<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
Quarterly Report under Section 13 or 15(d) of
the Securities Exchange Act of 1934
For the Quarter Ended September 30, 1998 Commission File Number 1-14516
PRENTISS PROPERTIES TRUST
(Exact Name of Registrant as Specified in its Charter)
MARYLAND 75-2661588
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
3890 West Northwest Highway, Suite 400, Dallas, Texas 75220
(Address of Registrant's Principal Executive Office)
(214) 654-0886
(Registrant's Telephone Number, Including Area Code)
Indicate by check mark whether the Registrant (i) 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 report), and (ii) has been subject to such
filing requirements for the past 90 days.
Yes X No
--------- ---------
The number of Common Shares of Beneficial Interest, $0.01 par value, outstanding
as of November 11, 1998, was 38,926,655 and the number of outstanding
Participating Cumulative Redeemable Preferred Shares of Beneficial Interest,
Series A, was 3,773,585.
<PAGE>
PRENTISS PROPERIES TRUST
INDEX
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<TABLE>
<CAPTION>
PART I: FINANCIAL INFORMATION PAGE NUMBER
-----------
<S> <C> <C>
Item 1. Financial Statements
Consolidated Balance Sheets of Prentiss Properties Trust at
September 30, 1998 (unaudited) and December 31, 1997 3
Consolidated Statements of Income of Prentiss
Properties Trust for the three month periods ended
September 30, 1998 and 1997 and the nine month
periods ended September 30, 1998 and 1997 (unaudited) 4
Consolidated Statements of Cash Flows of Prentiss
Properties Trust for the nine month periods ended
September 30, 1998 and 1997 (unaudited) 5
Notes to Consolidated Financial Statements 6-18
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 19-28
Item 3. Quantitative and Qualitative Disclosures about Market Risk 28
PART II: OTHER INFORMATION
Item 1. Legal Proceedings 29
Item 2. Changes in Securities 29
Item 3. Defaults Upon Mortgages and Notes Payable 29
Item 4. Submission of Matters to a Vote of Security Holders 29
Item 5. Other Information 29
Item 6. Exhibits and Reports on Form 8-K 29-31
SIGNATURE 32
</TABLE>
2
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PRENTISS PROPERTIES TRUST
CONSOLIDATED BALANCE SHEETS
(dollars in thousands, except share data)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 1997
-------------------- --------------------
(UNAUDITED)
<S> <C> <C>
ASSETS
Real estate..................................................... $1,804,884 $1,170,992
Less: accumulated depreciation............................... (59,090) (36,143)
---------- ----------
1,745,794 1,134,849
Deferred charges and other assets, net.......................... 56,451 24,636
Mortgage note receivable........................................ 36,101 36,331
Receivables, net................................................ 18,225 10,865
Cash and cash equivalents....................................... 3,530 7,075
Escrowed cash................................................... 5,820 4,524
Other receivables (affiliates).................................. -- 1,928
Investments in joint venture and unconsolidated subsidiary...... 10,976 19,638
---------- ----------
Total assets................................................... $1,876,897 $1,239,846
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Debt on real estate............................................ $ 811,621 $ 420,030
Accounts payable and other liabilities......................... 55,977 35,795
Other liabilities (affiliates)................................. 3,628 --
Distributions payable.......................................... 19,739 14,782
---------- ----------
Total liabilities........................................... 890,965 470,607
---------- ----------
Minority interest in operating partnership...................... 128,578 71,547
---------- ----------
Minority interest in real estate partnerships................... 1,308 1,060
---------- ----------
Commitments and contingencies
Shareholders' equity:
Series A Preferred shares $.01 par value, 20,000,000
shares authorized, 3,773,585 and 2,830,189 shares
issued and outstanding at September 30, 1998 and
December 31, 1997, respectively............................... 100,000 75,000
Common shares $.01 par value, 100,000,000 shares
authorized, 39,924,380 (includes 998,800 in treasury)
and 33,191,483 shares issued and outstanding at
September 30, 1998 and December 31, 1997,
respectively.................................................. 399 332
Additional paid-in capital..................................... 787,217 628,086
Distributions in excess of accumulated earnings................ (8,256) (6,786)
Common shares in treasury, at cost, 998,800 at
September 30, 1998........................................... (23,314) --
---------- ----------
Total shareholders' equity................................... 856,046 696,632
---------- ----------
Total liabilities and shareholders' equity................... $1,876,897 $1,239,846
========== ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
3
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PRENTISS PROPERTIES TRUST
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
(in thousands, except per share data)
<TABLE>
<CAPTION>
THREE MONTHS THREE MONTHS NINE MONTHS NINE MONTHS
ENDED ENDED ENDED ENDED
SEPT 30, 1998 SEPT 30, 1997 SEPT 30, 1998 SEPT 30, 1997
-------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
Revenues:
Rental income............................................. $63,531 $33,998 $167,470 $85,092
Mortgage interest......................................... 960 640 2,880 640
Management fees........................................... 201 218 691 690
Development, leasing, sale and other fees................. 379 724 852 1,591
------- ------- -------- -------
Total revenues........................................... 65,071 35,580 171,893 88,013
------- ------- -------- -------
Expenses:
Property operating and maintenance......................... 15,874 7,962 39,455 19,972
Real estate taxes.......................................... 6,828 3,683 18,096 9,386
General and administrative................................. 1,205 1,038 3,336 2,338
Personnel costs, net....................................... 684 1,073 2,432 2,437
Interest expense........................................... 11,566 5,893 28,245 12,926
Amortization of deferred financing costs................... 200 222 596 589
Depreciation and amortization.............................. 11,221 5,783 29,380 14,669
------- ------- -------- -------
Total expenses........................................... 47,578 25,654 121,540 62,317
------- ------- -------- -------
Equity in income of joint venture and unconsolidated
subsidiary................................................. 2,222 1,488 5,172 4,270
------- ------- -------- -------
Income before gain on sale, minority interests, and
extraordinary item......................................... 19,715 11,414 55,525 29,966
Gain on sale................................................ 4,379 8,203 243
Minority interests.......................................... (2,862) (1,298) (5,041) (3,753)
------- ------- -------- -------
Income before extraordinary item............................ 21,232 10,116 58,687 26,456
Extraordinary item.......................................... -- -- (8,908) (111)
------- ------- -------- -------
Net income.................................................. $21,232 $10,116 $ 49,779 $26,345
Preferred dividends......................................... (1,505) -- (4,146) --
------- ------- -------- -------
Net income applicable to common shareholders................ $19,727 $10,116 $ 45,633 $26,345
======= ======= ======== =======
Net income per Common Share before extraordinary item basic $ 0.50 $ 0.38 $ 1.41 $ 1.11
Extraordinary item.......................................... -- -- (0.23) --
------- ------- -------- -------
Net income per Common Share basic.......................... $ 0.50 $ 0.38 $ 1.18 $ 1.11
------- ------- -------- -------
Weighted average number of Common Shares outstanding basic. 39,349 26,289 38,680 23,646
======= ======= ======== =======
Net income per Common Share before
extraordinary item diluted............................. $ 0.49 $ 0.38 $ 1.38 $ 1.10
Extraordinary item.......................................... -- -- 0.21 --
------- ------- -------- -------
Net income per Common Share diluted........................ $ 0.49 $ 0.38 $ 1.17 $ 1.10
======= ======= ======== =======
Weighted average number of Common Shares and
Common Share equivalents outstanding diluted.............. 43,280 26,698 42,425 24,002
======= ======= ======== =======
</TABLE>
The accompanying notes are an integral part of these financial statements.
4
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PRENTISS PROPERTIES TRUST
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(dollars in thousands)
<TABLE>
<CAPTION>
NINE MONTHS NINE MONTHS
ENDED ENDED
SEPT 30, 1998 SEPT 30, 1997
----------------------- ---------------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income............................................................. $ 49,779 $ 26,345
Adjustments to reconcile net income to net cash provided by operating
activities:
Minority interests................................................. 5,041 3,753
Extraordinary item................................................. 8,908 111
Gain on sale....................................................... (8,203) (243)
Depreciation and amortization...................................... 29,380 14,669
Amortization of deferred financing costs........................... 596 589
Equity in income of joint venture and unconsolidated subsidiary.... (5,172) (4,270)
Non-cash compensation.............................................. 75 38
Changes in assets and liabilities, net of non-cash effect of
acquisitions:
Provision for doubtful accounts.................................... 827 24
Receivables........................................................ (8,129) (3,834)
Deferred charges and other assets.................................. (2,989) (3,219)
Escrowed cash...................................................... (599) (1,120)
Accounts payable and other liabilities............................. 8,916 4,989
Amounts due to/from affiliates..................................... 4,401 6,101
--------- ---------
Net cash provided by operating activities.............................. 82,831 43,933
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase and development of real estate................................ (594,263) (379,089)
Investment in real estate.............................................. (35,723) (34,741)
Investment in mortgage note receivable................................. 230 (36,378)
Investment in unconsolidated subsidiary................................ (667)
Proceeds from sale of real estate...................................... 42,905 3,030
Distributions received from joint venture and unconsolidated subsidiary 7,194 4,143
--------- ---------
Net cash used in investing activities.................................. (579,657) (443,702)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from sale of Common Shares................................ 106,841 135,971
Net proceeds from sale of Preferred Shares............................. 25,000 --
Net proceeds from sale of Preferred Units.............................. 95,000 --
Purchase of Treasury Shares............................................ (23,314) --
Distributions paid to limited partners................................. (3,061) (3,676)
Distributions paid to common shareholders.............................. (44,799) (24,897)
Distributions paid to preferred shareholders........................... (2,671) --
Distributing paid to preferred unit holders............................ (131) --
Proceeds from debt on real estate...................................... 617,441 574,671
Repayments of debt on real estate...................................... (277,025) (285,912)
--------- ---------
Net cash provided by financing activities.............................. 493,281 396,157
--------- ---------
Net increase in cash and cash equivalents.............................. (3,545) (3,612)
Cash and cash equivalents, beginning of period......................... 7,075 7,226
--------- ---------
Cash and cash equivalents, end of period............................... $ 3,530 $ 3,614
========= =========
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid for interest................................................. $ 29,492 $ 11,829
========= =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
5
<PAGE>
1. THE ORGANIZATION
The Company is a self-administered and self-managed Real Estate Investment
Trust ("REIT") that acquires, owns, manages, leases, develops and builds office
and industrial properties throughout the United States. The Company operates
principally through Prentiss Properties Acquisition Partners, L.P. and its
subsidiaries (the "Operating Partnership") and Prentiss Properties Limited, Inc.
(the "Manager") (collectively referred to herein as the "Company"). As of
September 30, 1998, the Company owned interests in a diversified portfolio of
253 primarily suburban Class "A" office and suburban industrial properties (the
"Properties") containing approximately 23.6 million net rentable square feet.
The Properties are located in 20 major U.S. markets and consist of 115 office
buildings (the "Office Properties") containing approximately 12.8 million net
rentable square feet and 124 industrial buildings (the "Industrial Properties")
containing approximately 8.9 million net rentable square feet. The Properties
include 13 office and two industrial development projects (including an
expansion of an existing Industrial Property) which upon completion will total
approximately 1.9 million square feet. Exclusive of the development projects,
as of September 30, 1998, the Office Properties were approximately 96% leased to
approximately 1,208 tenants and the Industrial Properties were approximately 96%
leased to approximately 349 tenants. In addition to the 253 Properties owned,
the Company manages, for third-parties, approximately 29.2 million net rentable
square feet in 258 primarily office and industrial properties, in 19 U.S.
markets.
The Properties
At December 31, 1997, the Company owned a total of 170 Properties. During
the nine month period ended September 30, 1998, the Company acquired 84
Properties comprising 5.0 million square feet (the "Acquired Properties"), and
sold three office and six industrial properties totaling 533,000 square feet.
Additionally, the Company began development on eight new Office Properties
during the nine months ended September 30, 1998, totaling 1.0 million square
feet.
The Acquired Properties consist of 33 Class "A" suburban Office Properties
(the "Acquired Office Properties") totaling 3.8 million square feet and 51
suburban Industrial Properties (the "Acquired Industrial Properties") totaling
1.2 million square feet.
The Company's property related transactions for the nine months ended
September 30, 1998 are summarized by fiscal quarter in the table below:
<TABLE>
<CAPTION>
# OF BLDGS. SQ. FT.
--------------- ---------------
(square feet in thousands)
<S> <C> <C>
PROPERTIES AS OF DECEMBER 31, 1997 170 18,082
ACTIVITY FOR THREE MONTHS ENDED MARCH 31, 1998
Property Acquisitions 59 1,769
Property Dispositions (1) (118)
Development Starts 1 97
--------------- ---------------
59 1,748
ACTIVITY FOR THREE MONTHS ENDED JUNE 30, 1998
Property Acquisitions 13 1,928
Property Dispositions (6) (218)
Development Starts 4 671
--------------- ---------------
11 2,381
ACTIVITY FOR THREE MONTHS ENDED SEPTEMBER 30, 1998
Property Acquisitions 12 1,318
Property Dispositions (2) (197)
Development Starts 3 248
--------------- ---------------
13 1,369
--------------- ---------------
PROPERTIES AS OF SEPTEMBER 30, 1998 253 23,580
=============== ===============
</TABLE>
Offerings, Unit Conversion, Preferred Shares, and Share Purchase and Repurchase
Programs
On February 2, 1998, the Company closed a direct placement of 1.1 million
common shares of beneficial interest, $0.01 par value per share ("Common
Shares"), to an affiliate of Union Bank of Switzerland ("UBS") for gross
6
<PAGE>
consideration of $29.7 million or $27.00 per share. In a related transaction,
the Company entered into a forward stock contract with UBS which provides that
during the first year after the closing of the direct placement, the Company
will have the right to periodically consummate a share settlement with UBS based
on the then market price of the Company's Common Shares. Alternatively, the
Company, at its option, may complete such settlement for cash consideration.
The net proceeds from the sale to UBS and its affiliates were contributed to the
Operating Partnership in exchange for Operating Partnership units ("Units"). As
of September 30, 1998, the Company has posted two letters of credit totaling
approximately $3.6 million as additional collateral (See Note 12).
On February 18, 1998, the Company closed two direct placements totaling
1,816,006 Common Shares resulting in gross proceeds of approximately $49.5
million or $27.25 per share. The Common Shares were underwritten in two
separate transactions by Prudential Securities Incorporated ("Prudential") and
Smith Barney Inc. ("Smith Barney"). Prudential underwrote 922,676 Common Shares
and Smith Barney underwrote 893,330 Common Shares. The net proceeds from the
sales to Prudential and Smith Barney were contributed to the Operating
Partnership in exchange for Units.
On February 23, 1998, the Company closed a direct placement of 1,198,157
Common Shares resulting in gross proceeds of approximately $32.5 million or
$27.125 per share. The Common Shares were underwritten by A.G. Edwards & Sons,
Inc. ("AG Edwards"). The net proceeds from the sale to AG Edwards were
contributed to the Operating Partnership in exchange for Units.
In connection with the Company's initial public offering ("IPO"), certain
entities affiliated with the Company (the "Merged Entities") received Units in
exchange for certain assets they contributed to the Operating Partnership. In
February 1998, (i) the Merged Entities distributed 113,500 Units to certain
employees of the Merged Entities (the "Merged Entity Employees"), (ii) the
Company issued 2,432,541 Common Shares in exchange for all of the capital stock
of the Merged Entities to the owners of the Merged Entities (the "Merged Entity
Owners"), and (iii) the Merged Entity Employees redeemed their 113,500 Units in
exchange for an equal number of Common Shares. These transactions were approved
by a quorum of the independent members of the Company's Board of Trustees.
On March 31, 1998, pursuant to an agreement entered into between the
Company and Security Capital Preferred Growth Incorporated ("SCPG"), the Company
issued 943,396 Series "A" Cumulative Convertible Redeemable Preferred Shares
("Series A Convertible Preferred Shares") for $26.50 per share. The Company
contributed the net proceeds from the sale of the Series A Convertible Preferred
Shares to the Operating Partnership in exchange for preferred Units. The
943,396 Series A Convertible Preferred Shares are convertible into an equal
number of Common Shares and have rights to a dividend equal to the dividend paid
on Common Shares. Subsequent to this transaction, SCPG held 3,773,585 Series A
Convertible Preferred Shares of the Company.
On June 26, 1998, the Company privately placed 1,900,000 Series B
Cumulative Redeemable Perpetual Preferred Units (the "Series B Perpetual
Preferred Units") with an institutional investor. The issue resulted in gross
consideration of $95.0 million. Such proceeds were used to repay borrowings
under the Company's Line of Credit (as defined in Note 4). The Series B
Perpetual Preferred Units are callable by the Company in five years at par value
and have a coupon rate of 8.3% per annum.
On June 30, 1998, the Company's Board of Trustees authorized the repurchase
of up to 2.0 million Common Shares in the open market or negotiated private
transactions. On July 2, 1998, the Company began purchasing shares in the open
market. As of November 10, 1998, the Company had repurchased 998,800 Common
Shares at an average price of $23.30 per share.
On August 6, 1998, the Company filed with the SEC (as defined herein) a
Registration Statement on Form S-3 relating to the Company's Dividend
Reinvestment and Share Purchase plan for all shareholders. This allows
shareholders to buy and sell shares directly through the Company. The plan
provides for the automatic reinvestment of cash dividends as well as for the
direct monthly purchase of shares.
2. BASIS OF PRESENTATION
The consolidated financial statements of the Company include all the
accounts of the Company, its majority-owned Operating Partnership and
subsidiaries. The financial statements for the three and nine months ended
September 30, 1998, include (i) the results of operations of 145 operating
Properties and 10 development projects for the entire periods presented, (ii)
the results of operations of the 84 Acquired Properties and eight
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development projects for the portion of the periods subsequent to acquisition or
commencement of development by the Company, (iii) the results of operations of
the 5307 East Mockingbird, Oceanside Distribution Center, West Loop Business
Park and Glendale Federal Bank Building Properties (the "Sold Properties") for
the portion of the periods prior to sale, (v) a 50% equity interest in the seven
Broadmoor Austin Properties, and (vi) results of operations of the Prentiss
Properties Service Business conducted primarily by the Manager in the periods
presented. The financial statements for the three and nine months ended
September 30, 1997, include (i) the results of operations of 88 operating
Properties and three development projects for the entire periods presented, (ii)
the results of operations of 42 Properties acquired during the period and eight
development projects for the portion of the period subsequent to acquisition or
commencement of development by the Company, (iii) an approximate 50% equity
interest in the seven Broadmoor Austin Properties, and (iv) results of
operations of the Prentiss Properties Service Business conducted primarily by
the Manager in the periods presented. All significant intercompany balances and
transactions have been eliminated.
The accompanying financial statements are unaudited; however, the financial
statements of the Company have been prepared in accordance with generally
accepted accounting principles ("GAAP") for interim financial information and
the rules and regulations of the Securities and Exchange Commission ("SEC").
Accordingly, they do not include all of the disclosures required by GAAP for
complete financial statements. In the opinion of management, all adjustments
(consisting solely of normal recurring matters) necessary for a fair
presentation of the financial statements for these interim periods have been
included. The results for the three and nine months ended September 30, 1998
are not necessarily indicative of the results to be obtained for the full fiscal
year. These financial statements should be read in conjunction with the
December 31, 1997 audited financial statements and notes thereto of the Company,
included in its annual report on Form 10-K for the fiscal year ended December
31, 1997.
3. REAL ESTATE
A brief description of the Properties acquired and other significant real
estate transactions occurring during the nine months ended September 30, 1998
follows:
On January 9, 1998, the Company acquired three Class "A" Office Properties
containing 141,139 square feet located in the suburban Philadelphia,
Pennsylvania, area. The purchase price of the Properties (the "Creamery Way
Properties"), excluding closing costs, totaled approximately $13.8 million.
On January 13, 1998, the Company acquired six Industrial Properties
containing 382,234 square feet located in the San Jose, California, area. The
purchase price of the Properties, excluding closing costs, totaled approximately
$26.6 million.
On January 30, 1998, the Company acquired a single Class "A" Office
Property containing 234,222 square feet located in the Denver, Colorado, area.
The purchase price of the Property, excluding closing costs, totaled
approximately $31.0 million.
On February 4, 1998, the Company acquired four Class "A" Office Properties
and 45 Industrial Properties containing 1.0 million square feet located in the
San Diego, California, and Tucson, Arizona, areas. The purchase price of the
Properties, excluding closing costs, totaled approximately $80.4 million.
On March 31, 1998, the Company sold the 5307 East Mockingbird Property for
total sale proceeds of approximately $8.2 million resulting in a gain on sale of
approximately $2.6 million.
On April 24, 1998, the Company acquired two Class "A" Office Properties
containing 52,665 square feet located in the suburban Philadelphia,
Pennsylvania, area. The purchase price of the Properties, excluding closing
costs, totaled approximately $5.2 million.
On May 18, 1998, the Company acquired two Class "A" Office Properties
totaling 148,108 square feet located in the Kansas City, Missouri, area. The
purchase price of the Properties, excluding closing costs, totaled approximately
$19.9 million.
8
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On May 21, 1998, the Company acquired a single Class "A" Office Property
containing 525,951 square feet located in the Oakland, California, area. The
purchase price of the Property, excluding closing costs, totaled approximately
$77.0 million.
On May 22, 1998, the Company sold the Oceanside Distribution Center
property for total sale proceeds of approximately $8.0 million resulting in a
gain on sale of approximately $455,000.
On June 12, 1998, the Company acquired seven Class "A" Office Properties
totaling 1,044,858 square feet located in the Houston, Texas, area.
Additionally, the Company acquired the related property management and leasing
operations for 700,000 square feet of office properties for third-party clients.
The purchase price of the Properties (the "Fidinam Office Portfolio"), excluding
closing costs, totaled approximately $87.0 million, including approximately
$31.6 million of debt assumed, approximately $50.8 million in cash, and the
issuance of 187,720 Units valued at $4.5 million.
On June 30, 1998, the Company acquired a single Class "A" Office Property
containing 156,000 square feet located in the metropolitan Washington, D.C.
area. The purchase price of the Property, excluding closing costs, totaled
approximately $22.4 million.
On June 30, 1998, the Company sold the West Loop Business Park Properties
for total sale proceeds of approximately $4.9 million resulting in a gain on
sale of approximately $1.3 million.
On July 10, 1998, the Company sold the Glendale Federal Bank Building
Properties for total sale proceeds of approximately $30.0 million resulting in a
gain on sale of approximately $4.4 million.
On August 5, 1998, the Company acquired a single Class "A" Office Property
containing 135,679 square feet located in the Chicago, Illinois area. The
purchase price of the Property, excluding closing costs, totaled approximately
$14.8 million.
On August 10, 1998, the Company acquired a single Class "A" Office Property
containing 66,959 square feet located in the Chicago, Illinois area. The
purchase price of the Property, excluding closing costs, totaled approximately
$10.4 million.
On August 18, 1998, the Company acquired two Class "A" Office Properties
totaling 387,469 square feet in the suburban Washington D.C. area. The purchase
price of the Properties, excluding closing costs, totaled approximately $76.0
million, which includes approximately $3.6 million attributable to 4.0 acres of
undeveloped land.
On August 26, 1998, the Company acquired seven Class "A" Office/Office
Research & Development Properties containing 347,967 square feet located in the
suburban Philadelphia, Pennsylvania area. The purchase price of the Properties,
excluding closing costs, totaled approximately $35.2 million.
On August 27, 1998, the Company acquired a single Class "A" Office Property
containing 379,685 square feet located in the Chicago, Illinois area. The
purchase price of the Property, excluding closing costs, totaled approximately
$65.0 million.
4. DEBT ON REAL ESTATE
At December 31, 1997, the Company had debt on real estate of $420.0
million, excluding the Company's proportionate share of the debt on the
Broadmoor Austin Properties. The Company owns a 50% equity interest in the
Broadmoor Austin Properties and accounts for its interest using the equity
method of accounting.
On December 31, 1997, the Company replaced the existing line of credit with
a new $300 million unsecured line of credit with a group of 12 banks (the "Line
of Credit"). The Line of Credit reduced the interest rate on borrowings from
LIBOR plus 175 basis points to LIBOR plus 137.5 basis points. The Line of
Credit is unsecured and has a term of three years. Additionally, the Company is
required to pay an average daily unused commitment fee of 20 basis points per
annum if the daily unused portion of the Line of Credit is greater than the
related daily balance outstanding. The fee is reduced to 15 basis points per
annum if the daily unused portion is less than the daily balance outstanding.
At December 31, 1997, the Company had no borrowings outstanding under the
9
<PAGE>
Line of Credit. The Company had net borrowings during the period and an
outstanding balance of $293.7 million at September 30, 1998.
On March 11, 1998, the Company closed a $35.0 million non-recourse mortgage
with CIGNA collateralized by the Walnut Glen Tower Property. The loan has a
6.92% interest rate and a seven-year term with an option to extend for one year.
The existing $10.0 million loan, which had a rate of 7.50%, was repaid with the
proceeds.
The Company is obligated under three loans (the "Construction Loans") to
fund the construction and development of four Properties. The Construction
Loans provide for total funding of $44.5 million, of which $27.7 million was
drawn during the nine months ended September 30, 1998, resulting in a balance of
approximately $37.8 million at September 30, 1998. The Construction Loans bear
interest at varying rates, from LIBOR plus 165 basis points to LIBOR plus 175
basis points, and mature on dates from September 2000 to December 2000.
In connection with the acquisition of certain of the Acquired Properties,
the Company assumed debt totaling approximately $46.0 million during the nine
months ended September 30, 1998. Such debt instruments are fixed rate,
amortizing loans with interest rates ranging from 7.84% to 8.65% per annum and
amortization periods of 20 to 25 years. The loans are collateralized by the
related Properties and mature on varying dates from February 2004 to December
2007.
In connection with the acquisition of certain of the Acquired Properties,
the Company entered into two separate notes, each payable to the former owner of
the Properties. The notes total $5.2 million, have interest rates ranging from
6.15% to 7.75% per annum and mature between December 31, 2000 and August 25,
2001.
During the nine months ended September 30, 1998, the Company repaid, to
First Union National Bank, $5.5 million of borrowings under a construction loan
which was assumed by the Company in connection with the acquisition of certain
Properties in October 1997. The loan which was repaid with proceeds from
borrowings under the Company's Line of Credit had a maturity of April 10, 1998
and bore interest at LIBOR plus 250 basis points.
At December 31, 1997, the Company had outstanding borrowings of $120
million under the short-term variable rate acquisition loan (the "Acquisition
Loan"). The Acquisition Loan has an interest rate of LIBOR plus 125 basis
points and a maturity date of January 1, 1999. The Company has received a term
sheet from the lender giving the Company the option to extend the maturity of
the loan. The Company is currently reviewing the terms and conditions and
evaluating the extension against other financing options.
On August 25, 1998, the Company entered into two hedging transactions with
a notional amount of $98.5 million, which effectively fixed the 10-year treasury
rate used as a benchmark for various permanent loans which the Company is
pursuing. Subsequent to September 30, 1998, the Company terminated $49.25
million of the hedging transactions. The cost of the hedging transactions will
be amortized over the life of two 12-year mortgages totaling $78.0 million on
which the Company has locked a rate with a large life insurance company. The
mortgages have both been approved by the insurance company's loan committee, but
are subject to customary closing due diligence. Inclusive of the amortization
relating to the hedging transactions, the mortgage debt of $78.0 million will
have an interest rate of 7.18% per annum.
On August 26, 1998, the Company closed a $60.0 million short-term bridge
facility, priced at LIBOR plus 137.5 basis points. The facility was put in
place to bridge timing differences between short-term capital needs and
execution of more permanent financings. At September 30, 1998, there were no
outstanding balances on the facility. The facility matures December 31, 1998.
The Company's debt balance at September 30, 1998 including its share of
unconsolidated joint venture debt was $888.6 million. Of this amount, $437.2
million was fixed rate, non-recourse, long-term mortgages. The remaining $451.4
million was floating rate debt, of which $110.0 million was hedged until
September 2004. Future scheduled principal repayments of debt on real estate
are as follows:
10
<PAGE>
<TABLE>
<CAPTION>
(in thousands)
<S> <C>
1998............................................................. $ --
1999............................................................. 120,000
2000............................................................. 341,476
2001............................................................. 1,127
2002............................................................. 3,030
Thereafter....................................................... 345,988
--------
$811,621(A)
========
</TABLE>
(A) The amount shown excludes the Company's 50% share of the mortgage
indebtedness which is collateralized by the Broadmoor Austin Properties.
5. DISTRIBUTION
On September 16, 1998, the Company declared a cash distribution for the
third quarter of 1998 in the amount of $.40 per share, payable on October 16,
1998 to common shareholders of record on September 30, 1998. Additionally, it
was determined that a distribution of $.40 per Unit would be made to the
partners of the Operating Partnership, and the holders of the Company's Series A
Convertible Preferred Shares. The total distributions were paid on October 16,
1998, totaling approximately $17.8 million. In addition, a quarterly
distribution equal to an annualized 8.3% of the face amount of the Series B
Perpetual Preferred Units, or $1,971,250, was declared on September 25, 1998 and
paid on October 5, 1998.
6. INVESTMENT IN JOINT VENTURE AND UNCONSOLIDATED SUBSIDIARIES
Included in investments in joint venture and unconsolidated subsidiaries
are the Company's investment in the Broadmoor Austin Associates Joint Venture
("Broadmoor Austin") and the Company's investment in the Manager. The Company
accounts for its 50% investment in Broadmoor Austin and its 95% investment in
the Manager using the equity method of accounting, and thus reports its share of
income and losses based on its ownership interest in the respective entities. At
September 30, 1998, the carrying value of the Company's interest in Broadmoor
Austin and the Manager totaled $7.0 million and $4.0 million, respectively. The
difference between the carrying value of the Company's interest in Broadmoor
Austin and the book value of the underlying equity is being amortized over 40
years.
The following is summarized financial information for 100% of Broadmoor
Austin at September 30, 1998 and December 31, 1997 and for the three and
nine months ended September 30, 1998 and 1997:
<TABLE>
<CAPTION>
SEPT. 30, 1998 DEC. 31, 1997
------------------ ------------------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
BALANCE SHEET:
- --------------
Real Estate and deferred charges, net......... $109,097 $111,524
Total assets.................................. $122,215 $126,341
Mortgage note payable......................... $154,000 $140,000
Venturers' deficit............................ $(32,419) $(17,134)
</TABLE>
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPT. 30, 1998 SEPT. 30, 1997 SEPT. 30, 1998 SEPT. 30, 1997
---------------- ----------------- ------------------ -----------------
(DOLLARS IN THOUSANDS) (DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
INCOME STATEMENT:
- ----------------
Rental and Other income........................ $4,950 $4,875 $ 14,846 $14,662
Interest expense............................... $2,771 $3,441 $ 8,840 $10,209
Depreciation and amortization.................. $1,085 $1,084 $ 3,251 $ 3,249
Extraordinary item............................. $ $ $ 12,900 $
Net income (loss).............................. $ 942 $ 183 $(10,620) $ 695
</TABLE>
On March 31, 1998 the Company closed a $154.0 million refinancing of its
Broadmoor Austin Properties. Broadmoor Austin is a joint venture between the
Operating Partnership and IBM who leases 100% of the Properties. The
refinancing, which was funded by an affiliate of Lehman Brothers Inc., is a 13-
year non-recourse term loan at a fixed rate of 7.04% per annum. The Company
repaid the existing $140.0 million mortgage which had an interest rate of 9.75%
per annum. In connection with the repayment of the existing loan, Broadmoor
Austin paid $12.7 million in prepayment penalties and wrote off unamortized
financing costs of approximately $200,000, both of which the joint
11
<PAGE>
venture recorded as extraordinary charges during the period. Concurrent with
this refinancing, IBM extended the lease on 70% of its space from 2006 to 2011.
The following is summarized financial information for 100% of the Manager
at September 30, 1998 and December 31, 1997 and for the three and nine
months ended September 30, 1998 and 1997:
<TABLE>
<CAPTION>
SEPT. 30, 1998 DEC. 31, 1997
----------------- -----------------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
BALANCE SHEET:
- --------------
Total assets................................... $11,553 $21,668
Total liabilities.............................. $ 7,378 $16,700
Owners' equity................................. $ 4,175 $ 4,968
</TABLE>
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPT. 30, 1998 SEPT. 30, 1997 SEPT. 30, 1998 SEPT. 30, 1997
----------------- ----------------- ----------------- -----------------
(DOLLARS IN THOUSANDS) (DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
INCOME STATEMENT:
- -----------------
Fee income..................................... $7,887 $7,565 $22,736 $19,400
Personnel costs, net........................... $4,398 $4,440 $14,963 $10,405
General office and administrative.............. $2,428 $1,465 $ 5,851 $ 4,212
Net income..................................... $1,784 $1,416 $ 4,070 $ 3,979
</TABLE>
7. SUPPLEMENTAL DISCLOSURE OF NON-CASH ACTIVITIES
During the three months ended September 30, 1998, the Company declared cash
distributions totaling $17.8 million payable to holders of Common Shares,
Operating Partnership Units and Series A Convertible Preferred Shares. The
distributions were paid October 16, 1998. In addition, a distribution totaling
$1,971,250 was declared on September 25, 1998 payable to holders of the
Company's Series B Perpetual Preferred Units. The distribution was paid on
October 5, 1998.
On February 6, 1998, the owners of the Merged Entities (as earlier defined)
paid deferred compensation to certain Merged Entity Employees in the form of
113,500 Units. The transaction resulted in a non-cash charge to the Company of
$2.9 million (net of the minority interests holders share of the charge of
approximately $193,000).
In addition, in connection with the acquisition of Properties during the
nine months ended September 30, 1998, the Company assumed $46.0 million of
mortgage debt and $8.7 million of net liabilities, entered into other corporate
debt of $5.2 million and issued Units valued at $11.6 million.
8. IMPACT OF THE YEAR 2000 ISSUE
The Year 2000 ("Y2K") compliance problem is the result of computer programs
designed to use two digit rather than four digit years. Thus, the year 1998 is
represented as 98 and the year 2000 would be represented as 00. This could be
interpreted as either 1900 or 2000. To systems that have Y2K related issues,
the time may seem to have reverted back 100 years. Systems, equipment and
software with exposure to Y2K related problems exist not only in computerized
information systems ("Information Systems") but also in building operating
systems such as elevators, alarm systems, energy management systems, phone
systems, and numerous other systems and equipment (the "Non-Information
Technology Systems") (collectively, the "Systems"). Failure to adequately
identify and correct Y2K related problems could result in a Systems failure or
malfunction with potential adverse effects including personal injury, property
damage, and disruption of operations. Any or all of these failures could
materially and adversely affect the Company's business, financial condition, or
results of operations.
Due to the exposure and potential liabilities inherent in both the Systems
used internally by the Company ("Internal Systems") and those Systems used by
third-parties to conduct business with the Company ("Third-Party Systems"), in
September 1997, the Company created a committee (the "Y2K Committee") headed by
the Vice President of Information Systems and Co-chaired by the Vice President
of National Property Operations. Due to the national presence of the Company,
the Y2K Committee appointed approximately 85 employees (the "Y2K Coordinators")
designated as either Y2K property coordinators ("Y2K Property Coordinators") or
Y2K corporate office coordinators ("Y2K Corporate Office Coordinators"). The
purpose of the Y2K Committee was to develop a plan to assess and mitigate the
Company's exposure to potential Y2K related problems (the "Company's Y2K Plan").
In order to implement the Company's Y2K Plan in a timely and uniform manner,
during August 1998 the Y2K Committee held classes to educate the Y2K
Coordinators on the steps to be taken to ensure Y2K compliance.
12
<PAGE>
Due to the risks associated with inadequate assessments and remediations of the
Systems, the Company engaged various independent sources to assist in the review
of the Company's Y2K Plan, including:
<TABLE>
<CAPTION>
CONSULTING COMPANY Area of Review
------------------ --------------
<S> <C>
DMR Consulting Embedded Systems
PricewaterhouseCoopers LLP Financial Systems
Munsch, Hardt, Kopf, Harr, & Dinan, P.C. Legal
Computer Sciences Corporation Overall Review
</TABLE>
Computer Sciences Corporation will return in December to review the
Company's progress. Additionally, PricewaterhouseCoopers LLP will also
return as they are the Company's independent accountants.
General Approach
----------------
The Company's general approach is the same whether it is for a building or
a large office. The steps involved are:
1) Communication with clients (owners, tenants, and asset managers)
regarding the potential for Y2K problems inherent in the Internal
Systems.
2) Communication with vendors regarding the potential for Y2K problems
inherent in their Third Party Systems.
3) Inventory and prioritization of the Internal Systems.
4) Initial assessment of the inventoried Internal Systems.
5) Contingency plan for the inventoried Internal Systems.
6) Test inventoried Internal Systems.
7) Prioritize resolution of any problems discovered with inventoried
Internal Systems. The resolution will include additional testing of the
solutions.
8) Review and revise if necessary, contingency plans for inventoried
Internal Systems.
9) Review vendor responses regarding their third Party Systems and take
necessary action accordingly.
The Company has substantially completed initial Year 2000 inventory and
assessments of Internal Systems for existing assets. In conjunction with the
budgeting and business planning process for 1999 the assessment and testing
phases of the Y2K effort were substantially completed for known Internal Systems
on or before October 31, 1998. The results of these tests should minimize the
doubt as to whether or not the inventoried Internal Systems have any Y2K issues.
These findings will enable the Company to reasonably determine the remaining
financial commitment necessary to remedy the Y2K problems. In some cases,
Systems that demonstrate Y2K related problems have previously been scheduled for
replacement or remediation as a normal course of business irrespective of Year
2000 related problems. Alternatively, certain systems that may have been
replaced after the January 1, 2000 must have their replacements accelerated due
to Y2K related problems creating adverse affects.
Information Systems
-------------------
The Company has inventoried its Information Systems according to reasonable
man standards relative to exposure. The majority of the Company's software is
off the shelf with a minimum amount of proprietary code.
The Company's primary financial software is from CTI Limited, Incorporated
which runs on an IBM AS/400. Assurances from both vendors accompanied by
thorough testing, with the assistance of PricewaterhouseCoopers LLP, have
resulted in minimal remediation necessary for proprietary modifications made
to the software over the years. These modifications have been completed and
will be implemented upon final acceptance testing by the users and review by
PricewaterhouseCoopers LLP. This should be completed by December 31, 1998.
The Company uses a number of personal computers and networks in the course
of its operations. Employees use off the shelf software such as Microsoft
Word, Microsoft Excel and Lotus Notes for productivity purposes. Personal
computer hardware is tested with the National Software Testing Laboratory
distributed testing software. The desktop software applications will require
software updates that will be distributed Company-wide in the second quarter
of 1999. Server operating systems that demonstrate Y2K related problems are
also scheduled to be upgraded by June 30, 1999.
13
<PAGE>
Non-Information Technology Systems
----------------------------------
Non-Information Technology Systems at properties owned as of September 30,
1998 have been substantially assessed with respect to date-sensitive operating
controls in order to quantify the Y2K exposure. Assessments will continue as
the Company acquires additional properties. The Y2K review process has been
incorporated into the due diligence processes. The Company's investment
committee formally considers the Y2K status of each investment during the
approval process.
Methodology for assessing and testing building systems will vary by
equipment and is typically dictated by the building type. The Company used an
outside firm, DMR Consulting (an Amdahl Company), to benchmark and review its
methodology in representative samples of each building type in the Company's
portfolio (i.e., low rise/industrial, mid-rise office, and high-rise office).
Although building systems may be similar from building to building within a
given building type, implementations can vary. Therefore, testing for
compliance is necessary where possible. Testing is substantially complete for
the known building systems on assets owned as of September 30, 1998. These
tests have been performed by either the Company's staff, outside vendors, or
a combination of both.
In conjunction with the budgeting and business planning process for 1999,
the assessment and testing phases of the Company's Y2K Plan was substantially
complete for Internal Systems on or before October 31, 1998. The results of
these tests should minimize the doubt as to whether or not the Internal
Systems have Y2K related issues. These findings will enable the Company to
reasonably estimate the remaining financial commitment necessary to remedy the
Y2K problems.
Third-Party Systems
-------------------
In addition to the Company's Y2K Plan with respect to Internal Systems, it
is also taking proactive steps to determine the impact on the Company of Y2K
related issues with Third-Party Systems.
The Company is identifying and contacting critical suppliers, service
providers, contractors, and clients to determine the extent to which the
Company's operations could be impacted as a result of third-parties' failure to
remedy their own Y2K related problems. The Company expects to be substantially
complete with this process by March 31, 1999, which coincides with the timing of
the Company's contingency planning milestone. To the extent the Y2K readiness
responses of the critical suppliers, service providers, contractors and clients
are unsatisfactory, the Company will evaluate the impact of this relationship.
Should this relationship prove materially detrimental, the Company will make
every effort to change to a critical supplier, service provider, contractor, or
client that demonstrates Y2K readiness. The Company is not currently aware of
any such situations, but the inability to locate an alternative supplier,
service provider, contractor, or client in a timely manner could materially and
adversely affect the Company's business, financial condition or results of
operations.
Estimate of Financial Impact
----------------------------
The total costs associated with required modifications to become Year 2000
compliant are not expected to be material to the Company's financial position.
The Company currently estimates the total Y2K readiness costs will be between
$500,000 and $600,000. Such costs are segregated into three categories along
with the timing of the estimated expenses as follows:
<TABLE>
<CAPTION>
LOW HIGH Q4/98 Q1/99 Q2/99
------------- ------------- -------------- -------------- --------------
<S> <C> <C> <C> <C> <C>
CATEGORY
Non-Information Technology Systems $400,000 $475,000 10% 80% 10%
Information Systems 40,000 50,000 20% 70% 10%
Y2K Committee 60,000 75,000 80% 10% 10%
-------- --------
Total $500,000 $600,000
======== ========
</TABLE>
These costs are net of the Company's personnel costs that are considered to
be part of normal operating costs. A significant portion of the Non-Information
Technology Systems costs are expected to be capitalized and recovered through
building operations while the balance will be expensed in the period incurred.
Much of the Information Systems costs are version upgrades that will be expensed
as incurred. The Y2K Committee costs consist largely of consulting charges that
are expensed as incurred.
14
<PAGE>
The Company's readiness program is an ongoing process and the estimates of
costs and completion dates for the various categories described above are
subject to material change.
Potential Risks of Inadequate Remediation
-----------------------------------------
Failure to correct a material Y2K problem could result in an interruption
in, or a failure of, certain normal business activities or operations that could
materially and adversely affect the Company's results of operations, liquidity,
and financial position. Much of the uncertainty lies with the ability of
critical suppliers, service providers, contractors, and clients to fully remedy
their Y2K problems. The Company's Y2K Plan should significantly reduce the
Company's level of uncertainty regarding the Y2K problem.
The most reasonable and likely worst case scenario might be the failure of
an energy management system in a building. This could adversely affect the
environmental conditions of the occupied space, thus creating discomfort and
inconvenience to the tenants until the condition could be manually corrected.
Persistence of this problem for a long period of time could result in an
increase in operating costs for the building until the energy management system
is restored to proper operations.
The Company is making substantial effort to eliminate the exposure to any
Y2K issues; however, no one can accurately predict how many Y2K problem-related
failures will occur or the severity, duration, or financial consequences of
these potential failures, especially with regard to Third-Party Systems. As a
result, a significant number of operational inconveniences and inefficiencies
for the Company and its clients that may divert management's time, attention,
financial, and human resources from its ordinary business activities; and a
lesser number of serious system failures that may require significant efforts by
the Company and it's clients to prevent or alleviate material business
disruption.
Contingency Plans
-----------------
The Company is developing contingency plans to be implemented as part of
its efforts to identify and correct Y2K issues. The scheduled target date for
the completion of the contingency plans is March 31, 1999. These contingency
plans will range from manual overrides, as described in the aforementioned
example, to alternative processes such as building lock downs in the event of a
long term power failure. Fortunately, most buildings currently have contingency
plans in place for natural disasters such as earthquakes, floods, ice storms,
and the like which provide a basis for the Y2K contingency plans. These plans
may also include short-term use of backup equipment and software, increased work
hours for Company personnel or use of contract personnel, and orderly shut down
of the building on December 31, 1999 and January 1, 2000 in order to perform
tests of critical systems.
Disclaimer
----------
The Company's Y2K readiness program is an ongoing process and the estimates
of costs and completion dates for various components of the Company's Y2K
readiness program described above are subject to change. Additionally, the
Company's discussion of its Y2K readiness program contains forward-looking
statements that are based on assumptions as to future events. There can be no
guarantee as to the outcome of these future events.
9. RECENTLY ISSUED ACCOUNTING STANDARDS
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 131, "Disclosures about Segments
of an Enterprise and Related Information" ("FAS No. 131").
FAS No. 131 requires disclosure of segment data in an entity's annual
financial statements and selected segment information in their quarterly report
to shareholders. FAS No. 131 also requires entity-wide disclosures about the
products and services an entity provides, the material countries in which it
holds assets and reports revenues, and its major customers. FAS No. 131
supersedes FAS No. 14, "Financial Reporting for Segments of a Business
Enterprise," and is effective for fiscal years beginning after December 15,
1997. FAS No. 131 is not required for interim reporting in the first year of
application. Thus, FAS No. 131 will be implemented by the Company for its year-
end December 31, 1998 reporting. The Company believes that upon implementation,
FAS No. 131 will not have a material impact on the financial statements of the
Company.
15
<PAGE>
In February 1998, the FASB issued Statement of Financial Accounting
Standards No. 132, "Employers' Disclosures about Pensions and Other
Postretirement Benefits" ("FAS No. 132").
FAS No. 132 provides additional information to facilitate financial
analysis and eliminates certain disclosures which are no longer useful. To the
extent practicable, the Statement also standardizes disclosures for retiree
benefits. FAS No. 132 is effective for financial statements issued for periods
ending after December 15, 1997. The Company believes that FAS No. 132 will not
have a material impact on the financial statements of the Company.
In June 1998, the FASB issued Statement of Financial Accounting Standards
No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("FAS
No. 133").
FAS No. 133 establishes accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts, (collectively referred to as derivatives) and for hedging activities.
It requires that an entity recognize all derivatives as either assets or
liabilities in the statement of financial position and measure those instruments
at fair value. FAS No. 133 is effective for all fiscal quarters of fiscal years
beginning after June 15, 1999. The Company believes that upon implementation,
FAS 133 will not have a material impact on the financial statements of the
Company.
10. PRO FORMA FINANCIAL INFORMATION
Due to the Company's significant acquisition activity between January 1,
1997 and September 30, 1998, the historical results of operations for the
periods presented may not be indicative of future results of operations. The
following Pro Forma Condensed Statements of Income for the nine months ended
September 30, 1998 and 1997 are presented as if the acquisitions and related
transactions occurred at the beginning of the periods presented. The pro forma
information is based upon historical information and does not purport to present
what actual results would have been had such transactions, in fact, occurred at
the beginning of the periods presented, or to project results for any future
period.
PRO FORMA CONDENSED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
NINE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, 1998 SEPTEMBER 30, 1997
------------------------ -------------------------
(in thousands, except per share data)
<S> <C> <C>
Total revenues....................................... $204,051 $197,477
Property operating and maintenance................... 45,794 46,386
Real estate taxes.................................... 22,190 20,013
General and administrative........................... 3,336 2,338
Personnel costs, net................................. 2,432 2,437
Interest expense..................................... 38,949 38,949
Amortization of deferred financing costs............. 596 596
Depreciation and amortization........................ 34,458 34,458
Equity in income of joint venture and unconsolidated
subsidiaries........................................ 5,172 4,270
-------- --------
Net income before minority interests................. 61,468 56,570
Minority interests................................... (8,172) (7,964)
-------- --------
Net income before preferred dividends................ 53,296 48,606
Preferred dividends.................................. (4,528) (4,528)
-------- --------
Net income applicable to common shareholders......... $ 48,768 $ 44,078
======== ========
Net income per Common Share basic................... $1.25 $1.13
======== ========
Net income per Common Share diluted................. $1.24 $1.12
======== ========
</TABLE>
11. EARNINGS PER SHARE
The Company calculates Earnings per Share in accordance with Statement of
Financial Accounting Standards No. 128, "Earnings per Share" ("FAS No. 128").
FAS No. 128 requires a dual presentation of basic and diluted Earnings per Share
on the face of the income statements. Additionally, FAS No. 128 requires a
reconciliation of the numerator and denominator used in computing basic and
diluted Earnings per Share.
16
<PAGE>
Reconciliation of Earnings per Share Numerator
<TABLE>
<CAPTION>
THREE MONTHS
THREE MONTHS ENDED ENDED NINE MONTHS ENDED NINE MONTHS ENDED
SEPT. 30, 1998 SEPT. 30, 1997 SEPT. 30, 1998 SEPT. 30, 1997
-------------------- ----------------- ------------------ -----------------
(in thousands, except per share data)
<S> <C> <C> <C> <C>
Net Income...................................... $21,232 $10,116 $49,779 $26,345
Preferred dividends............................. (1,505) -- (4,146) --
------- ----------------- ------- -----------------
Net Income available to common shareholders..... $19,727 $10,116 $45,633 $26,345
======= ======= ======= =======
Reconciliation of Earnings per Share Denominator
Weighted average common shares outstanding...... 39,349 26,289 38,680 23,646
======= ======= ======= =======
Basic Earnings per Share........................ $ 0.50 $ 0.38 $ 1.18 $ 1.11
======= ======= ======= =======
Dilutive Effect of Common Share Equivalents
Dilutive options................................ 157 409 279 356
Dilutive preferred shares....................... 3,774 -- 3,466 --
Weighted average common shares outstanding...... 39,349 26,289 38,680 23,646
------- ------- ------- -------
Weighted average common shares and common share
Equivalents.................................. 43,280 26,698 42,425 24,002
======= ======= ======= =======
Diluted Earnings per Share...................... $ 0.49 $ 0.38 $ 1.17 $ 1.10
======= ======= ======= =======
</TABLE>
12. SUBSEQUENT EVENTS
Subsequent to September 30, 1998, the Company closed a $100 million four-
year bank facility which funded on October 13, 1998. The term facility was
priced at LIBOR plus 137.5 basis points (with possible pricing reductions to
LIBOR plus 85 basis points under certain conditions) and is substantially
consistent with the existing terms and conditions under the Company's $300
million Line of Credit. Proceeds from the facility were used to reduce the
Company's borrowings under the Line of Credit.
On October 6, 1998, the Company terminated one of its two $49.25 million
hedge agreements and incurred settlements costs of $4.3 million due to the
substantial downward movement in the underlying treasury security. The
settlement cost of the hedging transaction will be amortized over the life of
two 12-year mortgages totaling $78.0 million on which the Company has locked a
rate with a large insurance company.
On October 14, 1998, the Company filed, with the SEC, Post-Effective
Amendment No. 1 to the Company's Form S-3 Registration Statement under the
Securities Act of 1933 (the "Post-Effective Amendment"). The registration
statement contains two forms of prospectus: the first relates to re-sales from
time to time by certain selling shareholders and the second relates to (i) the
primary issuance of shares to Union Bank of Switzerland, London Branch ("UBS-
LB") and (ii) subsequent primary issuances from time to time to UBS-LB. In
addition, this registration statement contains a form of prospectus supplement
to be used in connection with subsequent primary issuances from time to time to
UBS-LB.
On October 15, 1998, the Company filed, with the SEC, a Form S-3
Registration Statement ("Prospectus"). The Prospectus relates to 524,180 Common
Shares which the Company may issue to certain holders of 524,180 Units of
limited partnership interest in the Operating Partnership upon redemption of
such Units. The Company orginally issued the 524,180 Units to the related
holders of such Units in exchange for their contribution of certain assets to
the capital of the Operating Partnership.
On October 16, 1998, the Company filed, with the SEC, a Form S-3
Registration Statement ("Security Capital Registration Statement"), which
relates to the public offer and sale of the 3,773,585 Series A Convertible
Preferred shares of the Company which are held by SCPG (as defined in Note 1)
and up to 3,773,585 Common Shares that the Company may issue upon conversion of
the Series A Convertible Preferred Shares by the selling shareholder named
herein or its transferes, pledges, donees or successors.
17
<PAGE>
On November 5, 1998, the Company closed a $35.75 million 12-year mortgage
collateralized by the Park West C-2 property. The interest rate on the loan is
6.63% per annum and it is subject to a 30-year amortization schedule. Proceeds
from the facility were used to reduce the Company's borrowings under the Line of
Credit.
In addition to the two letter of credits (as discussed in Note 1), on
November 6, 1998, the Company placed approximately $3.7 million with UBS as cash
collateral related to the future settlement of the forward stock contract.
18
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
This Form 10-Q may include forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934. These statements are identified by phrases such as the
Company "expects" or "anticipates" and words of similar effect. The Company's
actual results may differ materially from those projected. Factors that could
cause such a difference include: the Company's inability or failure to acquire
properties under contract or additional properties; difficulties in integrating
and operating acquired properties; bankruptcy or default of major tenants
resulting in a failure or delay in payment of rent; and general risks associated
with investments in real estate, including the effect of changes in economic,
competitive and other market conditions in the markets where the Company's
properties are concentrated, non-renewal of expiring leases or inability to re-
let vacated space at adequate rates, the inability of properties to generate
adequate cash flow to fund debt service and operating expenses, financing and
refinancing risks related to the Company's floating rate debt and new debt
necessary to support growth. For additional information, please refer to the
detailed discussion of risks included in the Company's Current Report on Form 8-
K filed October 9, 1998, under the caption "Risk Factors."
OVERVIEW
The Company is a self-administered and self-managed Real Estate Investment
Trust ("REIT") that acquires, owns, manages, leases, develops and builds office
and industrial properties throughout the United States. The Company operates
principally through Prentiss Properties Acquisition Partners, L.P. and its
subsidiaries (the "Operating Partnership") and Prentiss Properties Limited, Inc.
(the "Manager") (collectively referred to herein as the "Company").
RESULTS OF OPERATIONS
As of September 30, 1998, the Company owned interests in a diversified
portfolio of 253 primarily suburban Class "A" office and suburban industrial
properties (the "Properties") containing approximately 23.6 million net rentable
square feet. The Properties are located in 20 major U.S. markets and consist of
115 office buildings (the "Office Properties") containing approximately 12.8
million net rentable square feet and 124 industrial buildings (the "Industrial
Properties") containing approximately 8.9 million net rentable square feet. The
Properties include 13 office and two industrial development projects (including
an expansion of an existing Property) which upon completion will total
approximately 1.9 million square feet.
The consolidated financial statements of the Company include all the
accounts of the Company, its majority-owned Operating Partnership and
subsidiaries. The financial statements for the three and nine months ended
September 30, 1998, include (i) the results of operations of 145 operating
Properties and 10 development projects for the entire periods presented, (ii)
the results of operations of the 84 Properties acquired subsequent to January 1,
1998 (the "Acquired Properties") and eight development projects for the portion
of the periods subsequent to acquisition or commencement of development by the
Company, (iii) the results of operations of the 5307 East Mockingbird, Oceanside
Distribution Center, West Loop Business Park and Glendale Federal Bank Building
Properties (the "Sold Properties") for the portion of the periods prior to sale,
(v) a 50% equity interest in the seven Broadmoor Austin Properties, and (vi)
results of operations of the Prentiss Properties Service Business conducted
primarily by the Manager in the periods presented. The financial statements for
the three and nine months ended September 30, 1997, include (i) the results of
operations of 88 operating Properties and three development projects for the
entire periods presented, (ii) the results of operations of 42 Properties
acquired during the periods and eight development projects for the portion of
the period subsequent to acquisition or commencement of development by the
Company, (iii) an approximate 50% equity interest in the seven Broadmoor Austin
Properties, and (iv) results of operations of the Prentiss Properties Service
Business conducted primarily by the Manager in the periods presented. All
significant intercompany balances and transactions have been eliminated.
The results of operations for the three and nine month periods ended
September 30, 1998 and 1997 include the respective operations of the Company.
The Company had a total of 111 comparative operating Properties for the entire
three month periods ended September 30, 1998 and 1997 and a total of 82
operating Properties for the entire nine month periods ended September 30, 1998
and 1997. Consequently, the comparisons of the periods provide only limited
information regarding the operations of the Company as currently constituted.
The tables below provide reconciliation of the comparative Properties owned for
the entire three month periods and nine month periods ended September 30, 1998
and 1997:
19
<PAGE>
<TABLE>
<S> <C>
Properties owned at September 30, 1998 253
Less:
Properties included above that were acquired during or subsequent to the three month
period ended September 30, 1997 118
Development projects included above that were started or completed during or subsequent to
the three month period ended September 30, 1997 17
Properties included above with operations accounted for using the equity method of
accounting 7
------------
Three Month Comparative Properties 111
============
Properties owned at September 30, 1998 253
Less:
Properties included above that were acquired subsequent to January 1, 1997 147
Development projects included above started or completed subsequent to January 1, 1997 17
Properties included above with operations accounted for using the equity method of
accounting 7
------------
Nine Month Comparative Properties 82
============
</TABLE>
Comparison of the Three Months Ended September 30, 1998 to the Three Months
- ---------------------------------------------------------------------------
Ended September 30, 1997
- ------------------------
Rental income increased by $29.5 million, or 86.8%, to $63.5 million from
$34.0 million primarily as a result of the Properties acquired subsequent to
July 1, 1997. As described above, the Company includes comparative results of
operations of 111 operating Properties for the three month periods ended
September 30, 1998 and 1997. The rental income for the combined 111 operating
Properties increased by a net $324,000, or 1.04%, from the three months ended
September 30, 1997 to the three months ended September 30, 1998. Rental income
from the related Sold Properties and the Property acquisitions subsequent to
July 1, 1997 account for a net $29.2 million increase in rental income.
Property operating and maintenance expenses increased by $7.9 million, or
99.4%, primarily as a result of the Properties acquired subsequent to July 1,
1997. The property operating and maintenance expenses for the 111 operating
Properties decreased by approximately $313,000, or 4.5%, from the three month
period ended September 30, 1997 to the three month period ended September 30,
1998. Property operating and maintenance expenses of the related Sold
Properties and the Property acquisitions subsequent to July 1, 1997 account for
an approximate $8.2 million increase from the three month period ended September
30, 1997 to the same period in 1998.
Real estate taxes increased by $3.1 million, or 85.4%, primarily as a
result of the Properties acquired subsequent to July 1, 1997. Such acquired
Properties, when combined with the Sold Properties, account for a $2.8 million
net increase in real estate expenses for the three month period ended September
30, 1998 compared to the prior year comparative period. The real estate tax
expense for the 111 operating Properties increased by approximately $299,000, or
8.6%, from the three months ended September 30, 1997 to the comparative period
in 1998.
Interest expense increased by $5.7 million, or 96.3%, primarily as a result
of the increase in debt on real estate from $432.6 million at September 30, 1997
to $811.6 million at September 30, 1998. The increase in debt on real estate is
attributable to borrowings incurred or assumed in connection with Property
acquisitions subsequent to September 30, 1997.
Depreciation and amortization expense increased by $5.4 million, or 94.0%,
primarily as a result of the Properties acquired subsequent to July 1, 1997.
Such acquired Properties, when combined with the related Sold Properties,
account for a $4.9 million increase in depreciation and amortization for the
three months ended September 30, 1998 from the prior year comparative period.
The depreciation and amortization expense for the 111 operating Properties
increased by approximately $512,000, or 9.5%, from the three months ended
September 30, 1997 to the comparative period in 1998.
During the three months ended September 30, 1998, the Company recorded a
gain on sale of $4.4 million. The gain on sale resulted from the Company's sale
of the Glendale Federal Bank Building Properties during the three months ended
September 30, 1998.
20
<PAGE>
Comparison of the Nine Months Ended September 30, 1998 to the Nine Months Ended
- -------------------------------------------------------------------------------
September 30, 1997
- ------------------
Rental income increased by $82.4 million, or 96.8%, to $167.5 million from
$85.1 million primarily as a result of the Properties acquired subsequent to
January 1, 1997. As described above, the Company includes comparative results
of operations of 82 operating Properties for the nine month periods ended
September 30, 1998 and 1997. The rental income for the combined 82 operating
Properties increased by $1.16 million, or 1.8%, from the nine months ended
September 30, 1997 to the nine months ended September 30, 1998. Exclusive of
the effect of the $511,000 of past due rents collected on the Milwaukee
Industrial Properties during the nine months ended September 30, 1997, the
increase from the 82 Properties totaled $649,000, or 1.0%. Rental income from
the related Sold Properties, and the Property acquisitions subsequent to
January 1, 1997 account for a $81.2 million increase in rental income.
Property operating and maintenance expenses increased by $19.5 million, or
97.6%, primarily as a result of the Properties acquired subsequent to January 1,
1997. The property operating and maintenance expenses for the 82 operating
Properties decreased by approximately $722,000, or 4.8%, from the nine month
period ended September 30, 1997 to the nine month period ended September 30,
1998. Property operating and maintenance expenses of the Sold Properties and
the Property acquisitions subsequent to January 1, 1997 account for an
approximate net $20.2 million increase from the nine month period ended January
1, 1997 to the same period in 1998.
Real estate taxes increased by $8.7 million, or 92.8%, primarily as a
result of the Properties acquired subsequent to January 1, 1997. Such acquired
Properties, when combined with the related Sold Properties, account for a net
$7.7 million increase in real estate expenses for the nine month period ended
September 30, 1998 compared to the prior year comparative period. The real
estate tax expense for the 82 operating Properties increased by approximately
$1.0 million, or 13.5%, from the nine months ended September 30, 1997 to the
comparative period in 1998.
Interest expense for the nine months ended September 30, 1998 increased by
$15.3 million, or 118.5%, primarily as a result of the increase in debt on real
estate from $432.6 million at September 30, 1997 to $811.6 million at September
30, 1998. The increase in debt on real estate is attributable to borrowings
incurred or assumed in connection with the Property acquisitions subsequent to
September 30, 1997.
Depreciation and amortization expense increased by $14.7 million, or
100.3%, primarily as a result of the Properties acquired subsequent to January
1, 1997. Such acquired Properties, when combined with the Sold Properties,
account for a net $13.3 million increase in depreciation and amortization for
the nine months ended September 30, 1998 from the prior year comparative period.
The depreciation and amortization expense for the 82 operating Properties
increased by approximately $1.4 million, or 12.2%, from the nine months ended
September 30, 1997 to the comparative period in 1998.
During the nine months ended September 30, 1998, the Company recorded gains
on sale totaling $8.2 million and extraordinary items of $8.9 million. The
gains on sale resulted from the Company's sale of the 5307 East Mockingbird,
West Loop Business Park and Glendale Federal Bank Building Properties. The
extraordinary item resulted from two items including (i) the Company's
recognition of its 50% proportionate share of $12.9 million, or $6.45 million,
of prepayment penalties and unamortized financing costs written-off, both of
which were recorded as extraordinary charges by the Broadmoor Austin joint
venture during the period; and (ii) the distribution of 113,500 Operating
Partnership units ("Units") by an affiliate of the Company to certain employees
of the Company resulting in a non-cash charge to the Company of $3.1 million.
The transactions were recorded net of the minority interest proportionate share
of each charge totaling $406,000 and $193,000, respectively.
Funds from Operations
- ---------------------
The Company generally considers Funds from Operations, in conjunction with
cash flows, to be an appropriate measure of liquidity of an equity REIT. "Funds
from Operations" as defined by the National Association of Real Estate
Investment Trusts ("NAREIT") means net income (computed in accordance with
Generally Accepted Accounting Principles ("GAAP")) excluding gains (or losses)
from debt restructuring and sale of property, plus depreciation and amortization
on real estate assets, and after adjustments for unconsolidated partnerships and
joint ventures. The Company's Funds from Operations may not be comparable to
Funds from Operations reported by other REITs that do not define that term using
the current NAREIT definition. Funds from Operations does not represent cash
generated from operating activities in accordance with GAAP and should not be
considered as an alternative to net income as an indication of the Company's
performance or to cash flows as a measure of liquidity or
21
<PAGE>
ability to make distributions. The following is a reconciliation of net income
to Funds from Operations for the three and nine month periods ended September
30, 1998 and 1997:
<TABLE>
<CAPTION>
THREE MONTHS THREE MONTHS NINE MONTHS NINE MONTHS
ENDED ENDED ENDED ENDED
SEPT. 30, 1998 SEPT. 30, 1997 SEPT. 30, 1998 SEPT. 30, 1997
------------------ ----------------- ------------------ ------------------
(dollars in (dollars in (dollars in (dollars in
thousands) thousands) thousands) thousands)
<S> <C> <C> <C> <C>
Net income $21,232 $10,116 $49,779 $26,345
Add:
Real estate depreciation and amortization... 11,221 5,783 29,380 14,669
Real estate depreciation and amortization
of unconsolidated subsidiary and joint
venture.................................. 532 532 1,664 1,605
Minority interest in operating partnership.. 2,832 1,269 4,948 3,673
Extraordinary item.......................... -- -- 8,908 111
Less:
Gain on sale................................ (4,379) -- (8,203) (243)
Dividend on perpetual preferred units....... (1,971) -- (2,102) --
------- ------- ------- -------
Funds from Operations $29,467 $17,700 $84,374 $46,160
======= ======= ======= =======
</TABLE>
Liquidity and Capital Resources
- -------------------------------
Cash and cash equivalents were $3.5 million and $3.6 million at
September 30, 1998 and September 30, 1997, respectively. Net cash provided by
operating activities was $82.8 million for the nine months ended September 30,
1998, compared to $43.9 million for the nine months ended September 30, 1997.
The increase is due primarily to the operating results of the Properties
acquired subsequent to January 1, 1997.
Net cash used in investing activities increased from $443.7 million for the
nine months ended September 30, 1997 to $579.7 million for the nine months ended
September 30, 1998. This increase is due primarily to the 84 real estate
Properties acquired during the nine months ended September 30, 1998 compared to
42 acquired during the same period in 1997, as well as an increase in cash
invested in real estate due to an increase in the number of development projects
commenced from eight in this period of 1997 to 10 in 1998.
Net cash provided by financing activities increased from $396.2 million for
the nine months ended September 30, 1997 to $493.3 million for the nine months
ended September 30, 1998. This increase is primarily attributable to the net
proceeds from the sale of common shares of beneficial interest, $0.01 par value
per share ("Common Shares"), Series "A" Cumulative Convertible Redeemable
Preferred Shares ("Series A Convertible Preferred Shares") and Series "B"
Cumulative Redeemable Perpetual Preferred Units ("Series B Perpetual Preferred
Units") and debt incurred or assumed in connection with property acquisitions
during the nine months ended September 30, 1998.
22
<PAGE>
The following table sets forth the Company's mortgage debt as of
September 30, 1998:
MORTGAGE DEBT
<TABLE>
<CAPTION>
ANNUAL
PRINCIPAL INTEREST INTEREST
PROPERTY(IES) AMOUNT RATE AMORTIZATION MATURITY PAYMENT
------------- ------------ ---------- ------------ ------------------ -------------
<S> <C> <C> <C> <C> <C>
Mortgage Loan...................................... $180,100,000(1) 7.58% None February 27, 2007 $13,651,580
Acquisition Loan................................... 120,000,000(2) 7.42%(3) None January 1, 1999 8,898,000
Line of Credit..................................... 293,650,000 6.65%(4) None December 31, 2000 19,532,306
PacifiCare Building................................ 6,000,000 7.30% None November 1, 2000 438,000
Walnut Glen Tower.................................. 35,000,000 6.92% None April 1, 2005 2,422,000
Crescent Centre.................................... 12,000,000 7.95% None March 1, 2004 954,000
Bachman Creek West................................ 3,030,131 8.63% 25 yr November 30, 2002 261,500
Broadmoor Austin Properties(5)..................... 77,000,000 7.04% None April 10, 2011 5,420,800
Southpoint (III)................................... 8,007,737 7.75% 20 yr April 14, 2014 620,600
CIGNA Loan (6)..................................... 60,000,000 6.80% None December 10, 2003 4,080,000
Highland Court..................................... 5,053,807 7.27% 25 yr April 1, 2006 367,412
Creamery Way....................................... 3,837,522 8.30% 20 yr September 19, 2006 318,514
Westheimer Central Plaza........................... 6,081,781 8.38% 25 yr August 1, 2006 509,653
One Westheimer Center.............................. 25,434,353 7.84% 25 yr February 1, 2004 1,994,053
Oaklands Corporate Center.......................... 6,408,382 8.55% 25 yr July 1, 2007 547,917
Oaklands Corporate Center.......................... 1,364,144 8.65% 25 yr August 1, 2006 117,998
Oaklands Corporate Center.......................... 2,700,452 8.40% 25 yr December 1, 2007 226,838
2500 Cumberland Building K......................... 11,395,038 7.03%(7) None August 1, 2000 801,071
Exec. Center Del Mar............................... 11,649,077 7.03%(8) None December 14, 2000 807,281
Westpoint.......................................... 14,748,000 7.03%(8) None November 15, 2000 1,022,036
Other Corporate Debt............................... 4,033,204 7.75% None December 31, 2000 312,573
Other Corporate Debt............................... 1,127,815 6.15% None August 25, 2001 69,361
------------ ---- -----------
Total/Weighted Average............................. $888,621,443 7.13% $63,373,493
============ ==== ===========
</TABLE>
(1) The Mortgage Loan is collateralized by the following 53 Properties: Park
West E1, Park West E2, One Northwestern Plaza, 3141 Fairview Park Drive,
O'Hare Plaza II, 1717 Deerfield, 2411 Dulles Corner Road, 4401 Fair Lakes
Court, Kansas City Industrial Properties (7 Properties), certain of the Los
Angeles Industrial Properties (18 Properties), certain of the Milwaukee
Industrial Properties (17 Properties), and the certain of the Chicago
Industrial Properties (3 Properties).
(2) The Acquisition Loan is collateralized by the following 16 Properties:
Natomas Corporate Center (6 Properties), The Academy (3 Properties), Seven
Mile Crossing (2 Properties), and Corporetum Office Campus (5 Properties).
(3) Represents the weighted average interest rate for the Interest Rate Swap of
$50 million at an effective rate of 7.503% and $60 million at an effective
rate of 7.498%. Additionally, rate shown reflects a variable rate on $10
million equal to LIBOR + 1.25%; on November 10, 1998, LIBOR was equal to
5.28%.
(4) Represents a variable rate equal to LIBOR + 1.38%; on November 10, 1998,
LIBOR was equal to 5.28%.
(5) The Company, through the Operating Partnership, owns a 50% general
partnership interest in the entity that owns the Broadmoor Austin
Properties, which interest is accounted for under the equity method of
accounting. The amount shown reflects the Company's proportionate share of
the mortgage indebtedness collateralized by the Properties.
(6) The CIGNA Loan is collateralized by the following 11 Properties: Lake
Center (2 Properties), Southpoint I and II (2 Properties), Valleybrooke (5
Properties) and Woodland Falls I and IV (2 Properties).
(7) Represents a variable rate equal to LIBOR + 1.75%; on November 10, 1998,
LIBOR was equal to 5.28%.
(8) Represents a variable rate equal to LIBOR + 1.65%; on November 10, 1998,
LIBOR was equal to 5.28%.
The Company's policy is to limit combined indebtedness plus its pro rata
share of joint venture debt so that at the time such debt is incurred, it does
not exceed 50% of the Company's total market capitalization (the "Debt
Limitation"). As of September 30, 1998, the Company had outstanding total
indebtedness, including its pro rata share of joint venture debt of
approximately $888.6 million, or approximately 43.47% of total market
capitalization based on a Common Share price of $23.875 per share. As of
September 30, 1998, the Company had the approximate capacity to borrow up to an
additional $267.1 million under the Debt Limitation. The amount of indebtedness
that the Company may incur, and the policies with respect thereto, are not
limited by the Company's Declaration of Trust and Bylaws, and are solely within
the discretion of the Company's Board of Trustees.
The Company's Properties require periodic investments of capital for
tenant-related capital expenditures and for general capital improvements. For
the three months ended September 30, 1998, the Company's recurring non-
incremental revenue-generating capital expenditures totaled $2.2 million.
The Company has considered its short-term liquidity needs and the adequacy
of adjusted estimated cash flows and other expected liquidity sources to meet
these needs. The Company believes that its principal short-term liquidity needs
are to fund normal recurring expenses, debt service requirements and the minimum
distribution required to maintain the Company's REIT qualification under the
Code. The Company anticipates that these needs
23
<PAGE>
will be fully funded from the Company's cash flows provided by operating
activities and, when necessary to fund shortfalls resulting from the timing of
collections of accounts receivable in the ordinary course of business, from the
Line of Credit, leasing development and construction business and from the
Manager. The Manager's sole sources of income are fees generated by its office
and industrial real estate management, leasing, development and construction
business.
The Company expects to meet its long-term liquidity requirements for the
funding of activities such as development, property acquisitions, scheduled debt
maturities, major renovations, expansions and other non-recurring capital
improvements through long-term collateralized and unsecured indebtedness and the
issuance of additional equity securities from the Company. The Company also
intends to use proceeds from the Line of Credit to fund property acquisitions,
development, redevelopment, expansions and capital improvements on an interim
basis.
The Company expects to make distributions to its shareholders primarily
based on its distributions from the Operating Partnership. The Operating
Partnership's income will be derived primarily from lease revenues from the
Properties and, to a limited extent, from fees generated by its office and
industrial real estate management properties.
Inflation
- ---------
Most of the leases on the Properties require tenants to pay increases in
operating expenses, including common area charges and real estate taxes, thereby
reducing the impact on the Company of the adverse effects of inflation. Leases
also vary in term from one month to 15 years, further reducing the impact on the
Company of the adverse effects of inflation.
Impact of the Year 2000 Issue
- -----------------------------
The Year 2000 ("Y2K") compliance problem is the result of computer programs
designed to use two digit rather than four digit years. Thus, the year 1998 is
represented as 98 and the year 2000 would be represented as 00. This could be
interpreted as either 1900 or 2000. To systems that have Y2K related issues,
the time may seem to have reverted back 100 years. Systems, equipment and
software with exposure to Y2K related problems exist not only in computerized
information systems ("Information Systems") but also in building operating
systems such as elevators, alarm systems, energy management systems, phone
systems, and numerous other systems and equipment (the "Non-Information
Technology Systems") (collectively, the "Systems"). Failure to adequately
identify and correct Y2K related problems could result in a Systems failure or
malfunction with potential adverse effects including personal injury, property
damage, and disruption of operations. Any or all of these failures could
materially and adversely affect the Company's business, financial condition, or
results of operations.
Due to the exposure and potential liabilities inherent in both the Systems
used internally by the Company ("Internal Systems") and those Systems used by
third-parties to conduct business with the Company ("Third-Party Systems"), in
September 1997, the Company created a committee (the "Y2K Committee") headed by
the Vice President of Information Systems and Co-chaired by the Vice President
of National Property Operations. Due to the national presence of the Company,
the Y2K Committee appointed approximately 85 employees (the "Y2K Coordinators")
designated as either Y2K property coordinators ("Y2K Property Coordinators") or
Y2K corporate office coordinators ("Y2K Corporate Office Coordinators"). The
purpose of the Y2K Committee was to develop a plan to assess and mitigate the
Company's exposure to potential Y2K related problems (the "Company's Y2K Plan").
In order to implement the Company's Y2K Plan in a timely and uniform manner,
during August 1998 the Y2K Committee held classes to educate the Y2K
Coordinators on the steps to be taken to ensure Y2K compliance. Due to the
risks associated with inadequate assessments and remediations of the Systems,
the Company engaged various independent sources to assist in the review of the
Company's Y2K Plan, including:
<TABLE>
<CAPTION>
CONSULTING COMPANY Area of Review
------------------ --------------
<S> <C>
DMR Consulting Embedded Systems
PricewaterhouseCoopers LLP Financial Systems
Munsch, Hardt, Kopf, Harr, & Dinan, P.C. Legal
Computer Sciences Corporation Overall Review
</TABLE>
Computer Sciences Corporation will return in December to review the
Company's progress. Additionally, PricewaterhouseCoopers LLP will also return
as they are the Company's independent accountants.
24
<PAGE>
General Approach
----------------
The Company's general approach is the same whether it is for a building or
a large office. The steps involved are:
1) Communication with clients (owners, tenants, and asset managers)
regarding the potential for Y2K problems inherent in the Internal
Systems.
2) Communication with vendors regarding the potential for Y2K problems
inherent in their Third Party Systems.
3) Inventory and prioritization of the Internal Systems.
4) Initial assessment of the inventoried Internal Systems.
5) Contingency plan for the inventoried Internal Systems.
6) Test inventoried Internal Systems.
7) Prioritize resolution of any problems discovered with inventoried
Internal Systems. The resolution will include additional testing of the
solutions.
8) Review and revise if necessary, contingency plans for inventoried
Internal Systems.
9) Review vendor responses regarding their third Party Systems and take
necessary action accordingly.
The Company has substantially completed initial Year 2000 inventory and
assessments of Internal Systems for existing assets. In conjunction with the
budgeting and business planning process for 1999 the assessment and testing
phases of the Y2K effort were substantially completed for known Internal Systems
on or before October 31, 1998. The results of these tests should minimize the
doubt as to whether or not the inventoried Internal Systems have any Y2K issues.
These findings will enable the Company to reasonably determine the remaining
financial commitment necessary to remedy the Y2K problems. In some cases,
Systems that demonstrate Y2K related problems have previously been scheduled for
replacement or remediation as a normal course of business irrespective of Year
2000 related problems. Alternatively, certain systems that may have been
replaced after the January 1, 2000 must have their replacements accelerated due
to Y2K related problems creating adverse affects.
Information Systems
-------------------
The Company has inventoried its Information Systems according to reasonable
man standards relative to exposure. The majority of the Company's software is
off the shelf with a minimum amount of proprietary code.
The Company's primary financial software is from CTI Limited, Incorporated
which runs on an IBM AS/400. Assurances from both vendors accompanied by
thorough testing, with the assistance of PricewaterhouseCoopers LLP, have
resulted in minimal remediation necessary for proprietary modifications made
to the software over the years. These modifications have been completed and
will be implemented upon final acceptance testing by the users and review by
PricewaterhouseCoopers LLP. This should be completed by December 31, 1998.
The Company uses a number of personal computers and networks in the course
of its operations. Employees use off the shelf software such as Microsoft
Word, Microsoft Excel and Lotus Notes for productivity purposes. Personal
computer hardware is tested with the National Software Testing Laboratory
distributed testing software. The desktop software applications will require
software updates that will be distributed Company-wide in the second quarter
of 1999. Server operating systems that demonstrate Y2K related problems are
also scheduled to be upgraded by June 30, 1999.
Non-Information Technology Systems
----------------------------------
Non-Information Technology Systems at properties owned as of September 30,
1998 have been substantially assessed with respect to date-sensitive operating
controls in order to quantify the Y2K exposure. Assessments will continue as
the Company acquires additional properties. The Y2K review process has been
incorporated into the due diligence processes. The Company's investment
committee formally considers the Y2K status of each investment during the
approval process.
Methodology for assessing and testing building systems will vary by
equipment and is typically dictated by the building type. The Company used an
outside firm, DMR Consulting (an Amdahl Company), to benchmark and review its
methodology in representative samples of each building type in the Company's
portfolio (i.e., low rise/industrial, mid-rise office, and high-rise office).
25
<PAGE>
Although building systems may be similar from building to building within a
given building type, implementations can vary. Therefore, testing for
compliance is necessary where possible. Testing is substantially complete for
the known building systems on assets owned as of September 30, 1998. These
tests have been performed by either the Company's staff, outside vendors, or
a combination of both.
In conjunction with the budgeting and business planning process for 1999,
the assessment and testing phases of the Company's Y2K Plan was substantially
complete for Internal Systems on or before October 31, 1998. The results of
these tests should minimize the doubt as to whether or not the Internal
Systems have Y2K related issues. These findings will enable the Company to
reasonably estimate the remaining financial commitment necessary to remedy the
Y2K problems.
Third-Party Systems
-------------------
In addition to the Company's Y2K Plan with respect to Internal Systems, it
is also taking proactive steps to determine the impact on the Company of Y2K
related issues with Third-Party Systems.
The Company is identifying and contacting critical suppliers, service
providers, contractors, and clients to determine the extent to which the
Company's operations could be impacted as a result of third-parties' failure to
remedy their own Y2K related problems. The Company expects to be substantially
complete with this process by March 31, 1999, which coincides with the timing of
the Company's contingency planning milestone. To the extent the Y2K readiness
responses of the critical suppliers, service providers, contractors and clients
are unsatisfactory, the Company will evaluate the impact of this relationship.
Should this relationship prove materially detrimental, the Company will make
every effort to change to a critical supplier, service provider, contractor, or
client that demonstrates Y2K readiness. The Company is not currently aware of
any such situations, but the inability to locate an alternative supplier,
service provider, contractor, or client in a timely manner could materially and
adversely affect the Company's business, financial condition or results of
operations.
Estimate of Financial Impact
----------------------------
The total costs associated with required modifications to become Year 2000
compliant are not expected to be material to the Company's financial position.
The Company currently estimates the total Y2K readiness costs will be between
$500,000 and $600,000. Such costs are segregated into three categories along
with the timing of the estimated expenses as follows:
<TABLE>
<CAPTION>
CATEGORY LOW HIGH Q4/98 Q1/99 Q2/99
------------- ------------- -------------- -------------- --------------
<S> <C> <C> <C> <C> <C>
Non-Information Technology Systems $400,000 $475,000 10% 80% 10%
Information Systems 40,000 50,000 20% 70% 10%
Y2K Committee 60,000 75,000 80% 10% 10%
-------- --------
Total $500,000 $600,000
======== ========
</TABLE>
These costs are net of the Company's personnel costs that are considered to
be part of normal operating costs. A significant portion of the Non-Information
Technology Systems costs are expected to be capitalized and recovered through
building operations while the balance will be expensed in the period incurred.
Much of the Information Systems costs are version upgrades that will be expensed
as incurred. The Y2K Committee costs consist largely of consulting charges that
are expensed as incurred.
The Company's readiness program is an ongoing process and the estimates of
costs and completion dates for the various categories described above are
subject to material change.
Potential Risks of Inadequate Remediation
-----------------------------------------
Failure to correct a material Y2K problem could result in an interruption
in, or a failure of, certain normal business activities or operations that could
materially and adversely affect the Company's results of operations, liquidity,
and financial position. Much of the uncertainty lies with the ability of
critical suppliers, service providers, contractors, and clients to fully remedy
their Y2K problems. The Company's Y2K Plan should significantly reduce the
Company's level of uncertainty regarding the Y2K problem.
26
<PAGE>
The most reasonable and likely worst case scenario might be the failure of
an energy management system in a building. This could adversely affect the
environmental conditions of the occupied space, thus creating discomfort and
inconvenience to the tenants until the condition could be manually corrected.
Persistence of this problem for a long period of time could result in an
increase in operating costs for the building until the energy management system
is restored to proper operations.
The Company is making substantial effort to eliminate the exposure to any Y2K
issues; however, no one can accurately predict how many Y2K problem-related
failures will occur or the severity, duration, or financial consequences of
these potential failures, especially with regard to Third-Party Systems. As a
result, a significant number of operational inconveniences and inefficiencies
for the Company and its clients that may divert management's time, attention,
financial, and human resources from its ordinary business activities; and a
lesser number of serious system failures that may require significant efforts by
the Company and it's clients to prevent or alleviate material business
disruption.
Contingency Plans
-----------------
The Company is developing contingency plans to be implemented as part of
its efforts to identify and correct Y2K issues. The scheduled target date for
the completion of the contingency plans is March 31, 1999. These contingency
plans will range from manual overrides, as described in the aforementioned
example, to alternative processes such as building lock downs in the event of a
long term power failure. Fortunately, most buildings currently have contingency
plans in place for natural disasters such as earthquakes, floods, ice storms,
and the like which provide a basis for the Y2K contingency plans. These plans
may also include short-term use of backup equipment and software, increased work
hours for Company personnel or use of contract personnel, and orderly shut down
of the building on December 31, 1999 and January 1, 2000 in order to perform
tests of critical systems.
Disclaimer
----------
The Company's Y2K readiness program is an ongoing process and the estimates
of costs and completion dates for various components of the Company's Y2K
readiness program described above are subject to change. Additionally, the
Company's discussion of its Y2K readiness program contains forward-looking
statements that are based on assumptions as to future events. There can be no
guarantee as to the outcome of these future events.
Recently Issued Accounting Standards
- ------------------------------------
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 131, "Disclosures about Segments
of an Enterprise and Related Information" ("FAS No. 131").
FAS No. 131 requires disclosure of segment data in an entity's annual
financial statements and selected segment information in their quarterly report
to shareholders. FAS No. 131 also requires entity-wide disclosures about the
products and services an entity provides, the material countries in which it
holds assets and reports revenues, and its major customers. FAS No. 131
supersedes FAS No. 14, "Financial Reporting for Segments of a Business
Enterprise," and is effective for fiscal years beginning after December 15,
1997. FAS No. 131 is not required for interim reporting in the first year of
application. Thus, FAS No. 131 will be implemented by the Company for its year-
end December 31, 1998 reporting. The Company believes that upon implementation,
FAS No. 131 will not have a material impact on the financial statements of the
Company.
In February 1998, the FASB issued Statement of Financial Accounting
Standards No. 132, "Employers' Disclosures about Pensions and Other
Postretirement Benefits" ("FAS No. 132").
FAS No. 132 provides additional information to facilitate financial
analysis and eliminates certain disclosures which are no longer useful. To the
extent practicable, the Statement also standardizes disclosures for retiree
benefits. FAS No. 132 is effective for financial statements issued for periods
ending after December 15, 1997. The Company believes that FAS No. 132 will not
have a material impact on the financial statements of the Company.
27
<PAGE>
In June 1998, the FASB issued Statement of Financial Accounting Standards
No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("FAS
No. 133").
FAS No. 133 establishes accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts, (collectively referred to as derivatives) and for hedging activities.
It requires that an entity recognize all derivatives as either assets or
liabilities in the statement of financial position and measure those instruments
at fair value. FAS No. 133 is effective for all fiscal quarters of fiscal years
beginning after June 15, 1999. The Company believes that upon implementation,
FAS 133 will not have a material impact on the financial statements of the
Company.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
28
<PAGE>
PART II: OTHER INFORMATION
---------------------------
ITEM 1. LEGAL PROCEEDINGS
None.
ITEM 2. CHANGES IN SECURITIES
None.
ITEM 3. DEFAULTS UPON MORTGAGES AND NOTES PAYABLE
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF
SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
Not applicable.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
Unless otherwise indicated, the exhibits listed below are filed as part
of this report or incorporated by reference * to the Company's
Registration Statement on Form S-11, File No. 333-9863 (the
"Registration Statement").
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
----------- -----------
<S> <C>
1.1 -- Purchase Agreement, dated February 2, 1998, between the
Company, Operating Partnership and UBS-LB (filed as Exhibit
1.1 to the Post Effective Amendment to the Company's
Registration Statement on Form S-3, file no. 333-49295,
filed on October 14, 1998)
1.2 -- Forward Stock Contract dated February 2, 1998, between the
Company, Operating Partnership and UBS-LB (filed as Exhibit
1.2 to the Post Effective Amendment to the Company's
Registration Statement on Form S-3, file no. 333-49295,
filed on October 14, 1998)
3.1* -- Form of Amended and Restated Declaration of Trust of the
Registrant
3.2* -- Bylaws of the Registrant
3.3 -- Articles Supplementary, dated December 18, 1997, Classifying
and Designating a Series of Preferred Shares of Beneficial
Interest as Series A Cumulative Convertible Redeemable
Preferred Shares of Beneficial Interest and Fixing
Distribution and Other Preferences and Rights of Such Shares
(filed as Exhibit 3.1 to the Company's Current Report on
Form 8-K, filed January 15, 1998)
3.4 -- Articles Supplementary, dated February 17, 1998, Classifying
and Designating a Series of Preferred Shares of Beneficial Interest
as Junior Participating Cumulative Convertible Redeemable Preferred
Shares of Beneficial Interest, Series B, and Fixing Distribution and
Other Preferences and Rights of Such Shares (filed as an Exhibit to the
Company's Registration Statement on Form 8-A filed on February 17, 1998,
SEC File No. 000-23813)
3.5 -- Articles Supplementary, dated June 25, 1998, Classifying and
Designating a Series of Preferred Shares of Beneficial
Interest as Series B Cumulative Redeemable Perpetual
Preferred Shares of Beneficial Interest and Fixing
Distribution and Other Preferences and Rights of Such Shares
(filed as an exhibit to the Company's Form 10-Q filed on
August 12, 1998)
4.1* -- Form of Common Share Certificate
</TABLE>
29
<PAGE>
<TABLE>
<CAPTION>
<S> <C>
4.2 -- Rights Agreement, dated February 6, 1998, between the
Company and First Chicago Trust Company of New York, as
Rights Agent (filed as Exhibit 4.1 to the Company's Current
Report on Form 8-K, filed on February 10, 1998)
4.3 -- Form of Rights Certificate (included as Exhibit A to the
Rights Agreement [Exhibit 4.2])
4.4 -- Form of Series A Preferred Share Certificate (filed as
Exhibit 4.2 to the Company's Registration Statement on Form
S-3, file no. 333-65793, filed on October 16, 1998 )
10.1 -- Second Amended and Restated Agreement of Limited Partnership
(included as exhibit 10.2 in the Company's Annual Report on
Form 10-K, filed March 25, 1997)
10.2 -- First Amendment to Second Amended and Restated Agreement of
Limited Partnership of Prentiss Properties Acquisition
Partners, L.P. (filed as Exhibit 4.1 to the Company's
Current Report on Form 8-K, filed January 15, 1998)
10.3 -- Second Amendment to Second Amended and Restated Agreement of
Limited Partnership of Prentiss Properties Acquisition
Partners, L.P. (filed as an exhibit to the Company's Form
10-Q filed on August 12, 1998)
10.4 -- Credit Agreement, dated December 30, 1997, among Prentiss
Properties Acquisition Partners, L.P., as Borrower, each of
the lenders that are a signatory therein, Bank One, Texas,
N.A., as Administrative Agent, and Nationsbank of Texas,
N.A., as Syndication Agent (filed as Exhibit 10.4 to the
Company's Current Report on Form 8-K, filed on February 10,
1998)
10.5* -- Form of Employment Agreement for Michael V. Prentiss
10.6* -- Form of Employment Agreement for Thomas F. August
10.7* -- Form of Agreement Not to Compete for Dennis J. DuBois
10.8* -- Contribution Agreement by and between the Operating
Partnership and PPL
10.9* -- Agreement of Purchase and Sale of Partnership Interest by
and Among Prentiss Properties Austin, L.P. and PPL
10.10* -- 1996 Share Incentive Plan
10.11 -- Contribution Agreement between Prentiss Properties
Acquisition Partners, L.P. , and certain Pennsylvania
limited partnerships named therein (filed as Exhibit 10.1 to
the Company's Current Report on Form 8-K, filed on
October 16, 1997)
10.12 -- Contribution Agreement between Prentiss Properties
Acquisition Partners, L.P., and certain New Jersey limited
partnerships named therein (filed as Exhibit 10.2 to the
Company's Current Report on Form 8-K, filed on October 16,
1997)
10.13 -- Agreement to Acquire Limited Partnership Interests between
OTR and Prentiss Properties Acquisition Partners, L.P.(filed
as Exhibit 10.3 to the Company's Current Report on Form 8-K,
filed on October 16, 1997)
10.14 -- Agreement to Assign Property Agreements and Other Assets
between Terramics Management Company, Terramics Property
Associates, Terramics Property Company and Prentiss
Properties Acquisition Partners, L.P. (filed as Exhibit 10.4
to the Company's Current Report on Form 8-K, filed on
October 16, 1997)
10.15 -- Stock Purchase Agreement among Southpoint Land Holdings,
Inc., Valleybrooke Land Holdings, Inc., certain shareholders
thereof and Prentiss Properties Limited, Inc. (filed as
Exhibit 10.5 to the Company's Current Report on Form 8-K,
filed on October 16, 1997)
10.16 -- Put and Call Option Agreement For Remaining Shares among
certain sellers named therein and Prentiss Properties
Limited, Inc. (filed as Exhibit 10.6 to the Company's
Current Report on Form 8-K, filed on October 16, 1997)
10.17 -- Purchase Agreement entered into by and between Jacob Brouwer
and Jeanette Brouwer (as "Sellers") and Prentiss Properties
Acquisition Partners, L.P. (as "Buyer") in respect to the
purchase and sale of the properties referred to therein as
"Carlsbad Pacifica" (filed as Exhibit 10.1 to the Company's
Current Report on Form 8-K, filed on February 10, 1998)
10.18 -- Purchase Agreement entered into by and between JJB Land
Company, LLC, (as "Seller") and Prentiss Properties
Acquisition Partners, L.P. (as "Buyer") in respect to the
purchase and sale of the properties referred to therein as
"The Plaza" (filed as Exhibit 10.2 to the Company's Current
Report on Form 8-K, filed on February 10, 1998)
</TABLE>
30
<PAGE>
<TABLE>
<CAPTION>
<S> <C>
10.19 -- Contribution/Purchase Agreement entered into by and between
the Sellers (therein identified) and Prentiss Properties
Acquisition Partners, L.P. (as "Buyer") in respect to the
purchase and sale of the properties referred to therein as
the "Shiley Interests" and "NNC Interests" (filed as Exhibit
10.3 to the Company's Current Report on Form 8-K, filed on
February 10, 1998)
10.20 -- Registration Rights Agreement, dated October 22, 1997,
between Prentiss Properties Trust, Prentiss Properties
Acquisition Partners, L.P., Prentiss Properties I, Inc.,
Peter O. Hausmann, Henry C. Gulbrandsen, Jr., Timothy J.
Webber and Steven A. Stattner (filed as Exhibit 10.1 to the
Company's Registration Statement on Form S-3, file no. 333-
65735, filed on October 15, 1998)
10.21 -- Registration Rights Agreement dated December 29, 1997,
between the Company and Security Capital Preferred Growth
Incorporated (filed as Exhibit 10 to the Company's
Registration Statement on Form S-3, file no. 333-65793,
filed on October 16, 1998)
27.1 -- Financial Data Schedule
</TABLE>
(b) Reports on Form 8-K
The Company filed a Current Report on Form 8-K on July 1, 1998, dated
June 30, 1998, with respect to the Company's share repurchase plan which was
authorized by the Board of Trustees. The Company was authorized to repurchase up
to 2.0 million common shares in the open market or negotiated private
transactions.
On October 9, 1998, the Company filed with the SEC a Current Report on
Form 8-K. Such report, dated May 21, 1998, relates to the acquisitions of a
single Class "A" suburban Office Property in Oakland, California (the "Ordway
Property") and two Class "A" Office Properties in suburban Washington, D.C. (the
"Willow Oaks Properties"). The Ordway Property totals 525,951 square feet and
was purchased for a price of approximately $76.3 million. The Willow Oaks
Properties total 387,469 square feet and were purchased for approximately $76.0
million. Such report also contains updated Risk Factors for the Company.
31
<PAGE>
SIGNATURE
---------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
PRENTISS PROPERTIES TRUST
Date: November 11, 1998 By: /s/ Thomas P. Simon
-----------------------------------------------
Thomas P. Simon
(Vice President and Chief Accounting Officer)
32
<TABLE> <S> <C>
<PAGE>
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<FISCAL-YEAR-END> DEC-31-1998 DEC-31-1997
<PERIOD-START> JAN-01-1998 JAN-01-1997
<PERIOD-END> SEP-30-1998 SEP-30-1997
<CASH> 3,530 3,614
<SECURITIES> 0 0
<RECEIVABLES> 19,557 9,709
<ALLOWANCES> 1,332 475
<INVENTORY> 0 0
<CURRENT-ASSETS> 0 0
<PP&E> 1,804,884 918,545
<DEPRECIATION> 59,090 30,490
<TOTAL-ASSETS> 1,876,897 985,269
<CURRENT-LIABILITIES> 0 0
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0 0
100,000 0
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<OTHER-SE> 755,647 453,805
<TOTAL-LIABILITY-AND-EQUITY> 1,876,897 985,269
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