k) Employment Agreement with James C. Mastandrea dated June 30, 1994 Form 10-Q July 13, 1994 ---- (10)(l) Employment Agreement with Gregory D. Bruhn dated June 30, 1994 Form 10-Q July 13, 1994 ---- (10)(m) Credit Agreement with National City Bank dated 1994 Form 10-K December 5, 1994 ---- (10)(n) Credit Agreement with Society National Bank dated 1995 Form 10-K March 4, 1996 ---- (10)(o) 1981 Employee Share Option Plan 1992 Proxy Statement ---- (10)(p) 1994 Long Term Incentive Performance Plan 1994 Proxy Statement ---- (10)(q) Bank Credit Agreement dated September 30, 1996 September 30, 1996 Form 10-Q ---- (10)(r) Credit agreement between Imperial Parking Limited and BT March 31, 1997 Bank of Canada Form 10-Q ---- (10)(s) Put agreement entered into between BT Bank of Canada, March 31, 1997 Hong Kong Bank of Canada and First Union Real Estate Form 10-Q Equity and Mortgage Investment ---- (10)(t) Share Purchase Agreement and amendments Impark March 31, 1997 Investments Inc. and First Union Real Estate Equity and Form 10-Q Mortgage Investments ---- (10)(u) Put agreement entered into between Impark E Investments March 31, 1997 Inc., the Onex Associates and First Union Real Estate Form 10-Q Equity and Mortgage Investments ---- (10)(v) Senior subordinated note by 3357392 Canada Inc. to March 31, 1997 3006302 Nova Scotia Company Form 10-Q ---- (10)(w) Senior subordinated note by 504463 N.B. Inc. to 3006302 March 31, 1997 Nova Scotia Company Form 10-Q ---- (10)(x) Shareholders Agreement dated April 17, 1997 between March 31, 1997 3357392 Canada, Inc. and 3355489 Canada, Inc. and the Form 10-Q individuals and trusts listed on Schedule A. ----
17 18
EXHIBIT INCORPORATED HEREIN BY NUMBER DESCRIPTION REFERENCE TO PAGE - ------ ----------- ------------ ---- (10)(y) Shareholders Agreement dated April 17, 1997 between March 31, 1997 504308 N.B., Inc. First Union Management, Inc. and the Form 10-Q individuals listed on Schedule A. ---- (10)(z) Assignment dated March 27, 1997 between First Union Real March 31, 1997 Estate Equity and Mortgage Investments and First Union Form 10-Q Management, Inc. ---- (10)(aa) Assignment dated April 16, 1997 between First Union March 31, 1997 Management, Inc. and 335489 Canada, Inc. Form 10-Q ---- (10)(ab) Assignment dated April 16, 1997 between 335489 Canada, March 31, 1997 Inc. and 3357392 Canada, Inc. Form 10-Q ---- (10)(ac) Amendment to assignment made May 8, 1997 between First March 31, 1997 Union Real Estate Equity and Mortgage Investments and Form 10-Q Imperial Parking Limited. ---- (10)(ad) Bank credit agreement dated December 5, 1997 1997 Form 10-K ---- (10)(ae) First amendment to employment agreement of James C. 1997 Form 10-K Mastandrea ---- (10)(af) Form of charge in control agreement 1997 Form 10-K/A (10)(ag) Fixed Rate Loan Agreement dated as of August 11, 1998 by Registration Statement on Form S-3 No. and among the Registrant, as borrower, Bankers Trust 333-63547 ---- Company, as agent, and Wellsford Capital and BankBoston, N.A., as lenders (10)(ah) Fixed Rate Loan Agreement dated as of August 11, 1998 by Registration Statement on Form S-3 No. and among the Registrant, as borrower, Bankers Trust 333-63547 ---- Company, as agent, and Gotham Partners, L.P., Gotham Partners III, L.P., Elliott Associates, L.P. and Blackacre Bridge Capital, L.L.C., as lenders (10)(ai) Employment contract for Daniel P. Friedman X ---- X (10)(aj) Employment contract for Anne N. Zahner ---- X (10)(ak) Employment contract for David Schonberger ----
18 19
EXHIBIT INCORPORATED HEREIN BY NUMBER DESCRIPTION REFERENCE TO PAGE - ------ ----------- ------------ ---- (10)(al) Amendment No. 2, dated as January 8, 1999, to Amended Form 8-K dated February 2, 1999. and Restated Credit Agreement, dated as of November 1, ---- 1997, among First Union Real Estate Equity and Mortgage Investments, and First Union Management, Inc., as borrower, and National City Bank, Bankers Trust Company, Key Bank National Associates, The Huntington National Bank, Mellon Bank, N.A. and First Merit Bank, as Lenders. First Amendment to Fixed Rate Loan Agreement between First Union Real Estate Equity and Mortgage Investments, as Borrower; and Blackacre Bridge Capital, L.L.C., Gotham Partners, L.P., Gotham Partners III, L.P. and Elliott Associates, L.P., as Lenders, dated January 8, 1999. Letter Agreement between First Union Real Estate Equity and Mortgage Investments, as Borrower; and Blackacre Bridge Capital, L.L.C. Gotham Partners, L.P., Gotham Partners III, L.P. and Elliott Associates, L.P., as Lenders, dated January 8, 1999 First Amendment to Fixed Rate Loan Agreement between First Union Real Estate Equity and Mortgage Investments, as Borrower; and BankBoston, N.A., Wellsford Capital and Bankers Trust Company, as Lenders, dated January 8, 1999. Letter Agreement between First Union Real Estate Equity and Mortgage Investments, as Borrower; and BankBoston, N.A., Wellsford Capital and Bankers Trust Company, as Lenders, dated January 8, 1999.
19 20
EXHIBIT INCORPORATED HEREIN BY NUMBER DESCRIPTION REFERENCE TO PAGE - ------ ----------- ------------ ---- Second Amendment, dated as of December 30, 1998, to the Amended and Restated Credit Agreement Dated as of April 17, 1997 between Imperial Parking Limited, as Borrower, Impark Services Limited, as Guarantor, and HongKong Bank of Canada and BT Bank of Canada, as Lenders. (12) Statements of Ratios of Combined Income from Operations and Combined Net Income to Fixed Charges X ---- (13) 1998 Annual Report X ---- (23) Consent of Independent Public Accountants X ---- (24) Powers of Attorney X ---- (27) Financial Data Schedule X ---- (C) REPORTS ON FORM 8-K. -------------------- None.
20 21 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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 BY: /s/ DANIEL P. FRIEDMAN -------------------------- Daniel P. Friedman, President and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE --------- ----- ---- Principal Executive Officer President, and Chief April 12, 1999 Executive Officer /s/ DANIEL P. FRIEDMAN - ---------------------- Daniel P. Friedman Principal Financial Officer Executive Vice President- April 12, 1999 Chief Financial Officer /s/ STEVEN M. EDELMAN - --------------------- Steven M. Edelman Principal Accounting Controller April 12, 1999 Officer /s/ GREGORY C. SCOTT - -------------------- Gregory C. Scott Trustees: ) Date William A. Ackman* ) April 12, 1999 Daniel J. Altobello* ) David P. Berkowitz* ) William E. Conway* ) Allen H. Ford* ) Daniel P. Friedman* ) Stephen J. Garchik* ) Russell R. Gifford* ) David S. Klafter* ) William Scully* ) Daniel Shuchman* ) Stephen S. Snider* ) Mary Ann Tighe* ) James A. Williams* ) SIGNATURE ) --------- ) ) *By: /s/ Paul F. Levin ) ) Paul F. Levin, Attorney-in-fact )
21 22 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON ------------------------------------------- FINANCIAL STATEMENT SCHEDULES ----------------------------- To First Union Real Estate Equity and Mortgage Investments: We have audited in accordance with generally accepted auditing standards, the combined financial statements included in the registrant's 1998 Annual Report, included as Exhibit 13 of this Form 10-K, and have issued our report thereon dated March 29, 1999. Our audit was made for the purpose of forming an opinion on those combined statements taken as a whole. The schedules listed under Item 14(a)(2) on page 14 are the responsibility of management and are presented for purposes of complying with the Securities and Exchange Commission's rules and are not part of the basic combined financial statements. These schedules have been subjected to the auditing procedures applied in the audit of the basic combined financial statements and, in our opinion, fairly state in all material respects the financial data required to be set forth therein in relation to the basic combined financial statements taken as a whole. Cleveland, Ohio, Arthur Andersen LLP March 29, 1999. 22 EX-13 2 EXHIBIT 13 1 Exhibit 13 FIRST UNION REAL ESTATE INVESTMENTS FINANCIAL HIGHLIGHTS YEARS ENDED DECEMBER 31, (IN THOUSANDS, EXCEPT PER SHARE DATA AND FOOTNOTE)
RESTATED 1998 1997 ---- ---- Revenues $ 324,526 $ 235,544 Income (loss) before capital gain, extraordinary loss and after minority interest (91,465) 4,434 Net income (loss) before preferred dividend (83,518) 5,676 Net income (loss) applicable to shares of beneficial interest (86,517) 845 Dividends declared 3,478 11,651 Per share Loss applicable to shares of beneficial interest before capital gain, extraordinary loss and after minority interest $ (3.07) $ (.02) Net income (loss) applicable to shares of beneficial interest, basic and diluted (2.81) .03 Dividends declared per share of beneficial interest .11 .44
MARKET PRICE AND DIVIDEND RECORD
DIVIDENDS 1998 QUARTERS ENDED HIGH LOW DECLARED ---- --- -------- December 31 $ 6 1/8 $ 3 7/16 $ September 30 9 9/16 5 3/16 June 30 11 7/8 8 3/4 March 31 16 7/8 11 .11 ----- $ .11 ===== 1997 QUARTERS ENDED December 31 $ 16 5/16 $13 5/16 $ .11 September 30 14 1/8 12 5/8 .11 June 30 14 1/4 12 3/4 .11 March 31 14 1/2 11 5/8 .11 ----- $ .44 =====
The Trust's shares are traded on the New York Stock Exchange (Ticker Symbol: FUR). As of December 31, 1998, there were 3,500 recordholders of the Trust's shares of beneficial interest. The Trust estimates the total number of beneficial owners at approximately 11,000. 1 2 SELECTED FINANCIAL DATA FOR THE YEARS ENDED DECEMBER 31, (IN THOUSANDS, EXCEPT PER SHARE DATA AND FOOTNOTES)
RESTATED(1) RESTATED(1) RESTATED(1) RESTATED(1) 1994 1995 1996 1997 1998 - ------------------------------------------------------------------------------------------------------------------------------------ OPERATING RESULTS Revenues(2) $ 76,339 $ 79,205 $ 81,867 $ 235,544 $ 324,526 Income (loss) before capital gain, extraordinary loss, cumulative effect of accounting change and before minority interest(2),(3),(4) 4,261 881 1,681 3,490 (91,465) Unrealized loss on carrying value of assets identified for disposition (14,000) Capital gains, net 31,577 1,468 10,346 Income (loss) before extraordinary loss, cumulative effect of accounting change and before minority interest(2),(3),(4) 4,261 18,458 1,681 4,958 (81,119) Extraordinary loss from early extinguishment of debt(5) (910) (286) (226) (2,399) Cumulative effect of change in accounting method(6) (4,325) Loss allocated to minority interest(2) 944 Net income (loss) before preferred dividend 4,261 13,223 1,395 5,676 (83,518) Net income (loss) applicable to shares of beneficial interest 4,261 13,223 550 845 (86,517) Dividends declared for shares of beneficial interest 7,273 7,542 7,684 11,651 3,478 Per share of beneficial interest Income (loss) before capital gain, extraordinary loss, cumulative effect of accounting change and after minority interest(2),(3),(4) $ .24 $ .05 $ .05 $ (.02) $ (3.07) Income (loss) before extraordinary loss, cumulative effect of accounting change and after minority interest(2),(3),(4) .24 1.02 .05 .04 (2.73) Extraordinary loss from early extinguishment of debt(5) (.05) (.02) (.01) (.08) Cumulative effect of change in accounting method(6) (.24) Net income (loss) applicable to shares of beneficial interest, basic and diluted .24 .73 .03 .03 (2.81) Dividends declared per share of beneficial interest .40 .41 .44 .44 .11 FINANCIAL POSITION AT YEAR END Total assets $ 352,005 $ 376,144 $ 413,054 $ 790,226 $ 786,684 Current portion of debt(7) 205,910 Long-term obligations(8) 238,296 258,454 254,868 483,459 383,089 Total equity 78,756 77,500 124,957 235,310 150,696 OTHER DATA Net cash provided by or (used for) Operations $ 19,053 $ 12,989 $ 11,085 $ 15,740 $ 6,413 Investing (26,507) (28,345) (47,002) (112,233) (52,429) Financing (28,094) 15,783 35,466 110,406 74,327
2 3 This selected financial data should be read in conjunction with the Combined Financial statements and notes thereto. (1) As a result of the Trust's review of lives assigned to real estate assets for calculation of depreciation expense during the fourth quarter of 1998, reduced asset lives have been assigned. Consequently, the Trust has restated its Combined Financial Statements for the years 1994 through 1998. Shareholders' equity at December 31, 1993 was restated from $103,766,000 to $81,806,000. (2) In September 1997, First Union acquired the interests of its joint venture partners in eight shopping malls and 50% of another mall for $88 million in cash and the assumption of $203 million of mortgage debt. In April 1997, First Union's affiliated management company acquired voting control of Impark for $37 million in cash, the assumption of $26 million in debt and the issuance of $12 million of stock in Impark to Impark employees and to its former owner. (3) In 1998, loss before capital gain, extraordinary loss, cumulative effect of accounting change and before minority interest included the following expenses related to the proxy contest and the resulting change in the composition of the Trust's Board of Trustees:
Litigation and proxy expenses $ 4.8 million Other professional fees to avoid change in composition of Board 1.5 million Severance expenses for employee change in control agreements and employment contract termination 6.1 million Expenses related to termination of First Union's former chairman, president and chief executive officer 3.4 million Vesting of restricted stock upon change in composition of Board 4.7 million --------------- $20.5 million ===============
In 1995, income before capital gain, extraordinary loss, cumulative effect of accounting change and minority interest included $1.6 million of litigation and proxy expenses. (4) In 1998, the Trust recognized $36 million in unrealized losses on the carrying value of properties identified for disposition and Impark recognized a $15 million reduction of goodwill. (5) In 1998, the Trust repaid approximately $87.5 million of its 8 7/8% Senior Notes resulting in $1.6 million in unamortized issue costs and solicitation fees being expensed. Also, in the fourth quarter of 1998, the Trust renegotiated its bank agreement and $90 million note payable resulting in $.8 million of deferred costs being expensed. In 1997 and 1996, the Trust renegotiated its bank credit agreements, resulting in a $226,000 and $286,000 charge, respectively, related to the write-off of unamortized costs. In November 1995, the Trust repaid approximately $36 million of mortgage debt resulting in a $910,000 charge for the write-off of unamortized costs and prepayment premiums. (6) In December 1995, the Trust changed its accounting method to directly expense internal leasing costs and recorded a $4.3 million noncash charge for the cumulative effect of the accounting change as of the beginning of 1995. Funds from operations for previous years have been restated for the change in accounting method on a basis comparable to 1995. (7) Included in the current portion of debt for 1998 is the $90 million note payable due August 11, 1999, the $101 million bank credit facility due August 1999, the $10.6 million deferred obligation, and 1999 mortgage principal payments. (8) Included in long-term obligations are senior notes and mortgage loans. Bank loans are classified as long term for 1994 through 1997. Impark's bank loans are classified as long term for 1997 and 1998. 3 4 COMBINED BALANCE SHEETS AS OF DECEMBER 31, (IN THOUSANDS)
RESTATED 1998 1997 ---- ------- ASSETS INVESTMENTS IN REAL ESTATE Land $130,340 $109,308 Buildings and improvements 676,519 647,000 -------- -------- 806,859 756,308 Less - Accumulated depreciation (165,357) (142,082) -------- -------- Total investments in real estate 641,502 614,226 INVESTMENT IN JOINT VENTURE 1,722 1,575 MORTGAGE LOANS AND NOTES RECEIVABLE, including current portion of $58 and $6,469, respectively 5,508 30,686 OTHER ASSETS Cash and cash equivalents - unrestricted 28,649 2,582 - restricted 16,526 14,282 Accounts receivable and prepayments, net of allowances of $1,395 and $1,462, respectively 21,809 20,070 Investments 5 13,103 Inventory 2,798 3,374 Goodwill, net 45,379 66,560 Management and lease agreements, net 1,852 4,113 Deferred charges and other, net 6,864 6,300 Unamortized debt issue costs, net 7,758 7,445 Other 6,312 5,910 -------- -------- Total assets $786,684 $790,226 ======== ======== LIABILITIES AND SHAREHOLDERS' EQUITY LIABILITIES Mortgage loans, including current portion of $4,308 and $3,877, respectively $345,042 $313,537 Notes payable 94,996 Senior notes 12,538 100,000 Bank loans 125,821 69,922 Accounts payable and accrued liabilities 42,659 38,000 Deferred obligations 10,602 10,807 Deferred capital gains and other deferred income 3,283 10,646 Liability to former owner of Impark 10,957 -------- -------- Total liabilities 634,941 553,869 -------- -------- MINORITY INTEREST 1,047 1,047 SHAREHOLDERS' EQUITY Preferred shares of beneficial interest, $25 liquidation preference, 2,300,000 shares authorized 1,349,000 shares and 2,300,000 shares outstanding in 1998 and 1997, respectively 31,737 54,109 Shares of beneficial interest, $1 par, unlimited authorization, outstanding 31,416 28,179 Additional paid-in capital 190,679 170,567 Undistributed loss from operations (115,968) (25,973) Undistributed capital gains 14,949 14,949 Deferred compensation (5,643) Accumulated other comprehensive income Available for sale securities (66) Foreign currency translation adjustment (2,117) (812) -------- -------- Total shareholders' equity 150,696 235,310 -------- -------- $786,684 $790,226 ======== ========
The accompanying notes are an integral part of these statements. 4 5 COMBINED STATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, (IN THOUSANDS, EXCEPT PER SHARE DATA)
RESTATED RESTATED 1998 1997 1996 --------- --------- --------- REVENUES Rents $ 320,592 $ 225,388 $ 75,555 Interest - Mortgage loans 1,211 2,907 4,732 - Short-term investments 1,337 1,525 80 - Investments 302 494 Equity in income from joint venture 148 488 528 Management fees 353 2,808 617 Other income 583 1,934 355 --------- --------- --------- 324,526 235,544 81,867 --------- --------- --------- EXPENSES Property operating 223,667 157,215 25,786 Real estate taxes 12,453 9,948 8,297 Depreciation and amortization 33,389 22,892 15,890 Interest - Mortgage loans 29,032 15,437 8,877 - Notes payable 3,757 - Senior notes 5,856 8,875 9,090 - Bank loans and other 12,214 5,552 5,459 General and administrative 37,577 12,135 6,787 Litigation and proxy 4,848 Foreign currency loss 2,198 Unrealized loss on carrying value of assets identified for disposition and impaired assets 51,000 --------- --------- --------- 415,991 232,054 80,186 --------- --------- --------- INCOME (LOSS) BEFORE CAPITAL GAIN, EXTRAORDINARY LOSS AND MINORITY INTEREST (91,465) 3,490 1,681 Capital gains, net 10,346 1,468 --------- --------- --------- INCOME (LOSS) BEFORE EXTRAORDINARY LOSS AND MINORITY INTEREST (81,119) 4,958 1,681 Extraordinary loss from early extinguishment of debt (2,399) (226) (286) Loss allocated to minority interest 944 --------- --------- --------- NET INCOME (LOSS) BEFORE PREFERRED DIVIDEND (83,518) 5,676 1,395 Preferred dividend (2,999) (4,831) (845) --------- --------- --------- NET INCOME (LOSS) APPLICABLE TO SHARES OF BENEFICIAL INTEREST $ (86,517) $ 845 $ 550 ========= ========= ========= PER SHARE DATA Income (loss) applicable to shares of beneficial interest before capital gain, extraordinary loss, and after minority interest $ (3.07) $ (.02) $ .05 Income (loss) before extraordinary loss and after minority interest (2.73) .04 .05 Extraordinary loss from early extinguishment of debt (.08) (.01) (.02) --------- --------- --------- NET INCOME (LOSS) APPLICABLE TO SHARES OF BENEFICIAL INTEREST, BASIC AND DILUTED $ (2.81) $ .03 $ .03 ========= ========= ========= ADJUSTED SHARES OF BENEFICIAL INTEREST, BASIC 30,772 24,537 17,172 ADJUSTED SHARES OF BENEFICIAL INTEREST, DILUTED 31,015 25,415 17,706 COMBINED STATEMENTS OF COMPREHENSIVE INCOME For the years ended December 31, (In thousands) Net income (loss) $ (86,517) $ 845 $ 550 Other comprehensive income Available for sale securities 66 (66) Foreign currency translation adjustment (1,305) (812) --------- --------- --------- Comprehensive income (loss) $ (87,756) $ (33) $ 550 ========= ========= =========
The accompanying notes are an integral part of these statements. 5 6 COMBINED STATEMENTS OF CHANGES IN CASH FOR THE YEARS ENDED DECEMBER 31, (IN THOUSANDS)
RESTATED RESTATED 1998 1997 1996 --------- --------- --------- CASH PROVIDED BY (USED FOR) OPERATIONS Net income (loss) before preferred dividend $ (83,518) $ 5,676 $ 1,395 Adjustments to reconcile net income (loss) before preferred dividend to net cash provided by operations Depreciation and amortization 33,389 22,892 15,890 Extraordinary loss from early extinguishment of debt 2,399 226 286 Capital gains, net (10,346) (1,468) Unrealized loss on carrying value of assets identified for disposition and impaired assets 51,000 Vesting of restricted shares 4,706 Foreign currency loss 2,198 Increase in deferred charges and other, net (1,316) (4,998) (963) Increase in deferred income 355 2,073 Increase in deferred interest on mortgage investments (6) (122) (400) (Decrease) increase in deferred obligations (20) (18) 155 Net changes in other assets and liabilities 7,572 (8,521) (5,278) --------- --------- --------- Net cash provided by operations 6,413 15,740 11,085 --------- --------- --------- CASH PROVIDED BY (USED FOR) INVESTING Repayment of mortgage investment and note payable 25,045 16,200 Principal received from mortgage investments 139 216 176 Proceeds from sales of properties 6,507 18,374 8,825 Purchase of investments (1,771) (12,746) Sale of investments 15,141 Investments in properties (63,022) (834) (5,491) Acquisition of joint venture interests, net of cash acquired (72,900) Investment in joint venture (30,248) Deposit for property acquisitions (170) (2,315) Investment in Impark, net of cash acquired (11,195) (36,574) Investments in capital and tenant improvements (23,103) (21,654) (20,264) --------- --------- --------- Net cash used for investing (52,429) (112,233) (47,002) --------- --------- --------- CASH PROVIDED BY (USED FOR) FINANCING Increase (decrease) in bank loans 57,446 19,582 (43,800) Issuance of preferred shares of beneficial interest, net of costs 54,109 Increase in notes payable 90,000 Increase in mortgage loans 30,000 2,737 48,500 Repayment of mortgage loans - Normal payments (3,951) (2,765) (3,286) - Balloon payments (468) (13,835) Repayment of senior notes (87,462) Repayment of medium term notes (5,000) Proceeds from sale of interest rate cap 1,025 Purchase of First Union shares (1,830) (7,125) Sale of First Union shares 2,996 121,291 252 Sale of hedge agreement 825 Debt issue costs paid (3,320) (1,261) (1,414) Dividends paid to shares of beneficial interest (6,577) (10,473) (7,789) Dividends paid to preferred shares of beneficial interest (3,332) (4,870) Other (6) --------- --------- --------- Net cash provided by financing 74,327 110,406 35,466 --------- --------- --------- Increase (decrease) in cash and cash equivalents 28,311 13,913 (451) Cash and cash equivalents at beginning of year 16,864 2,951 3,402 --------- --------- --------- Cash and cash equivalents at end of year $ 45,175 $ 16,864 $ 2,951 ========= ========= =========
The accompanying notes are an integral part of these statements. 6 7 COMBINED STATEMENTS OF SHAREHOLDERS' EQUITY (IN THOUSANDS, EXCEPT FOOTNOTES)
RESTATED PREFERRED UNDISTRIBUTED SHARES SHARES INCOME FOREIGN OF OF ADDITIONAL (LOSS) UNDISTRIBUTED DEFERRED CURRENCY AVAILABLE BENEFICIAL BENEFICIAL PAID-IN FROM CAPITAL COMPEN- TRANSLATION FOR SALE INTEREST INTEREST CAPITAL OPERATIONS(1)(2) GAINS SATION ADJUSTMENT SECURITIES -------- -------- ------- ---------------- ------- ------ ---------- --------- BALANCE DECEMBER 31, 1995 $17,485 $55,081 $ 16,823 $14,949 $(1,983) Prior period adjustment(1) (24,856) -------- ------- -------- --------- ------- ------------ ------- ----- Balance December 31, 1995 as restated 17,485 55,081 (8,033) 14,949 (1,983) ------- -------- --------- ------- ------------ Net income before preferred dividend (restated) 1,395 Dividends paid or accrued on shares of beneficial interest ($.44/share) (7,684) Dividends accrued on preferred shares ($.3674/share) (845) Sale of 2,300,000 preferred shares of beneficial interest, $25 per share, net $54,109 Shares sold under long-term incentive ownership plan and share option agreements 31 221 Restricted shares issued 142 1,603 (1,745) Restricted shares forfeited (36) (226) Deferred compensation related to restricted shares 499 Other (7) ------- ------- -------- --------- ------- ------------ ------- ----- BALANCE DECEMBER 31, 1996 (RESTATED) 54,109 17,622 56,672 (15,167) 14,949 (3,229) -- -- Net income before preferred dividend (restated) 5,676 Dividends paid or accrued on shares of beneficial interest ($.44/share) (11,651) Dividends accrued on preferred shares ($2.10/share) (4,831) Sale of 3,910,000 shares of beneficial interest, net 3,910 42,211 Sale of 6,325,000 shares of beneficial interest, net 6,325 68,139 Shares sold under long-term incentive ownership plan and share option agreements 96 611 Restricted shares issued 226 2,934 (3,160) Deferred compensation related to restricted shares 746 Foreign currency translation adjustment $ (812) Available for sale securities $ (66) ------- ------- -------- --------- ------- ------------ ------- ----- BALANCE DECEMBER 31, 1997 (RESTATED) 54,109 28,179 170,567 (25,973) 14,949 (5,643) (812) (66) Net loss before preferred dividend (83,518) Dividends paid on shares of beneficial interest ($.11/share) (3,478) Dividends paid or accrued on preferred shares ($2.10/share) (2,999) Conversion of preferred shares (22,372) 3,144 19,228 Shares sold under long-term incentive ownership plan and share option agreements 373 2,623 Restricted shares issued 343 4,632 (4,975) Restricted shares forfeited (453) (5,147) 5,600 Shares purchased (170) (1,660) Issuance of 500,000 stock warrants 436 Deferred compensation related to restricted shares 312 Vesting of restricted shares 4,706 Foreign currency translation adjustment (1,305) Available for sale securities 66 ------- ------- -------- --------- ------- ------------ ------- ----- BALANCE DECEMBER 31, 1998 $31,737 $31,416 $190,679(2) $(115,968)(3) $14,949 $ -- $(2,117) $ -- ======= ======= ======== ========= ======= ============ ======= =====
(1) The Trust changed its useful lives for the calculation of depreciation expense in 1998 and restated its Combined Financial Statements for the five years ended December 31, 1998. The cumulative effect of changing the asset lives prior to December 31, 1994 is $24,856,000. (2) Includes the balance of cumulative undistributed net loss of First Union Management, Inc. of $5,825,000, $6,621,000, $5,497,000 and $36,346,000 as of December 31, 1995, 1996, 1997 and 1998, respectively. (3) Cumulative distributions in excess of the Trust's net income from inception are $11,330,000. The accompanying notes are an integral part of these statements. 7 8 NOTES TO COMBINED FINANCIAL STATEMENTS 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES First Union Real Estate Investments ("Trust") and First Union Management Inc. ("Company") are in the real estate, parking management and parking and transit ticketing equipment manufacturing industries with properties and operations primarily in the United States and Canada. The accounting policies of the Trust and Company conform to generally accepted accounting principles and give recognition, as appropriate, to common practices within the real estate, parking and manufacturing industries. Under a trust agreement, the 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. Additionally, as the Company owns voting control of Imperial Parking Limited ("Impark"), the financial statements of Impark are consolidated with those of the Company. The preparation of the financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses during the reporting periods. Actual results could differ from these estimates. The Trust's properties are leased to the Company through February 28, 1999. Thereafter, the Trust became self-managed. At December 31, 1998 and 1997, buildings and improvements included equipment and appliances of $8.1 million and $7.2 million, respectively. Tenant leases generally provide for billings of certain operating costs and retail tenant leases generally provide for percentage rentals, in addition to fixed minimum rentals. The Trust and Company accrue the recovery of operating costs based on actual costs incurred and accrue percentage rentals based on current estimates of each retail tenant's sales. In July 1998, the Trust 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 Trust will accrue the majority of percentage rent income in the fourth quarter of each year in accordance with EITF-98-9. For the years ended December 31, 1998, 1997 and 1996, the accrued recovery of operating costs and percentage rent income approximated $36.2 million, $21.9 million and $15.7 million, respectively. Impark recognizes gross revenue collected or due from parking lots which it manages. Deferred revenue is derived primarily from revenue received in advance of its due date. Depreciation for financial reporting purposes is computed using the straight-line method. Buildings are depreciated over their estimated useful lives of 10 to 40 years, based on the property's age, overall physical condition, type of construction materials and intended use. Improvements to the buildings are depreciated over the remaining useful life of the building at the time the improvement is completed. Tenant alterations are depreciated over the life of the lease of the tenant. The Trust annually reviews its portfolio of properties for any impairment as required by Statement of Financial Accounting Standards (SFAS) 121 (Accounting for Long-Lived Assets and Long-Lived Assets to be Disposed of). The Trust's buildings are depreciated as follows:
LIFE BUILDINGS (IN YEARS) (IN THOUSANDS) 40 $669,583 30 2,042 25 4,736 10 158 -------- $676,519
The Trust's useful lives for the calculation of depreciation are as follows: Shopping malls 40 Apartments 40 Office buildings 40 Parking garages 25 - 40 Parking facilities 10
Equipment and appliances are depreciated over useful lives of five to ten years. Parking equipment is depreciated using the declining balance method resulting in approximately 20 - 30% of the equipment balance being depreciated per year. Parking leasehold improvements are depreciated over five years. Routine maintenance and repairs, including replacements, are charged to expense; while replacements which improve or extend the lives of existing properties are capitalized. 8 9 Goodwill represents the excess of cost over the value assigned to the net assets from the purchase of Impark. Goodwill is amortized on a straight-line basis over 40 years. Accumulated amortization at December 31, 1998 and 1997, was $2.3 million and $.8 million, respectively. Impark recorded a U.S. $15 million reduction of goodwill in December 1998, in accordance with SFAS 121. Lease and management agreements are recorded at cost and represent Impark's investment in parking lot agreements acquired from other parking lot management companies. The underlying value of this asset is calculated by discounting future cash flows of each agreement over its length of term. Management and lease agreements terminated before the life of the agreements are expensed. Amortization is provided on a straight-line basis over their useful lives of approximately three years as of the acquisition in April 1997. Accumulated amortization at December 31, 1998 and 1997 was $3.6 million and $1.3 million, respectively. Impark's inventory consists of equipment parts and supplies and is recorded at the lower of cost determined on a first-in, first-out basis, or replacement cost. The Trust accounts for its investment in a joint venture which it does not control using the equity method of accounting. This investment, which represents a 50% non-controlling ownership interest in a shopping mall, was recorded initially at the Trust's cost and subsequently adjusted for the Trust's equity in income and cash distributions. At December 31, 1998 and 1997, $12.6 million and $14.3 million of cash was restricted based on terms of a mortgage. Additionally, $3.9 million of cash as of December 31, 1998 was classified as restricted as it secures benefits under change of control agreements with employees of the Trust and Company. Investments as of December 31, 1997, consisted of shares of beneficial interest of other real estate investment trusts and a U.S. Treasury Bill. The shares of beneficial interest were classified as securities available for sale and were reported at their fair value in the balance sheet. The U.S. Treasury Bill was classified as a held-to-maturity security and was recorded at cost plus accrued interest. The U.S. Treasury Bill was collateral to secure an obligation due to the former owners of Impark. The classification of the U.S. Treasury Bill was changed to a security available for sale in 1998 when the obligation it secured was extinguished and the U.S. Treasury Bill was released as collateral. The shares of beneficial interest of other real estate investment trusts and the U.S. Treasury Bill were sold in 1998. The Trust has calculated earnings per share for 1998 and 1997 in accordance with SFAS 128 (Earnings Per Share) and restated 1996. SFAS 128 requires that common share equivalents be excluded from the weighted average shares outstanding for the calculation of basic earnings per share. The reconciliation of shares outstanding for the basic and fully diluted earnings per share calculation is as follows (in thousands):
1998 1997 1996 ------ ------ ------ Basic weighted average shares 30,772 24,537 17,172 Stock options, treasury method 243 571 367 Restricted shares, treasury method 307 167 ------ ------ ------ Diluted weighted average shares 31,015 25,415 17,706 ====== ====== ======
The preferred shares and warrants to purchase shares of beneficial interest are anti-dilutive and are not included in the weighted average shares outstanding for the diluted earnings per share. The assets and liabilities of the Canadian operations are translated into U.S. dollars at the exchange rates in effect at the balance sheet date. Income statement accounts are translated at the weighted average exchange rates for the year. The gains or losses resulting from these translations are recorded in a separate component of shareholders' equity. Gains or losses resulting from realized foreign currency and intercompany transactions are included in net income. Financial instruments held by the Trust and the Company include cash and cash equivalents, accounts receivable, mortgage loans receivable, accounts payable, revolving credit agreements, long-term debt, interest rate caps and a currency swap contract. The Trust and the Company do not hold or issue financial instruments or derivative financial instruments for trading purposes. During 1998, the Financial Accounting Standards Board ("FASB") issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." The statement requires companies to recognize all derivatives on the balance sheet as assets or liabilities, measured at fair value. Gains or losses resulting from changes in the values of those derivatives would be accounted for depending on the use of the derivative and whether it qualifies for hedge accounting. This statement is effective for fiscal years beginning after June 15, 1999. The Trust will adopt this Statement on January 1, 2000, and is in the process of determining the effect that adoption will have on its financial statements. In March 1998, the American Institute of Certified Public Accountants ("AICPA") issued Statement of Position ("SOP") 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use," which is effective for the Trust and Company as of January 1, 1999. This SOP requires capitalization of certain development costs of software to be used internally. 9 10 In April 1998, the AICPA issued SOP 98-5, "Reporting on the Costs of Start-Up Activities," which is effective for the Trust as of January 1, 1999. This SOP requires start-up and organization costs to be expensed as incurred and also requires previously deferred start-up costs to be recognized as a cumulative effect adjustment in the statement of income upon adoption. These SOPs, which the Trust and Company plan to adopt as of January 1, 1999, are not expected to have a material effect on the Trust's and Company's financial statements. Certain reclassifications have been made to prior year balances so that they are comparable to 1998. 2. RESTATEMENT OF COMBINED FINANCIAL STATEMENTS The Trust has restated its Combined Financial Statements for each of the five years ended December 31, 1998 as a result of changing the lives of assets used to calculate depreciation expense. The cumulative effect of changing the lives of the assets for years prior to 1994 results in a charge to undistributed income as included in shareholders equity of approximately $22 million. Net income and net income per share both basic and diluted prior to and after the restatement for the change in depreciation lives are disclosed in the following table (amounts in thousands except per share):
CHANGE IN CAPITAL GAINS FOR SOLD NET INCOME AS CHANGE IN PROPERTIES BASED ON PREVIOUSLY DEPRECIATION RESTATED RESTATED NET YEAR REPORTED EXPENSE DEPRECIATION INCOME ---- -------- ------- ------------ ------ 1997 $ 3,043 $(3,441) $1,243 $ 845 1996 3,291 (2,741) --- 550 1995 13,891 (2,375) 1,707 13,223 1994 6,485 (2,224) --- 4,261
NET INCOME PER CHANGE IN SHARE AS DEPRECIATION RESTATED NET PREVIOUSLY EXPENSE PER CHANGE IN CAPITAL INCOME (LOSS) YEAR REPORTED SHARE GAIN PER SHARE PER SHARE ---- -------- ----- -------------- --------- 1997 $.12 $(.14) $.05 $.03 1996 .19 (.16) --- .03 1995 .77 (.13) .09 .73 1994 .36 (.12) --- .24
3. LIQUIDITY The Trust has a $90 million note payable due on August 11, 1999 and the reduction of the availability of its bank loan facility commitment during 1999 with the facility to be terminated on August 11, 1999. As of December 31, 1998, the Trust has $90 million outstanding under the notes payable and $101 million outstanding under the bank credit facility. The Trust plans to repay the debt in 1999 with a combination of property sales, a $50 million rights offering, mortgage financing, and cash available. The Trust sold a shopping center and an office building in the first quarter of 1999 generating $11.1 million of net proceeds which was used to repay a portion of the note payable. Additionally, the Trust has entered into contracts to sell six properties to generate $45.6 million in net proceeds and obtain $66.4 million in mortgage financing on seven properties. The sale of the properties and mortgage financing is to be completed throughout the second quarter of 1999. The Trust also expects to complete a rights offering of approximately $50 million in April 1999 pending an effective registration statement. The cash generated from these transactions is expected to approximate $162 million. Additionally, the Trust had $28.6 million of cash at December 31, 1998. As a contingency to the aforementioned sales transactions, the Trust has contracted to sell an additional five shopping malls which is anticipated to generate $56.8 million in net proceeds. Although the Trust believes that the transactions listed above will occur as planned, there can be no assurance that each transaction will be completed or they will occur in the time frame or at the anticipated amounts. 10 11 4. COMPREHENSIVE INCOME Effective January 1, 1998, the Trust adopted SFAS 130 (Reporting Comprehensive Income) which requires disclosure of comprehensive income and its components in a full set of general-purpose financial statements. Comprehensive income is defined as changes in shareholders' equity such as foreign currency translation adjustments and reserves for the valuation of securities held for sale. The adoption of this statement had no impact on the Trust's net income or shareholders' equity. Prior year financial statements have been reclassified to conform to the requirements of this statement. 5. WARRANTS TO PURCHASE SHARES OF BENEFICIAL INTEREST The Trust in November 1998 issued 500,000 warrants which allow a third party to purchase 500,000 shares of beneficial interest at $10 per share. The warrants expire in November 2008. The Trust issued the warrants to the third party as part of the consideration for various services provided to the Trust and recorded $.4 million in expense as a measurement of this consideration. The fair value of the consideration was determined using the Black-Scholes model with the warrants' term of 10 years, a 4% dividend yield, a 4% risk free interest rate and a volatility factor of 32%. 6. FINANCIAL INSTRUMENT In 1997, the Trust entered into a foreign currency swap agreement maturing in 2009 to reduce the impact of foreign exchange rates on intercompany debt. The contract was tied to a $36 million Canadian principal, 4% per annum interest obligation with respect to a $26 million U.S. principal, 4.065% per annum interest, intercompany transaction. Both notional amounts increased by approximately 8% per annum. The interest differential paid or received on the swap contract was recognized as an adjustment to interest expense. The Trust was required to collateralize its position in the swap contract with a $2 million U.S. interest bearing deposit as of December 31, 1997. The collateral amount was not impaired as of December 31, 1997. In June 1998, the Trust sold the swap agreement for $825,000 in cash and was returned its full collateral securing this agreement. 7. COMBINED STATEMENTS OF CHANGES IN CASH The Trust and the Company consider all highly liquid short-term investments with original maturities of three months or less to be cash equivalents. The Trust and Company paid interest of $51.4 million, $29.9 million and $24.1 million in 1998, 1997 and 1996, respectively. During 1996, $121,000 of interest related to construction projects was capitalized. 8. UNREALIZED LOSS ON CARRYING VALUE OF ASSETS IDENTIFIED FOR DISPOSITION AND IMPAIRED ASSET Management reviews the net realizable value of the Trust's portfolio periodically to determine whether an allowance for possible losses is necessary. The carrying value of the Trust's investments in real estate is evaluated on an individual property basis in accordance with SFAS 121. In December 1998, the Trust recorded $36 million in unrealized losses on the carrying value of three shopping centers, two office properties and a parking facility which were identified for disposition. The Trust determined that these assets, which are actively being marketed for sale, were impaired based on the bids received for these assets as compared to their net book value. The bids received for these assets best represent the cash flow to be realized in accordance with SFAS 121. Assets identified for disposition as of December 31, 1998, had a net book value of $44.2 million, net of the $39.6 million balance of the asset reserve as of December 31, 1998. Impark recorded a $15 million U.S. reduction of goodwill in December 1998, in accordance with SFAS 121. Management annually evaluates the amortization life for goodwill by reviewing the recoverability of Impark's assets, including goodwill related to the acquisition of Impark. Measurement of the recoverability of the net book value of Impark is based on estimated undiscounted future cash flows of Impark over a holding period and applying a multiple of earnings of similar companies to value the entire operations, including goodwill. When the recoverability of Impark's assets, including goodwill, is less than its net book value, a discount factor is applied to the estimated future cash flows and the resulting amount is then compared to the net book value. The difference is recognized as an impairment under SFAS 121 by reducing goodwill. The estimates used for future cash flows may differ from actual performance due to the number of variables having an effect on daily operations and markets in which these operations are located. In January 1997, the Trust sold a shopping center for $9 million in cash. The sale resulted in a capital loss of $4 million which was provided for as part of a $14 million noncash, unrealized loss on the carrying value of certain assets that was recorded in December 1995. In February 1996, the Trust sold two office buildings and an attached parking garage in Cleveland, OH for $1.8 million in cash and a $7 million, 8% note secured by the properties. The note was repaid in June 1996. This sale resulted in a capital loss of $5.5 million which was provided for as part of a $14 million noncash, unrealized loss on the carrying value of certain assets that was recorded in December 1995. 11 12 The amount of assets identified for sale, the reserve for loss and the losses deducted from the reserve are summarized for the years ended December 31 in the following table (amounts in thousands):
RESTATED RESTATED 1998 1997 1996 -------- -------- -------- Assets identified for sale Net book value of assets identified for sale $ 5,163 $ 27,451 $ 41,527 (At historical cost less accumulated depreciation) Additions 79,034 808 1,362 Depreciation (360) (387) (1,312) Sales of assets (22,709) (14,126) -------- -------- -------- Net book value of assets identified for sale at year end $ 83,837 $ 5,163 $ 27,451 ======== ======== ======= Reserve for loss $ 3,630 $ 7,605 $ 13,060 Additions to reserve 36,000 Losses realized on sale of assets (3,975) (5,455) -------- -------- -------- Reserve at year end $ 39,630 $ 3,630 $ 7,605 ======== ======== =======
Property net operating income which is rents less operating expenses for assets identified for disposition are summarized for the years ended December 31 in the following table (amounts in thousands):
1998 1997 1996 ------- ------- ------- Revenues $15,217 $17,145 $20,842 Operating expenses 7,756 8,456 9,895 ------- ------- ------- Property net operating income $ 7,461 $ 8,689 $10,947 ======= ======= =======
9. CAPITAL GAINS AND LOSSES In May 1998, the Trust sold its investment in the land beneath the Huntington Building in Cleveland, OH for $6.1 million resulting in a capital gain of $1.7 million. Additionally, an $18.8 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 Trust received the mortgage note as consideration. In June 1998, the Trust sold a forward exchange agreement resulting in a gain of $.8 million. The forward exchange contract was purchased to protect the Trust from foreign currency fluctuations resulting from notes issued in conjunction with the acquisition of Impark. In December 1998, the Trust sold a land parcel in Monroe, LA resulting in a gain of $.1 million. In November 1997, the Trust sold an apartment complex in Dayton, OH, for $.7 million in cash, a $2.6 million, 8.75% second mortgage, secured by the property, and the assumption by the purchaser, of a $7.6 million existing mortgage loan. The capital gain recognized was $2.7 million. In December 1997, the Trust sold an office complex in Oklahoma City, OK, for $4.7 million in cash resulting in a capital loss of $1.2 million. 10. EXTRAORDINARY LOSS FROM EARLY EXTINGUISHMENT OF DEBT In 1998, the Trust repaid $87.5 million of its 8 7/8% senior notes resulting in $1.6 million of unamortized issue costs and solicitation fees being expensed. Additionally, the Trust renegotiated its bank credit agreement and the terms of the $90 million note payable in 1998 resulting in $.8 million of deferred costs related to the bank credit agreement and note payable being expensed. In 1997 and 1996, the Trust renegotiated its bank credit agreements resulting in $226,000 and $286,000, respectively, of deferred costs relating to its prior bank credit agreements being expensed. 11. ACQUISITIONS On April 17, 1997, the Company acquired voting control of Impark for $36.6 million in cash, assuming $26 million in debt and issuing to its former owners $10.5 million in non-voting stock in Impark and issuing to Impark employees $.7 million of non-voting stock, $.2 million in voting stock and $1 million in preferred stock of Impark. The transaction was recorded using purchase accounting. On September 1, 1997, the Trust purchased the interests of its joint venture partners in eight shopping malls and 50% of another mall for $88 million in cash and the assumption of $203 million of mortgage debt. The transaction was recorded using purchase accounting. The following unaudited pro forma information presents a summary of consolidated results of the Trust, the Company and Impark and the former joint venture properties as if the acquisitions occurred at the beginning of 1996 with pro forma adjustments to give effect to the amortization of goodwill, management and lease agreements, depreciation of property and interest expense (in thousands, except per share data): 12 13
RESTATED RESTATED (UNAUDITED) 1997 1996 ---- ---- Revenue $323,104 $313,303 Net income (loss) applicable to shares of beneficial interest (71) 47 Net income (loss) applicable to shares of beneficial interest per share -- --
12. LIABILITY TO FORMER OWNERS OF IMPARK The Company issued $10.5 million in non-voting common stock in Impark to its former owners in connection with the acquisition of Impark. The purchase price payable under the non-voting common stock increased from the aggregate issue price as of April 17, 1997 at an 8% per annum rate on the outstanding amount for the first six months and compounded by an additional one percentage point per annum each six month period thereafter up to a maximum rate of 17% per annum. To secure the Trust's obligations under this agreement, the Trust placed United States Treasury securities on deposit with a trustee and classified these securities as Investments in the December 31, 1997 Combined Balance Sheets. The non-voting common stock was recorded as an Other Liability in the Combined Balance Sheets as of December 31, 1997 and was being accreted to its final put price as a charge to expense. On June 1, 1998 the Company purchased the remaining non-voting common stock of Impark that it did not own for $11.2 million and the Trust subsequently sold the United States Treasury securities that served as collateral. 13. INVESTMENTS IN MORTGAGE LOANS AND NOTES RECEIVABLE As of December 31, the Trust had the following investments in mortgage loans and notes receivable (amounts in thousands):
CURRENT RATE ON INVESTMENT 1998 1997 ---------- ---- ---- First mortgage loan secured by an office building in Cleveland, OH, maturing in 2011 9.65% $18,908 Mortgage loan secured by a mall in Fairmount, WV, maturing in 1998 and partnership units of Crown American Properties, L.P. 9% 6,199 Second mortgage loan secured by an apartment complex in Dayton, OH, maturing in 2002 8.75% $2,581 2,600 Note receivable secured by management contract on an apartment complex in Atlanta, GA, maturing in 2008 10% 1,727 1,779 Note receivable secured by Temple Mall Company, maturing in 2023 6% 1,200 1,200 ------ ------- $5,508 $30,686 ====== =======
The Cleveland, OH and Fairmont, WV mortgages were paid in full in 1998. The book value of mortgage investments approximates fair market value as of December 31, 1998 based on current market conditions and market interest rates. 14. BANK LOANS TRUST As of December 31, 1998, the Trust has $101 million outstanding under a fully secured $110 million credit agreement at a weighted interest rate of 8.37% and 8.02% for December 31, 1997. In accordance with an agreement in principle subject to final documentation; the credit available under this agreement is reduced to $80 million on April 30, 1999 and $50 million on June 30, 1999. The pending agreement will amend the present commitment reduction dates of March 17, 1999 and May 17, 1999, respectively. The Trust expects to pay a fee of $.3 million to obtain the additional time period. The agreement in principle also provides for a reduction in the total credit facility commitment from $110 million. It also requires that $9 million of proceeds from an anticipated rights offering be used to repay exiting borrowings. This credit agreement matures in August 1999. Interest under this agreement is calculated, at the option of the Trust, based on an Eurodollar rate plus 300 basis points or the prime rate of the lender plus 50 basis points. The Trust may not use borrowings under this credit agreement to repay any other existing debt of the Trust, the Company or Impark. Additionally, the Trust has posted an $8 million letter of credit as collateral for Impark's credit facility, reducing the Trust's available borrowing by this amount. As the bank loans are at market interest rates, the fair value is the carrying amount of the loans. The weighted average interest rate for 1998 and 1997 for the credit agreement was 7.9% and 8%, respectively. Commitment fees not greater than 3/8% per annum are payable on the unused portion of the revolving credit 13 14 agreement. The agreement contains certain requirements including maintaining minimum funds from operations (income from operations plus depreciation and amortization), net worth, leverage, debt service and interest coverage. The Trust obtained a waiver at September 30, 1998 for violation of its financial covenants and also obtained modification to the debt service, interest coverage and net worth requirements and the methodology for calculating net income by excluding certain non-recurring or extraordinary charges or expenses through the termination of the credit facility. Also, the Trust has received a waiver with respect to the change in the majority of the Trust's Board of Trustees until June 30, 1999. The waiver and modification of the calculation of net income was obtained for an $.8 million fee. The Trust is in compliance with the required covenants as of December 31, 1998. The Trust has a rate guarantee contract in the notional amount of $63.5 million which is tied to LIBOR increasing to a maximum rate of 7%. This rate contract is used by the Trust to reduce the impact of changes for interest rates on its floating rate bank loans. The contract expires in October 2000 and the cost is being amortized over the life of the contract. IMPARK As of December 31, 1998, Impark has $33.8 million Canadian outstanding under a secured credit agreement at a weighted average interest rate of 7% and 6% for December 31, 1997. The credit agreement consists of revolving, acquisition, and term bank commitments of $6.5 million, $.9 million and $31.4 million Canadian, respectively. The revolving, acquisition and term bank facilities have $1.5 million, $.9 million, and $31.4 million Canadian outstanding, respectively, at December 31, 1998. The credit agreement matures in April 2000. The weighted average interest rate for the credit agreement was 7% for 1998 and 5.6% for 1997. As the bank loans are at market interest rates, the fair value is the carrying amount of the loans. The Trust for a fee to the bank facility lenders, provided a letter of credit for $8 million U.S. to secure a portion of the balance outstanding under the bank facility, and has agreed to collateralize, on August 11, 1999, the bank facility with $5 million U.S. in securities and to allow the bank facility to be put to the Trust in November 1999. The revolving and acquisition credit facilities bear interest at the lender's prime rate plus 50 basis points and the term facility bears interest at the Canadian Bankers Acceptance rate plus 150 basis points. Both interest rates increase by 25 basis points after June 30, 1999. Additionally, Impark will pay a fee of 55 basis points retroactive to the bank credit facilities inception date to the lenders upon maturity of the credit facility. In exchange for a fee of $.4 million Canadian, Impark has obtained reduced requirements under its interest coverage and leverage financial covenants through September 30, 1999 and may deduct certain non-recurring or extraordinary charges for determining earnings before interest, taxes, depreciation and amortization for covenant purposes. The fee also waived Impark's non-compliance with its financial covenants at September 30, 1998. Impark also received a waiver for the change in the majority of the Trust's Board of Trustees through June 30, 1999. Impark was in compliance with its bank covenants at December 31, 1998. 15. MORTGAGE LOANS PAYABLE AND DEFERRED OBLIGATION As of December 31, 1998, the Trust had outstanding $345 million of mortgage loans due in installments extending to the year 2018. Interest rates on fixed rate mortgages range from 6.869% to 12.25% with $34 million of mortgage loans bearing interest based on LIBOR. The weighted average interest rate of these mortgages is 7.32% at December 31, 1998. Principal payments due during the five years following December 31, 1998 are $4.3 million, $4.7 million, $39.1 million, $52.3 million and $5.6 million, respectively. A $38.7 million mortgage at 12.25% requires participation in the cash flow of the secured property over predefined levels. An $162.1 million mortgage note at 8.43% requires all rents and other tenant charges from the seven properties that are security for the mortgage to be directly deposited into a bank account which is pledged as additional security for the mortgage note and is restricted in use by the lender. The Trust also has outstanding a $10.6 million deferred obligation at an interest rate of 14.88%, which is due upon demand. The fair value of the mortgage loans payable and deferred obligation at December 31, 1998 is approximately book value based on current market interest rates and market conditions. 16. SENIOR NOTES In July 1998, the Trust 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. Concurrent with the tender offer, the Trust 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. 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 Trust purchased approximately $87.5 million principal amount of Senior Notes. The Trust has approximately $12.5 million of 8 7/8% Senior Notes outstanding at December 31, 1998. The fair value of the Senior Notes is approximately $12.4 million based on current market quotations. 17. PREFERRED SHARES OF BENEFICIAL INTEREST In October 1996, the Trust issued $57.5 million of Series A cumulative convertible redeemable preferred shares of beneficial interest ("Series A Preferred Shares"). The 2,300,000 Series A Preferred Shares were issued at a par value of $25 per share and are each convertible into 3.31 shares of beneficial interest. The distributions on the 15 Series A Preferred Shares are cumulative and equal to the greater of $2.10 per share (equivalent to 8.4% of the liquidation preference per annum) or the cash distributions on the shares of beneficial interest into which the Series A Preferred Shares are convertible (determined on each of the quarterly distribution payment dates for the Series A Preferred Shares). The Series A Preferred Shares are not redeemable prior to October 29, 2001, and at no time will they be redeemable for cash. On and after October 29, 2001, the Series A Preferred Shares are redeemable at the option of the Trust at the conversion rate of one Series A Preferred Share for 3.31 shares of beneficial interest. The Trust may exercise its option only if for 20 trading days within any period of 30 consecutive trading days, the closing price of the shares of beneficial interest on the New York Stock Exchange equals or exceeds the conversion price of $7.5625 per share of beneficial interest. In February 1998, 951,000 preferred shares of beneficial interest were converted to 3,144,000 shares of beneficial interest. 18. NOTES PAYABLE The Trust as of December 31, 1998 has notes payable of $90 million and $4.9 million outstanding. The $90 million note payable bears interest at 12% and has a final maturity of August 11, 1999. The Trust has an agreement in principle with the lenders, subject to final documentation, whereby the Trust will be required to reduce the outstanding principal balance to less than $70 million by May 15, 1999 and to less than $50 million by May 31, 1999. Additionally, a fee of 1% of the outstanding balance as of February 11, 1999, a fee of 50 basis points of the outstanding principal amount of the note on March 31, 1999 if the balance exceeds $60 million, and a fee of 50 to 100 basis points of the outstanding note balance on May 31, 1999 depending on the balance outstanding is required to be paid under the terms of the note. The Trust agreed, in principle, to pay a fee of $2.0 million to obtain a stand-by purchase commitment from the Gotham entities, who are also shareholders, to purchase up to $50 million from a contemplated rights offering. The note payable lenders have agreed, in principle, to allow $9.0 million of the net proceeds from the rights offering, that would otherwise be used to repay a portion of the note payable, to be used to repay the bank loans. This $9.0 million portion of the note payable will bear interest at 15% annually and matures on August 11, 1999. The Gotham entities are entitled to receive the $2.0 million standby commitment fee but agreed to accept $1.8 million. The standby commitment fee is payable whether or not the offering is consummated and is payable upon the earlier of the closing of the offering or March 31, 1999. Additionally, if a second rights offering is conducted by the Trust, the standby purchasers are entitled to another fee of up to 4% of their standby commitment unless the Trust cancels or decreases the standby commitment. The standby purchasers possess certain rights to terminate their obligation as standby purchasers under both the first and second offerings. The standby purchase arrangements with respect to the first offering expire on August, 1999 and with respect to the second offering expire on August 11, 1999. The note payable requires that the Trust and Impark be in compliance with all financial covenants under its bank facilities. The note payable lenders granted the Trust a waiver under this requirement as of September 30, 1998, in exchange for a fee of $300,000. The Trust is in compliance with the note payable covenants as of December 31, 1998. The fair value of the note payable is book value based on current market conditions. The Trust has a $4.9 million note payable to the trustee of an escrow account which secures the change in control agreements entered into by the Trust and the Company with their employees. The note is payable upon demand by the trustee. The fair value of the note payable is book value based on current market conditions. 19. SHARE OPTIONS The Trust has the following share option plans for key personnel. 1981 STOCK OPTION PLAN This plan provides that option prices be at the fair market value of the shares at the date of grant and that option rights granted expire 10 years after the date granted. Adopted in 1981, the plan originally reserved 624,000 shares for the granting of incentive and nonstatutory share options. Subsequently, the shareholders approved amendments to the plan reserving an additional 200,000 shares, for a total of 824,000 shares, for the granting of options and extending the expiration date to December 31, 1996. The amendments did not affect previously issued options. In June 1998, a change in the majority of the Trust's Board of Trustees resulted in all share options not previously vested to become fully vested as of that date. The activity of the plan is summarized for the years ended December 31 in the following table:
1998 WEIGHTED 1997 WEIGHTED 1996 WEIGHTED SHARES AVERAGE SHARES AVERAGE SHARES AVERAGE ------ ------- ------ ------- ------ ------- Granted --- --- 409,500 $7.37 Exercised 186,155 $8.51 39,809 $7.64 9,455 9.42 Canceled 317,281 8.22 13,590 13.14 96,450 15.84 Expired 16,120 17.43 22,880 17.55 21,640 24.76 Available --- --- 23,427
15 16 As of December 31, 1998, the following options were outstanding under the 1981 plan:
Options Outstanding Options Exercisable ------------------------------------------------------------------ ---------------------------- Weighted Year Average Weighted Weighted Options Number Range of Remaining Years Average Number Average Granted Outstanding Exercise Prices of Options Exercise Price Exercisable Exercise Price ------- ----------- --------------- --------------- -------------- ----------- -------------- 1989 31,720 $17.07-18.87 .70 $17.51 31,720 $17.51 1990 3,120 11.06 1.80 11.06 3,120 11.06 1992 2,000 10.00 3.80 10.00 2,000 10.00 1994 6,250 7.375 5.30 7.375 6,250 7.375 1996 69,240 7.375 7.20 7.375 69,240 7.375 ------- ------- ------- ------- 112,330 $10.386 112,330 $10.386 ======= ======= ======= =======
The weighted average of 631,886 options outstanding on January 1, 1998 was $ 8.93 per share. Included in the above table are 9,360 shares that the Company may purchase from the Trust at prices ranging from $11.06 to $17.07 per share to satisfy the Company's obligations to deliver shares to certain of its key employees pursuant to options previously granted. The option agreements with the Company's employees provide that option prices be at the fair market value of the Trust shares at the date of grant and that option rights granted expire 10 years after the date granted. 1994 LONG-TERM INCENTIVE OWNERSHIP PLAN This plan, adopted in 1994, reserved 1,629,785 shares for the granting of incentive and nonstatutory share options and restricted shares. In accordance with the plan, 9% of the shares of beneficial interest resulting from the conversion of preferred shares in February 1998 and the January and June 1997 shares of beneficial interest offerings have been reserved and added to the plan for grant. The share options expire eight to ten years after being granted. The price of the options is the fair market value of the shares at the date of grant with the exception of the option grants in November 1998. The stock options granted in 1998 were granted at exercise prices exceeding market. Additionally, these options have a cost of capital feature whereby the exercise price of the options will increase by 10%, compounded annually and prorated monthly, beginning in May 2000 and in each November thereafter, less the amount of per share dividends or other distributions to shareholders. As the 1998 option grants are deemed to be variable, compensation expense will be recorded when the market price of shares of beneficial interest exceeds the option price for these shares at the date of grant for these options. As of December 31, 1998, the option price of shares of beneficial interest did not exceed the market price of shares of beneficial interest, consequently no compensation expense was recorded for 1998. In June 1998, a change in the majority of the Trust's Board of Trustees occurred resulting in all stock options vesting that had been previously granted. Since the inception of this plan and prior to the June 1998 change in the composition of the Board of Trustees, restricted shares were issued to key employees. The restricted shares received dividends and had voting rights but could not be sold or transferred until the restriction period lapsed after eight years from the date of grant, or earlier if the Trust's share price equaled or exceeded $21 for 20 consecutive days, or upon a change in control as defined in the plan. Restricted shares were granted when defined levels of funds from operations and net capital gains were achieved during any four consecutive calendar quarters. Additionally, restricted shares were granted in place of share options. These restricted shares received dividends and had voting rights but could not be sold or transferred for four years or upon a change in control as defined in the plan. Beginning in 1998, other restricted shares were granted to plan participants based on defined improvements to funds from operations and shareholder return. These restricted shares were to vest when funds from operations for four consecutive quarters doubled as compared to the funds from operations in the quarter the restricted shares were granted, or the share price of shares of beneficial interest was 50% greater than the share price on the five trading days of the quarter immediately preceding the grant date of the shares, or upon a change of control as defined in the plan. The restricted shares received dividends and were eligible to vote. In June 1998, a change in the majority of the Trust's Board of Trustees occurred resulting in all restrictions being removed from the restricted shares that had been previously granted and a $4.7 million expense was recorded for the remaining deferred compensation which had not been expensed as of that date. Deferred compensation of $5 million in 1998, $3.2 million in 1997 and $1.7 million in 1996 was recorded. Amortization of the deferred compensation of $312,000, $746,000 and $499,000, respectively, was recognized in 1998, 1997 and 1996. 16 17 The activity of this plan is summarized for the years ended December 31 in the following table:
1998 WEIGHTED 1997 WEIGHTED 1996 WEIGHTED SHARES AVERAGE SHARES AVERAGE SHARES AVERAGE ----------------- ------------------ ---------------- Share options granted 1,800,000 $ 7.50 327,000 $14.19 79,000 $7.38 Share options canceled 501,468 10.83 7,102 7.38 18,400 7.37 Share options exercised 168,382 7.10 52,754 7.31 10,700 6.84 Restricted shares granted 343,964 226,867 142,500 Restricted shares canceled 606,852 3,521 37,007 Shares purchased by employees 18,499 9,005 11,094 Additional shares reserved 282,941 921,150 Available share options and restricted shares 270,485 1,041,687 672,786
As of December 31, 1998, the 1994 plan had the following options outstanding:
Outstanding Options Options Exercisable -------------------------------------------------------------------------------------------- Weighted Year Average Weighted Weighted Options Number Range of Remaining Years Average Number Average Granted Outstanding Exercise Prices of Options Exercise Price Exercisable Exercise Price ------- --------------------------- ---------- -------------- ----------- -------------- 1995 11,003 $ 7.50-7.75 4.40 $ 7.6629 11,003 $ 7.6629 1996 21,171 7.375 5.20 7.375 21,171 7.375 1997 60,000 14.125-14.25 6.30 14.1875 60,000 14.1875 1998 1,800,000 6.50-8.50 9.83 7.50 --------- ------ ------ ------- 1,892,174 $7.7116 92,174 $11.8439 ========= ======= ====== ========
The weighted average price of the 762,024 options outstanding as of January 1, 1998 was $10.13 per share. The Trust accounts for stock option awards in accordance with APB 25 and has adopted the disclosure-only provisions of SFAS 123 (Accounting for Stock-Based Compensation). Consequently, no compensation cost has been recognized for the share option plans. If compensation expense for the Trust's two share option plans had been recorded based on the fair value at the grant date for awards in 1998, 1997 and 1996, consistent with SFAS 123, the Trust's net income would be adjusted as follows (amounts in thousands, except per share data):
Restated Restated 1998 1997 1996 ---- ---- ---- Net income (loss) applicable to shares of $(86,517) $845 $550 beneficial interest Effect of stock options as calculated (557) (569) (430) -------- ----- ---- Net income (loss) as adjusted $(87,074) $ 276 $120 ======== ===== ==== Per share Basic and diluted: Net income (loss) $(2.81) $.02 $.03 Effect of stock options as calculated (.02) (.02) (.02) -------- ----- ---- Net income (loss), as adjusted $(2.83) $ -- $.01 ======== ===== ====
The fair value of each option grant is estimated on the date of the grant using the Black-Scholes option pricing model, with the following weighted average assumptions used for grants in 1998, 1997 and 1996.
1998 1997 1996 ---- ---- ---- Risk-free interest rate 5% 5.7% 6.35% Expected option life 10 4 10 Expected volatility 32% 23% 30% Expected dividend yield 4% 3.5% 3.5%
20. SHAREHOLDER RIGHTS PLAN In March 1990, the Board of Trustees declared a dividend consisting of one right to purchase one share of beneficial interest of the Trust with respect to each share of beneficial interest. The rights may be exercised only if a person or group acquires 15% or more of the outstanding shares of beneficial interest, makes a tender offer for at least 17 18 15% of the outstanding shares of beneficial interest or is declared to be an "adverse person." The exercise price of each right is $50. If a person or group acquires 15% or more of the outstanding shares of beneficial interest (except in a tender offer approved by the Board of Trustees), is declared to be an "adverse person" or engages in certain self-dealing transactions with the Trust ("flip-in events"), each right (other than rights owned by a 15% owner or an "adverse person") entitles the holder to purchase one share of beneficial interest of the Trust for par value (now $1 per share). The Board of Trustees has agreed to increase the 15% threshold for shares of beneficial interest acquired through a contemplated rights offering so that a "flip-in" event will not occur due to the rights offering. If the Trust is acquired in a merger or other business combination ("flip-over events"), each right entitles the holder to purchase, for $1, shares of the acquiring company having a market value equal to the market value of one share of beneficial interest of the Trust. The rights may be redeemed by the Trust at a price of $0.01 per right at any time prior to the earlier of a "flip-in" or "flip-over" event or the expiration of the rights on March 30, 2000. 21. FEDERAL INCOME TAXES The Trust has made no provision for current or deferred income taxes on the basis that it qualified under Sections 856-860 of the Internal Revenue Code as a real estate investment trust and has distributed all of its taxable income to shareholders. The Trust and Company have accrued $.6 million and $1.2 million in taxes relating to Canadian operations for 1998 and 1997, respectively. The Trust and Company treat certain items of income and expense differently in determining net income reported for financial reporting and tax purposes. Such items resulted in a net increase in income for tax reporting purposes of approximately $72 million in 1998, $8 million for 1997, and $1.6 million for 1996. As of December 31, 1998, net investments after accumulated depreciation in real estate for tax purposes was approximately $655 million. The 1998 quarterly allocation of cash dividends per share of beneficial interest for individual shareholders' income tax purposes was as follows:
LONG-TERM CAPITAL ORDINARY TOTAL DATE PAID GAINS INCOME PAID --------- ----- ------ ---- February 2, 1998 $.1066 $.0034 $.11 April 30, 1998 .1066 .0034 .11 ------ ------ ---- $.2132 $.0068 $.22 ====== ====== ====
For the year ended December 31, 1997, the cash dividends paid of $.44 consisted of $.3174 per share of ordinary income and $.1226 per share of capital gains, and for the year ended December 31, 1996, $.422 per share of ordinary income and $.018 per share of capital gains. The 1998 quarterly allocation of cash dividends per share for the preferred shares of beneficial interest for individual shareholders' income tax purposes was as follows:
LONG-TERM CAPITAL ORDINARY TOTAL DATE PAID GAINS INCOME PAID --------- --------- -------- ------ February 2, 1998 $.5086 $.0164 $.525 April 30, 1998 .5086 .0164 .525 July 31, 1998 .5086 .0164 .525 October 30, 1998 .5086 .0164 .525 ------- ------ ----- $2.0344 $.0656 $2.10 ======= ====== =====
For the year ended December 31, 1997, the cash dividends paid of $2.1172 per share for the preferred shares of beneficial interest consisted of $1.5272 per share of ordinary income and $.59 of capital gain. 22. LEGAL CONTINGENCY The Trust has pursued legal action against the State of California associated with the 1986 flood of Sutter Buttes Center, formerly Peach Tree Center. In September 1991, the court ruled in favor of the Trust on the liability portion of this inverse condemnation suit, which the State of California appealed. The Trust is proceeding with its damage claim. No recognition of potential income has been made in the accompanying Combined Financial Statements. 18 19 23. BUSINESS SEGMENTS In 1998, the Trust and Company adopted SFAS No. 131 (Disclosures about Segments of an Enterprise and Related Information). This statement requires companies to identify segments consistent with the manner in which management makes decisions about allocating resources to segments and measuring their performance. The Trust's and the Company's business segments include ownership of shopping centers, apartment complexes, office buildings, parking facilities, mortgage investments and parking management (Impark). Corporate rent and operating expense consist primarily of ground lease income from a property leased to a third party. Rent, property operating expense and real estate taxes, interest expense, depreciation, capital improvements and identifiable assets for real estate assets and for Impark have been identified for each of the business segments for the last three years. Impark derives 87% and 88% of its rent from Canadian operations for 1998 and 1997, respectively. Property net operating income is property rent less property operating expense and real estate taxes. Corporate interest expense consists of the Trust's non-recourse notes payable, senior notes, and bank loan interest expense. Corporate depreciation and amortization consist primarily of the amortization of deferred issue costs on non-recourse debt and the leasehold improvements for its corporate office. Corporate assets consist primarily of cash and cash equivalents, leasehold improvements for the corporate office and deferred issue costs for non-recourse debt and senior notes. All intercompany transactions between segments have been eliminated. (See table of business segments on next page.) 19 20
RESTATED RESTATED 1998 1997 1996 ---- ---- ---- Rents Shopping Centers $ 97,584 $ 58,284 $ 42,570 Apartments 17,056 17,835 16,306 Office Buildings 13,275 13,989 11,794 Parking Facilities 10,805 4,206 3,722 Impark 180,760 129,918 --- Corporate 1,112 1,156 1,163 --------- --------- --------- $ 320,592 $ 225,388 $ 75,555 Less - Operating Expenses Shopping Centers $ 32,433 $ 17,182 $ 11,911 Apartments 6,182 6,729 6,105 Office Buildings 6,069 6,753 6,701 Parking Facilities 2,444 1,017 200 Impark 175,625 124,624 --- Corporate 914 910 869 --------- --------- --------- $ 223,667 $ 157,215 $ 25,786 Less - Real Estate Taxes Shopping Centers $ 8,918 $ 6,857 $ 5,736 Apartments 975 1,382 1,234 Office Buildings 992 1,085 885 Parking Facilities 1,568 624 442 --------- --------- --------- $ 12,453 $ 9,948 $ 8,297 Property Net Operating Income Shopping Centers $ 56,233 $ 34,245 $ 24,923 Apartments 9,899 9,724 8,967 Office Buildings 6,214 6,151 4,208 Parking Facilities 6,793 2,565 3,080 Impark 5,135 5,294 --- Corporate 198 246 294 --------- --------- --------- $ 84,472 $ 58,225 $ 41,472 --------- --------- --------- Less - Depreciation and Amortization Shopping Centers $ 15,880 $ 10,414 $ 8,574 Apartments 2,751 2,952 2,796 Office Buildings 4,282 3,963 3,410 Parking Facilities 1,604 281 214 Impark 5,789 4,105 --- Corporate 3,083 1,177 896 --------- --------- --------- $ 33,389 $ 22,892 $ 15,890 Less - Interest Expense Shopping Centers $ 23,832 $ 11,224 $ 4,693 Apartments 2,819 3,406 2,951 Office Buildings --- 15 143 Parking Facilities 2,381 784 753 Impark 2,682 2,082 --- Corporate 19,145 12,353 14,886 --------- --------- --------- $ 50,859 $ 29,864 $ 23,426 Mortgage Investment Income $ 1,211 $ 2,907 $ 4,732 Corporate Income (Expense) Short-term investment income $ 1,337 $ 1,525 $ 80 Other income 1,386 5,724 1,500 General and administrative (37,577) (12,135) (6,787) Foreign currency loss (2,198) --- --- Litigation and proxy costs (4,848) --- --- Unrealized loss on carrying value of real estate and impaired assets (51,000) --- --- --------- --------- --------- Income (loss) before capital gain, extraordinary loss and minority interest $ (91,465) $ 3,490 $ 1,681 ========= ========= ========= Capital expenditures Shopping Centers $ 12,585 $ 9,381 $ 10,083 Apartments 2,081 1,497 1,606 Office Buildings 8,045 9,741 8,444 Parking Facilities 392 1,035 131 --------- --------- --------- $ 23,103 $ 21,654 $ 20,264 ========= ========= ========= Identifiable assets Shopping Centers $ 471,996 $ 498,238 $ 179,899 Apartments 79,011 79,386 89,090 Office Buildings 45,404 45,412 49,343 Parking Facilities 81,554 17,353 7,238 Impark 66,169 88,529 --- Mortgages 5,508 30,686 42,466 Corporate 37,042 30,622 45,018 --------- --------- --------- Total Assets $ 786,684 $ 790,226 $ 413,054 ========= ========= =========
20 21 24 SUBSEQUENT EVENT The Trust in February 1999 sold a shopping center for $21.6 million, resulting in net proceeds of $9.3 million after repayment of mortgage debt. The Trust in March 1999 sold an office building resulting in net proceeds of $1.8 million. 25. MINORITY INTEREST IN IMPARK The Company owns 76% of the voting common stock of Impark with the remainder owned by employees of Impark. Consequently, for financial reporting purposes the financial statements of Impark and the Company are consolidated with the minority interest's share of the loss resulting from Impark being allocated to the employee shareholders. As the equity of the minority shareholders was depleted as of December 31, 1997, no further losses have been allocated to the minority shareholders subsequent to 1997. 26. MINIMUM RENTS The future minimum lease payments that are scheduled to be received under noncancellable operating leases are as follows (amounts in thousands): 1999 $ 67,856 2000 60,308 2001 52,710 2002 46,936 2003 41,309 Thereafter 154,058 -------- $423,177 ========
27. RELATED PARTY TRANSACTIONS In connection with the $90 million note payable, the Trust paid fees of $1.4 million to the lenders. One of the lenders is Gotham Partners, L.P. and another is Gotham Partners III, L.P. ("Gotham") which received fees of $.2 million through December 31, 1998. The Trust paid interest of $3.7 million to the lenders, of which Gotham received $.6 million through December 31, 1998. The fees and interest were allocated among the lenders based on the amounts they loaned to the Trust. Gotham agreed to provide a stand-by commitment to purchase up to $50 million from a contemplated rights offering in exchange for a fee of $2.0 million. The Gotham entities are entitled to receive $2.0 million, but agreed to accept $1.8 million. Gotham also agreed to provide a stand-by commitment for a second rights offering of up to $40 million in exchange for a fee of up to 4%. Gotham owns 9.70% of the shares of beneficial interest as of December 31, 1998. The Trust in 1998 reimbursed Gotham for $3.1 million in proxy expenses. The Company has engaged a law firm, that has a partner who is a Trustee, to advise it on strategic matters regarding Impark. As of December 31, 1998, no payments have been made to this firm. The Company leases four of its parking facilities to a third party which is partially owned by an affiliate of a Trust shareholder, Apollo Real Estate Investment Fund II, L.P. and Apollo Real Estate Advisors. In 1998, the Trust received $.9 million in rent from this third party. The Trust in December 1998 engaged a company, a shareholder of which is a relative of a principal of Gotham, to provide mortgage brokerage services. No fees have been paid to this party through December 31, 1998 28. SEVERANCE ACCRUAL During 1998, the Trust recorded severance expense of $6.1 million for change in control agreements, other compensation arrangements for continuation of employment, and termination of an employment contract. At December 31, 1998, the Trust had paid $1.0 million of these benefits and has a balance of $5.1 million remaining to be paid. The Trust recognizes these expenses over the periods that employees are required to remain in the employment of the Trust. If an employee is terminated without any period of required continuing employment, these benefits are expensed if and when paid. The Trust also paid $3.4 million related to the termination of employment of its former chairman, president and chief executive officer. As a result of the proxy contest in 1998 and the change in the composition of the Trust's board of Trustees, restricted stock became unrestricted and the Trust recognized $4.7 million of deferred compensation as an expense. 29. CONTINGENCIES The Trust, in exchange for a fee from Impark, has provided performance guarantees for the manufacturing and installation of transit ticket vending equipment. The guarantees of $5.3 million and $6.2 million expire in February 2001 21 22 and 2002, respectively. As of December 31, 1998, no amounts have been drawn against these guarantees. 30. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED) The following is an unaudited condensed summary of the combined results of operations by quarter for the years ended December 31, 1998 and 1997. In the opinion of the Trust and Company, all adjustments (consisting of normal recurring accruals) necessary to present fairly such interim combined results in conformity with generally accepted accounting principles have been included. The first three quarters of 1998 and four quarters of 1997 have been restated to reflect the change in the lives of assets used to calculate depreciation. Additionally, the third quarter of 1998 has been restated for the reduction of a severance accrual made in the fourth quarter of 1998.
QUARTERS ENDED --------------------------------------------------------- RESTATED RESTATED RESTATED MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31 -------- ------- ------------ ----------- (IN THOUSANDS, EXCEPT PER SHARE DATA AND FOOTNOTES) 1998 ---- Revenues $ 80,354 $ 81,847 $ 78,670 $ 83,655 -------- -------- -------- -------- Loss before preferred dividend and extraordinary loss from early extinguishment of debt (3,579) (11,076) (8,598) (57,866) Extraordinary loss from early extinguishment of debt (1,633) (766) -------- -------- -------- -------- Net loss before preferred dividend (3,579)(1) (11,076)(2) (10,231)(3) (58,632)(4) -------- -------- -------- -------- Net loss applicable to shares of beneficial interest $ (4,454) $(11,784) $(10,939) $(59,340) ======== ======== ======== ======== Comprehensive net loss $ (4,450) $(12,073) $(11,276) $(59,957) ======== ======== ======== ======== Per share Loss applicable to shares of beneficial interest before extraordinary loss $ (.15) $ (.38) $ (.30) $ (1.87) Extraordinary loss from early extinguishment of debt (.05) (.02) -------- -------- -------- -------- Net loss applicable to shares of beneficial interest, basic and diluted $ (.15) $ (.38) $ (.35) $ (1.89) ======== ======== ======== ======== As previously reported: Net loss previously disclosed $ (3,272) $(10,602) $(11,657) Change in depreciation expense (1,182) (1,182) (1,182) Change in severance accrual 1,900 -------- -------- -------- Net loss as restated $ (4,454) $(11,784) $(10,939) ======== ======== ======== Net loss per share as previously disclosed, basic and diluted $ (0.11) $ (0.34) $ (0.37) Net loss per share as restated, basic and diluted (0.15) (0.38) (0.35)
(1) Included $.9 million loss U.S. from Impark's manufacturing subsidiary and $.9 million in proxy and litigation expenses. (2) Included $3.4 million expense for the termination of the former chairman, president and chief executive officer, $3.9 million in proxy and litigation expenses, $4.7 million expense for the vesting of restricted shares, $2.25 million loss of a property acquisition deposit due to the Trust terminating the deal, $1.5 million in professional fees to avoid a change in the composition of the Trust's Board, $1.0 million in bank loan waiver fees, a $.4 million loss for the termination of a systems project and $1.5 million in foreign currency translation loss. (3) Included $1.7 million severance accrual, $.8 million in expense for terminations of former employees, $1.6 million in legal fees for possible corporate and financial transactions of the Trust, $1.1 million in foreign currency translation loss for marking an intercompany receivable to the spot rate, the reduction in the accrual of percentage rent of $1.5 million due to the adoption of EITF 98-9 and a $1.6 million extraordinary loss from the repayment of $87.5 of Senior Notes prior to their maturity. (4) Included $1.1 million in expense for various services provided to the Trust by a third party and warrants issued in connection therewith, $.8 million in legal fees for a rights offering and potential acquisitions and sales, $.5 million in professional fees resulting from an unsuccessful effort to refinance the Trust's bridge and bank loans, $.8 extraordinary loss resulting from amendments to the Trust's bank credit facility and $90 million note payable, $4.4 million severance accrual offset by $1.5 million in additional percentage rent accrued due to the prospective adoption of EITF 98-9. Also included $51 million unrealized loss on carrying value of assets identified for disposition and impaired. (5) Included a noncash recognition of income from the repayment of a wraparound mortgage investment. (6) Included recognition of income of $.5 million from a casualty loss. 22 23
QUARTERS ENDED ----------------------------------------------------- RESTATED RESTATED RESTATED RESTATED MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31 -------- ------- ------------ ----------- 1997 - ---- Revenues $ 22,122 $ 58,946 $ 73,135 $ 81,341 -------- -------- -------- -------- Income before preferred dividend, extraordinary 1,318 1,074 1,086 2,424 loss from early extinguishment of debt and after minority interest Extraordinary loss from early extinguishment of debt (226) -------- -------- -------- -------- Net income before preferred dividend 1,318 1,074 1,086 2,198 -------- -------- -------- -------- Net income applicable to shares of beneficial interest $ 110(5) $ (135)(6) $ (123) $ 993 ======== ======== ======== ======== Comprehensive net income (loss) $ 114 $ (150) $ (209) $ 212 ======== ======== ======== ======== Per share Loss applicable to shares of beneficial interest before extraordinary loss and after minority interest $ .01 $ (.01) $ (.01) $ .05 Extraordinary loss from early extinguishment of debt (.01) -------- -------- -------- -------- Loss applicable to shares of beneficial interest - basic and diluted $ .01 $ (.01) $ (.01) $ .04 ======== ======== ======== ======== As previously reported: Net income previously disclosed $ 970 $ 727 $ 738 $ 608 Change in depreciation expense (860) (862) (861) (860) Change in loss on sale of property 1,245 -------- -------- -------- -------- Net income (loss) as restated $ 110 $ (135) $ (123) $ 993 ======== ======== ======== ======== Net income per share as previously disclosed, $ 0.05 $ 0.03 $ 0.03 $ 0.04 basic and diluted Net income (loss) per share as restated, basic and diluted 0.01 (0.01) (0.01) 0.04
23 24 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS TO THE SECURITYHOLDERS AND TRUSTEES OF FIRST UNION REAL ESTATE EQUITY AND MORTGAGE INVESTMENTS: We have audited the accompanying combined balance sheets of First Union Real Estate Equity and Mortgage Investments (an unincorporated Ohio business trust, also known as First Union Real Estate Investments) and First Union Management Inc. (a Delaware corporation) and its subsidiaries as of December 31, 1998 and 1997, and the related combined statements of operations, combined statements of comprehensive income, shareholders' equity and changes in cash for each of the three years in the period ended December 31, 1998 (1997 and prior as restated - see note 2). These financial statements are the responsibility of management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the combined financial position of First Union Real Estate Equity and Mortgage Investments and First Union Management Inc. and its subsidiaries as of December 31, 1998 and 1997, and the results of their operations and their changes in cash for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. Cleveland, Ohio, March 29, 1999. ARTHUR ANDERSEN LLP 24 25 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESTATEMENT OF COMBINED FINANCIAL STATEMENTS - -------------------------------------------- The Trust has restated its Combined Financial Statements for each of the five years ended December 31, 1998 as a result of changing the lives of assets to calculate depreciation expense. FINANCIAL CONDITION - ------------------- In January 1998, the Trust 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 Trust 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 Trust acquired a surface parking lot adjacent to the Ballpark at Arlington in Arlington, TX for $3 million in cash. In July 1998, the Trust acquired a parking garage in Nashville, TN for $2.1 million in cash and the assumption of a $4.5 million mortgage. During 1998, the Trust acquired three parcels of land adjacent to two shopping centers that it owns for $.7 million. The cash required for these acquisitions was funded with proceeds from the Trust's bank credit facilities. The Trust in January 1998 received $6.2 million in cash as full repayment of a mortgage investment secured by a property in Fairmont, WV. In May 1998, the Trust 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 Trust'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 Trust in May 1998, sold its investment in the land beneath an office building in Cleveland for $6.1 million resulting in a capital gain of $1.7 million. The proceeds were used to reduce short-term borrowings. In May 1998, the Trust 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 Trust's affiliated management company purchased the remaining non-voting common shares of Impark for $11.2 million from Impark's former owner. The non-voting common stock was recorded as an Other Liability in the Combined Financial Statements. The Trust, 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 Trust sold $11.5 million of U.S. Treasury bills which had collateralized the financial guarantee. In July 1998, the Trust 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. Concurrent with the tender offer, the Trust 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 purpose of the tender offer and consent solicitation was (i) to prevent the possibility that the Trust would be required to purchase the Senior Notes at 101% of their principal amount, an obligation which the Trust did not have the financial resources to satisfy, and (ii) to provide the Trust with additional financial and operating flexibility. Prior to its amendment, the Senior Note indenture required the Trust 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 levels. In April 1998, S&P placed the Trust on Credit Watch and in November 1998, downgraded the Trust's debt rating. In June 1998, Moody's placed the Senior Notes under review for possible downgrade and in October 1998, downgraded its rating for the Senior Notes. 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 the Senior Notes were delisted from the New York Stock Exchange. The Trust purchased approximately $87.5 million principal amount of Senior Notes. The purchase of the Senior Notes was financed with the proceeds of a $90 million loan (the "Bridge Loan") that matures in August 1999. 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 matters, accrued severance expenses for employee terminations, a new accounting pronouncement requiring the deferral of percentage rent from tenants, and foreign currency mark-to-market 25 26 losses, the Trust was not in compliance with the debt service coverage, interest coverage, 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 in the majority of the Trust's Board of Trustees occurred in June 1998. This change in the Board would have breached covenants under both credit facilities, but the lenders waived these breaches. The lenders under the Trust credit facility agreed to modify the debt service and interest coverage requirements and the methodology for calculating net income by excluding certain non-recurring or extraordinary charges or expenses, including percentage rent on a pro forma basis, and eliminating any expense or adjustment in any fiscal quarter relating to any non-cash foreign currency mark-to-market expense or adjustment. In addition, the lenders under the Trust's credit facility extended the waiver with respect to the Board of Trustees' change of control until June 30, 1999. In consideration for these modifications, the Trust paid the lenders an $825,000 fee. Concomitant with the covenant modifications and the waiver extension, the lenders reduced their maximum commitment under the Trust credit facility from $125 million to $110 million and will reduce such commitment further to $80 million on March 17, 1999 and to $50 million on May 17, 1999. The lenders have agreed in principle in March 1999 in exchange for a payment fee of $300,000, extended by 45 days the reduction of the commitment to April 30, 1999 and June 30, 1999, respectively. As part of the Amendment to extend the dates of the commitment reduction in March 1999, the lenders reduced the credit facility commitment by $5 million to $105 million. Additionally, upon the completion of the rights offering, $9 million of the proceeds will be used to repay the credit facility and the commitment will be reduced by $9 million to $96 million. The lenders also increased the interest rate under the facility from the Eurodollar rate plus 200 basis points or the prime rate to the Eurodollar rate plus 300 basis points or the prime rate plus 50 basis points. The lenders under the Impark credit facility agreed to (i) modify the interest coverage and leverage requirements and the methodology for determining earnings before interest, taxes, depreciation and amortization by adjusting for certain non-recurring or extraordinary charges or expenses for each of the quarters ended September 30, 1998 through September 30, 1999 and (ii) decrease the margin added to the Canadian Bankers Acceptance interest rate from 175 basis points to 150 basis points. In addition, the lenders extended the waiver with respect to the default caused by the change in the majority of the Trust's Board of Trustees until June 30, 1999. In consideration for these amendments and the waiver extension, the principal balance under the Impark credit facility was reduced from Cdn. $50 million to Cdn. $38.8 million, Impark paid the lenders a fee of Cdn. $388,400, and the Trust issued an $8 million U.S. letter of credit under the Trust's credit facility as collateral for Impark's obligations and agreed to provide an additional $5 million U.S. in collateral for such obligations on August 11, 1999. The lenders under the Bridge Loan agreed to extend the maturity of the loan to August 11, 1999 and incorporate the revised covenants in the Trust's credit facility. In consideration for these amendments, the Trust paid the Bridge Loan lenders a fee of $300,000 and agreed, in principle, to (i) reduce the outstanding principal balance under the Bridge Loan to less than $70 million by May 15, 1999 (previous reduction date was March 31, 1999) and to less than $50 million by May 31, 1999, (ii) increase the lenders' interest rate on the loan from 9.875% to 12% per annum and (iii) pay (A) on February 11, 1999 a fee of 1% of the outstanding principal amount of the loan on such date, (B) a fee in an amount equal to 50 basis points of the outstanding principal amount of the loan on March 31, 1999, if the balance outstanding is greater than $60 million and (C) a fee in an amount equal to 50 or 100 basis points of the outstanding principal amount of the loan on May 31, 1999, depending on the loan balance outstanding at May 31, 1999. The Trust further amended the Bridge Loan, in principle, to have $9.0 million of proceeds from an anticipated rights offering, that would otherwise be used to repay a portion of the Bridge Loan, to be used to repay the Trust's credit facility. This $9.0 million portion of the Bridge Loan will bear interest at 15% annually. In November 1998, in consideration for various services that it had previously provided to the Trust, a third party was issued ten-year warrants exercisable for 500,000 shares of beneficial interest at a price of $10 per share and was paid $750,000. The Trust recorded $436,000 in expense as a measurement of the consideration represented by the stock warrants based on the Black-Scholes option pricing model. In December 1998, the Trust, and Impark recorded a non-cash charge of approximately $51 million in accordance with SFAS 121, "Impairment of Long Lived Assets". The Trust determined that certain real estate assets held for sale are impaired based on the bids received from purchasers compared to the net book value of these assets held for sale and recorded a $36 million charge. As the Trust intends to sell these assets, the bids received best represent the cash flow to be realized in accordance with SFAS 121. Additionally, Impark recorded a $15 million U.S. reduction of goodwill. A review for impairment was triggered based on Impark's operating results being less than the proforma projection used to purchase Impark. The impairment was indicated by projected undiscounted future cash flows of Impark being less than the net book value of Impark's assets, including goodwill related to the acquisition. The impairment amount was calculated based on discounting projected cash flows of Impark, which showed the net book value of Impark's assets, including goodwill, would not be realized by $15 million U.S. YEAR 2000 - --------- In June 1998, the Trust 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 26 27 to be critical to the Trust'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 December 31, 1998, the inventory and priority assessment phases of the Project were completed. Critical items are those believed by the Trust 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 the first quarter of 1999. 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 Trust'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 October 31, 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 Trust. Testing and repair of this equipment is in process. The Trust'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 June 30, 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 Trust 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 Trust'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 problem. The failure to correct a material Year 2000 issue could result in the interruption or failure of certain normal business activities or operations. The most reasonable worst case scenarios for the Trust are - A significant number of tenants at shopping centers will not be able to record sales transactions using their automated equipment or accept credit card transactions, and - Electric utility companies will not be able to provide power to operate shopping centers, office buildings, apartment complexes or parking facilities. The most reasonable worst case scenarios for Impark are - Its financial reporting system will not work on or after January 1, 2000, and - Parking equipment that has been identified as non-compliant will not accept credit cards from parking patrons at the facilities it manages. The Trust does not have a contingency plan but is in the process of developing one upon completion of repairing and testing equipment used in operations and based on responses of critical third party tenants, suppliers and customers. FEDERAL TAX LEGISLATION - ----------------------- On July 22, 1998, tax legislation was enacted limiting the "grandfathering rules" applicable to stapled real estate investment trusts (REITs), such as the Trust which has a paired management company. The shares of the Trust's affiliated management company are considered to be "paired" with the shares of the Trust. As a result of this legislation, the income and activities of the affiliated management company, with respect to any real property interests acquired by the Trust and the affiliated management company after March 26, 1998, will be attributed to the Trust for purposes of determining whether it qualifies as a REIT under the Internal Revenue Code. The Trust terminated the management arrangements with its affiliated management company in March 1999, and self manages its retail, apartment and office portfolios. The Trust also entered into third-party management arrangements for the parking facilities it owns in the United States. Consequently, the Trust believes that the legislation will not have a material effect on its operating results or its present qualification as a REIT. 27 28 LIQUIDITY AND CAPITAL RESOURCES - ------------------------------- Net cash provided by operations was $6.4 million as compared to cash provided by operations of $15.7 million when comparing 1998 to 1997. The decrease in cash provided from operations is primarily the result of a net loss before the preferred dividend of $83.5 million. The net loss was primarily caused by several charges relating to the proxy contest and change in the Board of Trustees' composition as detailed in the following section "Results of Operations" and the non cash charge of $51 million for the unrealized loss on the carrying value of assets held for sale and impaired. The net loss of $83.5 million is offset by the non cash charges of $33.4 million for depreciation and amortization and the $51 million charge to recognize the unrealized loss on the carrying value of assets held for sale and impaired. Dividends to shares of beneficial interest paid in 1998 of $6.6 million represented 103% of net cash from operations. The Trust received $25 million in full repayment of two mortgage investments secured by a mall in Fairmont, WV and an office building in Cleveland, OH during 1998. The proceeds were used to repay borrowings under the Trust's bank credit facilities. Additionally, the Trust in May 1998 sold land in Cleveland, OH for $6.1 million which was also used to repay bank credit facilities. As noted previously, the Trust 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 Trust invested $23.1 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 Trust's affiliated management company purchased the remaining non-voting common stock of Impark in June 1998 for $11.2 million. During the second quarter of 1998, the Trust 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 Trust had made in conjunction with the Trust's affiliated management company's acquisition of Impark. In May 1998, the Trust 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 Trust 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 Trust has adopted a policy of making dividend distributions on an annual basis. The Trust, for 1998, has made all distributions required to maintain its tax status as a REIT. As noted previously, the Trust obtained a $90 million Bridge Loan which was used to repurchase approximately $87.5 million in Senior Notes. The Trust in 1999 has the following debt maturities (in thousands of dollars): Bank loans $101,000 Bridge loan 90,000 Mortgage principal payments 4,308 Other obligations 10,602 ---------- $205,910 ==========
The bank loans require paydowns to $80 million and $50 million by April 30, 1999 and June 30, 1999, respectively. The remaining $50 million must be repaid by August 11, 1999. The Bridge Loan must be paid down to $70 million by May 15, 1999 and to $50 million on May 31, 1999. The remaining $50 million must be paid by August 11, 1999. The $10.6 million obligation may be called during 1999 at the option of the creditor. To fund the repayment of these obligations, the Trust intends to sell certain assets, conduct a rights offering, use cash available of $28.6 million as of December 31, 1998, refinance certain assets, and use cash from operations. To facilitate the rights offering, the Trust, in September 1998, filed a registration statement on Form S-3 with the Securities and Exchange Commission. If the Trust is not able to meet the deadlines for debt repayment, it may be forced to seek bankruptcy protection. QUANTITATIVE AND QUALITATIVE DISCLOSURES OF MARKET RISK EXCHANGE RATE RISK Impark, the affiliated management company's Canadian subsidiary, operates internationally and enters into transactions denominated mainly in Canadian currency. As a result, the Trust and its affiliated management company are subject to the variability that arises from exchange rate movements. The Trust continually monitors its economic exposure to changes in foreign exchange rates and in 1997 entered into a foreign exchange forward contract to limit risk associated with intercompany debt. This contract was cancelled in 1998. The Trust and its affiliated management company no longer hedge risks in foreign currency exchange rate movements and do not intend to do so in the foreseeable future. The only Canadian denominated debt obligation that is sensitive to foreign currency exchange rates is the Impark bank loan. The table presents its principal cash flow and related weighted average interest rate by expected maturity date. The weighted average variable rate is based on the rate in effect at December 31, 1998. No assumptions have been made about future interest rates. The information is presented in U.S. dollar equivalents, which is First Union's reporting currency. INTEREST RATE RISK The Trust and Impark have entered into certain financing arrangements that require interest payments based on variable interest rates. As such, the combined financial statements are subject to changes in the market rate of interest. To reduce the exposure to changes in the market rate of interest, the Trust has entered into a rate guarantee contract (also known as an interest rate cap) for a portion of its floating rate financing arrangements. The Trust does not enter into rate guarantee contracts for trading purposes. The table below provides information about the Trust's and its affiliated management company's derivative financial instruments and other financial instruments that are sensitive to changes in interest rates, including the interest rate cap and debt obligations. Weighted average variable rates are based on the rates in effect at December 31, 1998. No assumptions have been made about the future interest rates. The Canadian dollar denominated obligation is presented in U.S. dollar equivalents, which is First Union's reporting currency.
As of December 31,1998 ------------------------------------------------------------------------------ Expected Maturity Dates (amounts in millions) ----------------------------------------------------------- Fair 1999 2000 2001 2002 2003 Thereafter Total Value ---- ---- ---- ---- ---- ---------- ----- ----- LIABILITIES Bank loans at variable rates (See Notes to Combined Financial Statements for variable rates) --First Union $101.0 $101.0 $101.0 Weighted average interest rate 8.37% --Impark ($US) $24.8 $24.8 $24.8 Weighted average interest rate 7.00% Mortgage loans and deferred obligation - -- Fixed rate $4.3 $4.7 $5.1 $52.3 $5.6 $239.0 $311.0 $311.0 Weighted average interest rate 8.62% 8.62% 8.40% 8.95% 9.02% 8.80% - -- Variable rate (based on LIBOR) $34.0 $34.0 $34.0 Weighted average interest rate 7.32% Senior notes - -- Fixed rate $12.5 $12.5 $12.4 Interest rate 8.875% Notes payable - -- $90 million note payable $90.0 $90.0 $90.0 Interest rate 12% - -- $4.9 million note payable $4.9 $4.9 $4.9 Interest rate 12% INTEREST RATE DERIVATIVES Rate guarantee contract, purchased cap, in the notional amount of $63.5 million, declining to $33.5 million in 1999, expiring in 2000; tied to LIBOR increasing to more than 7%, at which time the Company would receive a payment under the contract.
28 29 RESULTS OF OPERATIONS - 1998 VERSUS 1997 - ---------------------------------------- Net loss applicable to shares of beneficial interest for 1998 was $86.5 million as compared to net income of $.8 million for 1997. The net loss for 1998 included a $2.25 million loss on a property acquisition deposit that was approved prior to the change in the majority of the Board of Trustees in June 1998, and which was offset by $200,000 later in 1998 by assigning the contract to a third party, a $3.4 million payment to the Trust's former chairman and chief executive officer, a $4.7 million expense due to lifting of restrictions on restricted shares which followed the change in the majority of the Trust's Board of Trustees, $1.5 million in other professional fees to avoid a change in the composition of the Trust's Board, $4.8 million in proxy and litigation expenses and a $51 million noncash charge to recognize the loss on carrying value of assets held for sale and impaired assets. Additionally, the Trust incurred $2.2 million in foreign currency mark-to-market losses, $6.1 million in accrued severance expenses for change in control agreements and for employee terminations and $2.6 million in legal fees. In February 1998, 951,000 preferred shares of beneficial interest were converted into common shares of beneficial interest resulting in a decreased preferred dividend when comparing 1998 to 1997. Net loss for 1998 included $10.3 million of capital gains. The Trust sold its land beneath a building in Cleveland, OH 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 Trust received the mortgage note as purchase consideration. The Trust also realized a capital gain from the sale of a forward exchange contract of $.8 million in the second quarter of 1998. In December 1998, the Trust sold a land parcel in Monroe, LA resulting in a $.1 million capital gain. Additionally, the net loss for 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 Trust repaid approximately $87.5 million of the Senior Notes prior to their maturity and $.8 million of deferred costs which were expensed when the Trust renegotiated its bank agreement and $90 million Bridge Loan. Mortgage loan interest income declined by $1.7 million, when comparing 1998 to 1997. The decline in interest income when comparing 1998 to 1997 was caused by the repayment of a mortgage investment secured by a shopping mall in Fairmont, WV in January 1998 and the repayment of a mortgage investment secured by an office building in Cleveland, OH in May 1998. The Trust 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 Trust'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 Trust's affiliated management company purchased voting control of Impark in April 1997. The REIT stock was acquired in the third and fourth quarters of 1997 as a long-term investment. As noted previously, the non-voting common stock of Impark was purchased in June 1998 allowing the Trust to sell the U.S. Treasury bills. The Trust also sold its holdings in the REIT stock as a result of its change in investment strategy. In September 1996, the Trust invested in a joint venture that owned eight shopping malls and 50% of another mall. The Trust in September 1997 purchased the interests of its joint venture partners. Consequently, the Trust's investment income and management fees for the Trust's affiliated management company declined when comparing 1998 to 1997. Property net operating income for 1998 increased $26.2 million when comparing 1998 to 1997 on a non-comparable basis. The acquisition of the former joint venture properties in September 1997 and the five parking facilities in the first three months of 1998 produced $21.8 million and $3.7 million, respectively, of increased property net operating income when comparing 1998 to the same period of 1997. These increases were offset by the decrease in property net operating income of $1.5 million resulting from the sale of an office building and an apartment complex in the last four months of 1997. Property net operating income increased by $2.2 million for the comparable portfolio when comparing 1998 to the same period of 1997. The increase was attributable to the continued lease-up of the North Valley Tech Center and increased rental rates in the apartment portfolio. Mortgage interest expense increased when comparing 1998 to that of 1997 primarily due to the $203 million in mortgage debt assumed in September 1997 in conjunction with the purchase of the remaining interest in the Trust's joint venture and the $30 million mortgage obtained in May 1998. Bank loan interest expense increased when comparing 1998 to the prior year due to increased borrowing, exclusive of the bank debt assumed in the April 1997 acquisition of Impark. The average balance for 1998 outstanding, exclusive of Impark's bank debt, was $90 million. The average balance outstanding for 1997 was approximately $19 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 Trust's purchase of its partners' interest in the joint venture and to fund tenant and capital improvements during 1998 and 1997. Additionally, the bank covenant waiver fees of $.6 million for the second quarter covenant waivers were recorded as bank loan interest expense in 1998. Offsetting the increase in the bank credit facilities were 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 29 30 the $30 million mortgage obtained in May 1998. Additionally, the inclusion of Impark for all of 1998, as compared to eight and a half months in 1997, in the results of the affiliated management company, resulted in bank interest expense increasing by $.8 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 Trust 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 increased when comparing 1998 to 1997 primarily related to several charges as a result of the proxy contest and the change in the majority of the Board of Trustees. The charges in the second quarter of 1998 included $4.8 million in proxy and litigation expenses of which $3.1 million was a reimbursement for Gotham's proxy expenses, $3.4 million resulting from the termination of the former chairman, president and chief executive officer, $4.7 million for the vesting of restricted shares which occurred upon the change in the majority of the Board of Trustees, and $1.5 million in additional professional fees to avoid a change in the composition of the Trust's Board. Additionally, in the third and fourth quarters of 1998, the Trust accrued $6.1 million of severance expense for employee termination, change in control and continuation of employment agreements. During the last six months of 1998, the Trust incurred approximately $2.6 million in legal fees for negotiation of the $90 million note payable and credit facilities, potential sales of properties and corporate acquisitions and corporate due diligence and preparation of a rights offering. In November 1998, the Trust issued 500,000 ten-year warrants to Enterprise Asset Management Inc. ("Enterprise") and paid Enterprise $750,000 for consulting services provided to the Trust during the summer of 1998 when the Trust was evaluating its retail portfolio and marketing the properties for sale. The Trust recognized total expense of $1.1 million for the fee paid to Enterprise and the fair values of the warrants based on the Black-Scholes model. The Trust expensed $.5 million in fees for an unsuccessful effort to refinance its current debt in December 1998. Impark's general and administrative expenses increased over 1997 due to its inclusion in results for a full year in 1998 versus eight and a half months in 1997, and approximately $2.5 million in expansion costs into U.S. markets incurred in 1998 and a $.4 million expense for the termination of a contract to replace its computer system. The Trust also recorded a $2.25 million expense when it did not close on the purchase of a parking facility because the Board of Trustees believed that the contract, which was approved prior to the change in the majority of the Board in June 1998, was on disadvantageous terms. First Union partially offset this loss by assigning the contract to a third party for $200,000. RESULTS OF OPERATIONS - 1997 VERSUS 1996 - ---------------------------------------- Net income applicable to shares of beneficial interest for 1997 was $.8 million. The net income applicable to shares of beneficial interest for 1997 included a noncash recognition of $700,000 of income from the repayment of a wraparound mortgage investment, as the proceeds of $18 million exceeded the Trust's basis in the wraparound investment and the recognition of $500,000 in income from a casualty loss at one of the Trust's shopping centers. Net income applicable to shares of beneficial interest for 1997 was after the $4.8 million preferred dividend for the preferred shares which were issued in October 1996. In November 1997, the Trust sold an apartment complex in Dayton, OH, resulting in a capital gain of $2.7 million; while in December 1997, the Trust sold an office complex in Oklahoma City, OK, resulting in a loss of $1.2 million. The net capital gain resulting from these transactions was $1.5 million. Mortgage investment income declined when comparing 1997 to 1996 due primarily to the repayment of a wraparound mortgage investment in February 1997, as noted previously. Short-term investment income increased in 1997 as compared to 1996 due to the Trust having an average of $31 million invested in short-term securities in 1997 versus minimal short-term investments in 1996. Property net operating income was $16.8 million greater when comparing 1997 and 1996. The comparable office property portfolio produced $1.2 million in increased property net operating income when comparing 1997 and 1996 primarily due to increased occupancy at a former retail center in Denver, CO, and at office buildings in Cleveland, OH, and Indianapolis, IN, and a real estate tax refund in Cleveland, OH. The comparable parking portfolio had a decline of $500,000 in property net operating income primarily due to increased real estate tax expense and the expiration of a fixed minimum rent management contract. The comparable retail portfolio had decreased net operating income of $1.2 million when comparing 1997 and 1996 due primarily to the recognition of a $1.1 million termination fee in 1996. The comparable apartment portfolio had increased property net operating income of $600,000 when comparing 1997 and 1996 primarily due to the increased occupancy at an apartment complex in Durham, NC, and rent increases at the Trust's other apartment complexes. The acquisition of Impark in April 1997 and the Trust's purchase of its partners' interest in the joint venture in September 1997 produced $17.2 million in property operating income on a non-comparable basis. The acquisition of an apartment complex in December 1996 and parking facilities in May 1997 partially offset the decline in property net operating income from the shopping mall, office buildings and apartment complex sold in January 1997 and last four months of 1997, resulting in a decline of $400,000 in property net operating income. 30 31 Mortgage interest expense increased when comparing 1997 to 1996 due to the $203 million in mortgage debt assumed in September 1997 in conjunction with the Trust's purchase of the remaining interest of the joint venture. Interest on bank loans decreased when comparing 1997 to the same period of 1996. In 1997, the Trust had an average of $19 million in bank borrowings versus $51 million in 1996. The net proceeds from the sale of preferred shares of beneficial interest in October 1996, the proceeds from a sale of a shopping mall in January 1997 and a portion of the net proceeds from the sale of shares of beneficial interest in January 1997 and June 1997 were used to repay short-term bank loans. However, partially offsetting the decrease in bank loan interest and other expense is the addition, in April 1997, of approximately $26 million in bank loans assumed in the acquisition of Impark and the accrual of the liability associated with a put-right which was attached to the Impark common shares issued to the former owners of Impark as part of the acquisition consideration. Depreciation and amortization expense increased when comparing 1997 to 1996. This increase in depreciation and amortization expense was primarily attributed to the amortization of goodwill and management contracts related to the acquisition of Impark, the depreciation of the malls acquired in September 1997, and the Trust's capital improvement program. These increases are partially offset by the non-recurring, non-cash $680,000 write-off of a tenant allowance which occurred in the first quarter of 1996 when the Trust replaced an anchor tenant at one of its malls. General and administrative expenses for 1997 increased when compared to 1996. The increase is mainly attributed to the general and administrative expenses from the management of the nine properties acquired in a joint venture for 1997 and the acquisition of Impark in the second quarter of 1997. The increase in general and administrative expenses for 1997 was partially offset by a non-recurring, noncash charge of $650,000 in 1996 for the termination of an employment contract of a former executive. Certain statements contained in the annual report 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 10K. 31 EX-23 3 EXHIBIT 23 1 EXHIBIT 23 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS As independent public accountants, we hereby consent to the incorporation of our reports included in this Form 10-K, into the registrant's previously filed Registration Statements on Form S-3 (Registration Nos. 2-88719, 33-2818, 33-11524, 33-19812, 33-26758, 33-33279, 33-38754, 33-45355, 33-57756 and 333-953). Cleveland, Ohio, Arthur Andersen LLP April 9, 1999. -----END PRIVACY-ENHANCED MESSAGE-----