FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1998
.............................................
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from................... to.........................
Commission file number: 1-13375
.....................................................
TOWER REALTY TRUST, INC.
...........................................................
(Exact name of registrant as specified in its charter)
Maryland 13-3938558
.................................. ........................
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
292 Madison Avenue, 3rd Floor, New York, New York 10017
............................................................
(Address of principal executive offices)
(Zip Code)
(212) 448-1864
...........................................................
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
----- ------
The number of shares of common stock, par value $0.01 per share,
outstanding on November 12, 1998 was 16,959,355.
<PAGE>
TOWER REALTY TRUST, INC.
This Quarterly Report on Form 10-Q contains forward-looking statements within
the meaning of the Private Securities Litigation Reform Act of 1995, which
involves certain risks and uncertainties. The Company's actual results in future
periods may be materially different from any future performance anticipated
herein. Each forward-looking statement that the Company believes is material is
accompanied by a cautionary statement or statements identifying important
factors that could cause actual results to differ materially from those
described in the forward-looking statement. In the context of forward-looking
information provided in this Quarterly Report on Form 10-Q and in other reports,
please refer to the discussion of risk factors detailed in, as well as the other
information contained in, the Company's filings with the Securities and Exchange
Commission during the past 12 months.
<TABLE>
<CAPTION>
INDEX
Part I -- FINANCIAL INFORMATION Page
Number
Item 1. Financial Statements. ------
<S> <C> <C>
Condensed Consolidated Balance Sheets of Tower Realty Trust, Inc. (the "Company") as of
September 30, 1998 and December 31, 1997 (Unaudited)........................................... 3
Condensed Consolidated Statements of Operations of the Company for the Three Months Ended
September 30, 1998 and 1997 and Condensed Combined Statement of Operations of Tower
Predecessor for the Three Months Ended September 30, 1997 (Unaudited).......................... 4
Condensed Consolidated Statements of Operations for the Company for the Nine Months Ended
September 30, 1998 and 1997 and Condensed Combined Statement of Operations of Tower
Predecessor for the Nine Months Ended September 30, 1997....................................... 5
Condensed Consolidated Statements of Cash Flows of the Company for the Nine Months Ended
September 30, 1998 and 1997 and Condensed Combined Statement of Cash Flows of Tower
Predecessor for the Nine Months ended September 30, 1997....................................... 6
Notes to Condensed Consolidated and Combined Financial Statements.............................. 7
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.......... 16
Item 3. Quantitative and Qualitative Disclosures About Market Risk..................................... 23
Part II -- OTHER INFORMATION
Item 1. Legal Proceedings.............................................................................. 24
Item 2. Changes in Securities and Use of Proceeds...................................................... 24
Item 3. Defaults Upon Senior Securities................................................................ 24
Item 4. Submission of Matters to a Vote of Security Holders............................................ 24
Item 5. Other Information.............................................................................. 25
Item 6. Exhibits and Reports on Form 8-K............................................................... 25
Signatures. ........................................................................................... 26
</TABLE>
2
<PAGE>
Part I -- FINANCIAL INFORMATION
Item 1. Financial Statements.
<TABLE>
<CAPTION>
TOWER REALTY TRUST, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(Dollars in thousands)
ASSETS September 30, December 31,
1998 1997
-------------------- ----------------------
<S> <C> <C>
Real estate $ 686,697 $ 620,557
Less: accumulated depreciation (14,040) (2,444)
-------------------- ----------------------
672,657 618,113
Deferred charges, net 12,798 11,495
Receivables, net 8,767 3,820
Cash and cash equivalents 7,175 1,347
Escrowed cash 7,307 6,373
Other assets 6,143 12,537
Investments in joint ventures 2,968 2,411
-------------------- ----------------------
Total assets $ 717,815 $ 656,096
==================== ======================
LIABILITIES AND STOCKHOLDERS' EQUITY
Debt on real estate $ 228,760 $ 228,990
Line of credit 62,400 -
Accounts payable and accrued liabilities 11,027 7,494
Distributions payable 7,877 6,543
Deferred real estate taxes payable 9,713 9,758
Other liabilities 9,613 6,602
Amounts due to affiliates 309 372
-------------------- ----------------------
Total liabilities 329,699 259,759
-------------------- ----------------------
Minority interest in Operating Partnership net of
dividends declared 35,065 33,920
-------------------- ----------------------
Stockholders' equity:
Preferred shares 50,000,000 shares authorized,
none issued and outstanding - -
Common shares, $0.01 par value, 150,000,000 shares authorized,
16,959,355 shares issued and outstanding 169 169
Additional paid in capital 365,814 364,250
Distribution in excess of accumulated earnings (12,932) (2,002)
-------------------- ----------------------
Total stockholders' equity 353,051 362,417
-------------------- ----------------------
Total liabilities and stockholders' equity $ 717,815 $ 656,096
==================== ======================
The accompanying notes are an integral part of these financial statements.
</TABLE>
3
<PAGE>
<TABLE>
<CAPTION>
TOWER REALTY TRUST, INC.
CONDENSED CONSOLIDATED AND COMBINED STATEMENTS OF OPERATIONS
(Unaudited)
(Dollars in thousands, except per share amounts)
Tower
The Company The Company Predecessor
(Consolidated) (Consolidated) (Combined)
For the Three For the Three For the Three
Months Ended Months Ended Months Ended
September, 1998 September, 1997 September, 1997
----------------------- ------------------- ----------------
Revenues:
<S> <C> <C> <C>
Rental income $ 28,478 $ - $ 6,992
Management fees - 1,147 73
Construction, leasing and other fees 166 - 88
------------- ----------- -----------
Total revenues 28,644 1,147 7,153
------------- ----------- -----------
Expenses:
Property operating and maintenance 7,537 - 1,506
Real estate taxes 3,823 - 1,162
General and administrative 1,745 1,532 384
Interest expense 5,248 53 3,744
Depreciation and amortization 4,506 - 1,761
Ground rent/air rights expense 170 - 150
Sale of the Company 2,915 - -
Severance and other compensation costs 1,011 - -
------------- ----------- -----------
Total expenses 26,955 1,585 8,707
------------- ----------- -----------
Equity in income of joint ventures and
267 127 17
Unconsolidated subsidiaries
Net income (loss) before extraordinary
gain on early extinguishment of debt
and minority interest 1,956 (311) (1,537)
Minority interest (173) - -
-------------- ------------ -------------
Net income (loss) $ 1,783 $ (311) $ (1,537)
============== ============ =============
Net income per common share - basic
and dilutive $ .11
=============
Weighted average number of common shares
outstanding-basic and dilutive 16,959,355
=============
The accompanying notes are an integral part of these financial statements.
</TABLE>
4
<PAGE>
<TABLE>
<CAPTION>
TOWER REALTY TRUST, INC.
CONDENSED CONSOLIDATED AND COMBINED STATEMENTS OF OPERATIONS
(Unaudited)
(Dollars in thousands, except per share amounts)
Tower
The Company Predecessor
(Consolidated) The Company (Combined)
For the Nine (Consolidated) For For the Nine
Months Ended the Nine Months Months Ended
September 30, Ended September 30, September 30,
1998 1997(1) 1997
---------------- -------------------- ------------------
Revenues:
<S> <C> <C> <C>
Rental income $ 82,568 $ - $ 20,513
Management fees - 1,147 318
Construction, leasing and other fees 660 33 562
----------- ---------------- -----------------
Total revenues 83,228 1,180 21,393
----------- ---------------- -----------------
Expenses:
Property operating and maintenance 19,513 - 4,209
Real estate taxes 11,040 - 3,493
General and administrative 6,585 1,532 2,130
Interest expense 15,144 229 10,772
Depreciation and amortization 13,149 - 5,255
Ground rent/air rights expense 512 - 449
Sale of the Company 3,865 - -
Severance and other compensation costs 2,454 - -
----------- --------------- -------------------
Total expenses 72,262 1,761 26,308
----------- --------------- -------------------
Equity in income of joint ventures and
unconsolidated subsidiaries 557 187 85
Net income (loss) before extraordinary gain on
early extinguishment of debt and minority
interest 11,523 (394) (4,830)
Extraordinary gain on early extinguishment of
debt - - 6,475
Minority interest (1,027) - -
------------- --------------- -------------------
Net income (loss) $ 10,496 $ (394) $ 1,645
============= =============== ===================
Net income per common share - basic and dilutive
$ .62
============
Weighted average number of common shares
outstanding - basic and dilutive 16,941,961
============
(1) The Company (Consolidated) for the nine months ended September 30, 1997 represents operations from March 27, 1997
(date of inception) to September 30, 1997.
</TABLE>
The accompanying notes are an integral part of these financial statements.
5
<PAGE>
<TABLE>
<CAPTION>
TOWER REALTY TRUST, INC.
CONDENSED CONSOLIDATED AND COMBINED STATEMENTS OF CASH FLOWS
(Unaudited)
(Dollars in thousands)
Tower
The Company The Company Predecessor
(Consolidated) (Consolidated) (Combined)
For the Nine For the Nine For the Nine
Months Ended Months Ended Months Ended
September 30, September 30, September 30,
1998 1997(1) 1997
--------------- --------------- ---------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income (loss) $ 10,496 $ (394) $ 1,645
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation and amortization 13,149 - 4,349
Amortization of deferred financing costs 1,288 - 906
Unbilled rental income (5,245) - 1,012
Extraordinary gain on early extinguishment of debt - - (6,475)
Equity in income of joint ventures and unconsolidated (557) (187) -
subsidiaries
Changes in assets and liabilities:
Receivables 298 (190) (1,567)
Escrowed cash (934) - (352)
Other assets 2,020 - 907
Deferred real estate taxes liability (45) - -
Accounts payable and other liabilities 6,534 487 566
Minority interest 1,027 - -
Other liabilities and amounts due to affiliates 2,948 - 3,527
Stock compensation to employees 682 - -
------------------ ------------------ -----------------
Net cash provided by operating activities 31,661 (284) 4,518
------------------ ------------------ -----------------
Cash flows from investing activities:
Acquisitions of real estate, joint venture interests
and tenant improvements (65,912) (11,200) (3,362)
Contribution to Management Company - - 591
Increase in due from affiliates - (750) -
------------------ ------------------ -----------------
Net cash used in investing activities (65,912) (11,950) (2,771)
------------------ ------------------ -----------------
Cash flows from financing activities:
Proceeds from debt on real estate and other debt 119,910 12,299 15,581
Repayments of debt on real estate (57,740) - (17,360)
Partners' contributions, net - - (6)
Distributions to OP Unitholders (1,995) - -
Distributions to common stockholders (20,296) - -
Proceeds from issuance of common stock - 1 -
Proceeds from Lawrence H. Feldman in lieu of OP Units 200 - -
------------------ ------------------ ----------------
Net cash provided by (used in) financing 40,079 12,300 (1,785)
activities ------------------ ------------------ ----------------
Net increase (decrease) in cash and cash equivalents 5,828 66 (38)
Cash and cash equivalents, beginning of period 1,347 - 4,985
------------------ ------------------ -----------------
Cash and cash equivalents, end of period $ 7,175 $ 66 $ 4,947
================== ================== =================
(1) The Company (Consolidated) for the nine months ended September 30, 1997 represents operations from March 27, 1997
(date of inception) to September 30, 1997.
</TABLE>
The accompanying notes are an integral part of these financial statements.
6
<PAGE>
TOWER REALTY TRUST, INC.
NOTES TO CONDENSED CONSOLIDATED AND
COMBINED FINANCIAL STATEMENTS
1. Organization and Basis of Presentation:
Tower Realty Trust, Inc.
Tower Realty Trust, Inc. (collectively with its subsidiaries, the
"Company") was incorporated in the state of Maryland on March 27, 1997.
As of October 16, 1997, the Company consummated an initial public
offering (the "Offering") of 13,817,250 shares of common stock, par value
$0.01 per share (the "Common Stock") (including the exercise of the
underwriters' over-allotment option of 1,802,250 shares) and effected
concurrent private placements (the "Concurrent Private Placements") of
1,153,845 shares of Common Stock at a price of $26.00 per share and
realized net proceeds therefrom of approximately $353.35 million. In
addition, in connection with the formation transactions (the "Formation
Transactions") relating to the Offering, including the acquisition of
certain property interests and the cancellation of certain indebtedness,
the Company issued 1,949,360 shares of Common Stock. Upon consummation of
the Offering, the Company acquired a sole 1% general partner interest in
Tower Realty Operating Partnership, L.P., a Delaware limited partnership
(the "Operating Partnership") and a 90.4% limited partner interest in the
Operating Partnership. At September 30, 1998, the Company had a 1%
general partner interest and a 90.0% limited partner interest in the
Operating Partnership.
The Company was formed to continue and expand the commercial real estate
business of Tower Equities & Real Estate Corp. and its affiliates
(collectively with its predecessor entities and affiliates, "Tower
Equities"), including developing, acquiring, owning, renovating,
managing, and leasing office properties in the Manhattan, Phoenix,
Tucson, and Orlando markets. Upon consummation of the Offering and the
Formation Transactions, the Operating Partnership owned or had interests
in 21 office properties (the "Initial Properties"). On (i) December 31,
1997, the Company purchased the approximately 700,000 square foot office
tower located at 810 Seventh Avenue in Midtown Manhattan ("810 Seventh
Avenue") for approximately $150.0 million, including closing costs, (ii)
January 16, 1998, the Company purchased the approximately 126,000 square
foot Blue Cross/Blue Shield office complex located in Phoenix, Arizona
("Blue Cross/Blue Shield") for $16.9 million (see Note 4) and (iii) May
6, 1998, the Company purchased the approximately 335,000 square foot,
25-story downtown New York City office building located on 90 Broad
Street (the "90 Broad Property") for approximately $34.3 million (see
Note 4). The Initial Properties, together with the 810 Seventh Avenue,
Blue Cross/Blue Shield and the 90 Broad Property, are collectively
referred to herein as the "Properties." The Company also owns or has an
option to acquire four parcels of land adjacent to four properties (the
"Development Parcels"), which can support 2.2 million rentable square
feet of development. In November 1997, the Company exercised its option
to purchase one of the optioned Development Parcels located in Phoenix,
Arizona for approximately $10.3 million.
On March 31, 1997, interests in certain properties, partnerships and
limited liability companies were contributed to the Operating Partnership
in exchange for units of limited partnership interest in the Operating
Partnership (the "OP Units"). Certain of these interests were owned by
the Operating Partnership after consummation of the Offering.
Simultaneously with such contribution of these interests, the Company
issued $12.3 million of notes (the "MSAM Notes") to certain investors
advised by Morgan Stanley Asset Management, Inc. ("MSAM"). The MSAM Notes
were collateralized by certain interests in the Properties. Upon
completion of the Offering, all MSAM Notes were converted into Common
Stock of the Company.
The net proceeds from the Offering were contributed to the Operating
Partnership in exchange, in part, for the Company's approximate 91.4%
interest therein. The Operating Partnership used the proceeds received
from the Company, the $107.0 million net cash proceeds from the Company's
term loan facility (the "Term Loan"), borrowed concurrent with and
subsequent to the Offering and approximately $12.3 million of proceeds
received in connection with the issuance of the MSAM Notes, as follows:
(i) approximately $281.0 million for repayment of certain indebtedness
(including associated prepayment penalties) relating to the Initial
Properties and the partnerships that own the Initial Properties (the
"Property Partnerships"); (ii)
7
<PAGE>
TOWER REALTY TRUST, INC.
NOTES TO CONDENSED CONSOLIDATED AND
COMBINED FINANCIAL STATEMENTS (Continued)
approximately $137.0 million to acquire certain equity, debt and fee
interests in the Initial Properties; (iii) approximately $3.1 million to
pay for commitment fees and expenses related to the Term Loan and the
Company's $200.0 million unsecured line of credit (the "Line of Credit");
(iv) approximately $3.0 million to pay transfer taxes and other expenses
associated with the acquisition of the Initial Properties; and (v) the
remaining approximately $48.6 million for working capital.
The Tower Equities management and leasing companies and Properties
Atlantic, Inc. management and leasing company (which, prior to the
Offering, was controlled and operated by Clifford L. Stein, Managing
Director, Southeast Region of the Company) (collectively, the
"Predecessor Management Companies") contributed an undivided 95% interest
in the assets of such companies to the Operating Partnership, which, in
turn, recontributed such assets to Tower Equities Management, Inc. (the
"Management Company") in exchange for 100% of the non-voting stock and 5%
of the voting stock in the Management Company (which entitles the Company
to receive 95% of the dividends of the Management Company).
The Management Company and each of the members of Tower Equities that
hold interests in seven retail properties that continue to be owned by
Tower Equities after the consummation of the Offering (the "Excluded
Properties") entered into management agreements with respect to each of
the Excluded Properties. In consideration for the services to be provided
under the management agreements, the Management Company receives a
property management fee and applicable construction fees and leasing
commissions which are determined by reference to existing market areas
for similar transactions.
The Company operates so as to qualify as a real estate investment trust
("REIT") for federal income tax purposes. The federal income tax
provisions governing treatment of a REIT are highly technical, complex
and subject to interpretation. Accordingly, there is no assurance that
the Internal Revenue Service, upon examination would not interpret
provisions in a manner that differs from the Company's interpretation of
these provisions.
Tower Predecessor
The following Properties and entities comprising the Tower Predecessor
were controlled and managed by Tower Equities, all of which were
controlled by Lawrence H. Feldman, the former Chairman of the Board,
Chief Executive Officer and President of the Company (see Note 10):
<TABLE>
<CAPTION>
Lawrence H. Feldman's
Ownership Percentage Location
----------------------------- ----------------------
<S> <C> <C>
Tower 45 6% New York City
120 Mineola Boulevard 5% Long Island, NY
Maitland Forum 15% Maitland, FL
Maitland Center Parkway (3 properties) 90% Maitland, FL
5750 Major Boulevard (purchased in October 1996) 6% Orlando, FL
Predecessor Management Companies 90% New York City and
Maitland, FL
</TABLE>
Lawrence H. Feldman owned a majority general partner interest in the
partnerships owning these properties. Accordingly, the Tower Predecessor
financial statements reflect, on a combined basis, 100% of the assets,
liabilities and operations of these properties.
Lawrence H. Feldman held a non-controlling interest in the partnerships
that owned the properties listed below. Lawrence H. Feldman was a general
partner in these partnerships, and DRA Advisors, Inc. ("DRA") was the
managing general partner. These properties are collectively referred to
as the "DRA Joint Ventures."
8
<PAGE>
TOWER REALTY TRUST, INC.
NOTES TO CONDENSED CONSOLIDATED AND
COMBINED FINANCIAL STATEMENTS (Continued)
The Tower Predecessor financial statements reflect the investments in the
DRA Joint Ventures using the equity method of accounting. Upon
consummation of the Offering, the Company purchased all of the
partnership interests in the DRA Joint Ventures:
<TABLE>
<CAPTION>
Lawrence H. Feldman's
Ownership Percentage Location
--------------------------- --------------------
<S> <C> <C>
286 Madison Avenue 3% New York, NY
290 Madison Avenue 3% New York, NY
292 Madison Avenue 3% New York, NY
Corporate Center Building (6 properties) 20% Phoenix, AZ
5151 East Broadway 3% Tucson, AZ
One Orlando Center 3% Orlando, FL
</TABLE>
Lawrence H. Feldman also held a 3.8% non-controlling interest in a
partnership controlling the 2800 North Central Avenue Property ("2800
North Central"). The Tower Predecessor financial statements reflect this
investment using the equity method of accounting. The Company, upon
consummation of the Offering, acquired this interest and the interests of
Tower Equities (10% aggregate interest).
In connection with the acquisition of certain Property Partnership
interests, the Company acquired cash and other assets, the economic
benefits of which were retained by the respective partners. The net
aggregate remaining liability of such partners is reflected in the
accompanying financial statements as due to affiliates.
Basis of Presentation
The condensed consolidated balance sheet of the Company as of September
30, 1998, the condensed consolidated statements of operations and cash
flows of the Company for the three- and nine-month periods ended
September 30, 1998 and 1997, and the condensed combined statements of
operations for the three- and nine-month periods ended September 30, 1997
of Tower Predecessor and the condensed consolidated and combined
statement of cash flows of the Company for the nine months ended
September 30, 1998 and 1997 and Tower Processor for the nine months ended
September 30, 1997 are unaudited. The Company's condensed consolidated
balance sheet as of December 31, 1997 have been derived from the Company
audited consolidated financial statements. The unaudited financial
statements of the Company and Tower Predecessor have been prepared in
accordance with the rules and regulations of the Securities and Exchange
Commission for interim financial statements. They do not include all of
the disclosures required by generally accepted accounting principles for
a complete presentation. In the opinion of management, all adjustments
(consisting of normal recurring adjustments) 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 year. These financial statements should be read in conjunction
with the December 31, 1997 audited financial statements and notes
thereto, included in the Company's Annual Report on Form 10-K for the
fiscal year ended December 31, 1997.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities
and disclosure of contingent assets and liabilities at the date of the
financial statements, and reported amounts of revenues and expenses
during the reporting period. The most significant estimates and
assumptions are related to the recoverability and depreciable lives of
real estate and the determination of the Company's REIT status. Actual
results could differ from those estimates.
Net income per common share has been computed by dividing net income
applicable to common stockholders by the weighted average number of
Common Shares outstanding of 16,959,355 and 16,941,961,
9
<PAGE>
TOWER REALTY TRUST, INC.
NOTES TO CONDENSED CONSOLIDATED AND
COMBINED FINANCIAL STATEMENTS (Continued)
respectively, for the three and nine months ended September 30, 1998. A
total of 975,000 shares were reserved for issuance under the Company's
1997 Incentive Plan and Non-Employee Directors' Stock Option Plan. The
effect of the outstanding options has been excluded from the calculation
of net income per common share as these options had an antidilutive
effect in the current period.
2. Sale of the Company:
On July 9, 1998, the Company entered into an agreement (the "Merger
Agreement") relating to the merger of the Company with Metropolitan
Partners LLC ("Metropolitan"), a newly formed joint venture between
Reckson Associates Realty Corp. ("Reckson") and Crescent Real Estate
Equities Company ("Crescent"). The Merger Agreement and the transactions
contemplated thereunder (collectively the "Merger") were approved by the
Company's Board of Directors on July 8, 1998.
Pursuant to the Merger Agreement, each share of the Company's Common
Stock will be exchanged, at the election of each Company stockholder, for
either $24 in cash or .4615 of a share, par value $.01 per share, of
Reckson (the "Reckson Shares") and .3523 of a share of beneficial
interest, par value $.01 per share, of Crescent (the "Crescent Shares")
in lieu of the $24 in cash (such fractions of shares being subject to
downward adjustments if the stock prices of Reckson Shares and Crescent
Shares increase by more than 7% after July 7, 1998) for up to an
aggregate of 40% of the total consideration payable in the transaction.
In addition, if a stockholder of the Company elects to receive Reckson
Shares and Crescent Shares, they will be entitled to share in the benefit
of up to, and including, a 7% increase in the value of each share of
Reckson Shares and Crescent Shares after July 7, 1998. If, however, there
has been an increase of more than 7% in the stock price of either Reckson
Shares or Crescent Shares, then the exchange ratio for the applicable
common stock will be adjusted downward in proportion to the increase in
excess of 7%, such that Company stockholders who receive Reckson Shares
and Crescent Shares will receive fewer shares. As a result, the benefit
of any appreciation in the stock value of either Reckson Shares or
Crescent Shares is effectively limited to 7%.
On November 2, 1998, the Company commenced an action in New York State
Supreme Court against Reckson, Crescent and Metropolitan alleging breach
of the of the Merger Agreement. The Company is seeking $75 million in
compensatory damages of not less than $75 million, declaratory and other
relief. As stated in the Company's press release on such date, such
action was filed after the Company had been informed by Crescent, Reckson
and Metropolitan that they would not proceed with the Merger Agreement
(see Note 10).
In connection with the Merger and other strategic initiatives explored by
the Company (the "Initiatives"), the Company entered into an agreement
with Merrill Lynch & Co. ("Merrill Lynch") on April 16, 1998 whereby
Merrill Lynch acts as the exclusive financial advisor to the Company in
connection with the Initiatives. Pursuant to the terms of this agreement,
Merrill Lynch is entitled to .6% of the aggregate purchase price paid to
the Company for its sale upon closing of the applicable sale agreement.
If the Merger does not occur as anticipated, the Company will be
responsible for payments in the amount of approximately $1.0 million to
Merrill Lynch. As of September 30, 1998, the Company has charged $1.0
million to operations, representing the retainer and the delivered
fairness opinion under the agreement, which is included in the Sale of
the Company item on the condensed consolidated statements of operations.
Other items relating to the Initiatives that have been included in the
Sale of the Company item for three- and nine-month periods ended
September 30, 1998 consist of legal, accounting and consulting fees
incurred through September 30, 1998. The Company anticipates that
significant additional costs will be incurred to the extent that the
Merger is completed or in connection with the litigation relating to the
Merger Agreement.
10
<PAGE>
TOWER REALTY TRUST, INC.
NOTES TO CONDENSED CONSOLIDATED AND
COMBINED FINANCIAL STATEMENTS (Continued)
3. Severance and Other Compensation Costs:
On April 18, 1998, Joseph D. Kasman resigned as Senior Vice President and
Chief Financial Officer of the Company. Pursuant to, and under the terms
and conditions of, his employment agreement with the Company, severance
payments will be payable over the course of a 12-month period in monthly
installments of approximately $46,000. A severance provision of
approximately $556,000.00 has been charged to operations during the
second quarter of 1998.
During the second quarter of 1998, Lawrence H. Feldman transferred
approximately 28,900 OP Units and $200,000 of cash to the Company, and in
turn, the Company issued 28,900 shares of Common Stock and paid $200,000
of cash to four current and former employees for their efforts during the
time of the Offering. In connection with this event, the Company recorded
$887,000 of compensation expense during the second quarter of 1998.
On August 3, 1998, Lawrence H. Feldman resigned from his positions as
Chairman of the Board, Chief Executive Officer and President of the
Company. In connection with his resignation, the Company expects to pay
Mr. Feldman a severance payment equal to 2.99 times his "base amount" as
described in his employment agreement and as defined in Section 290G of
the Internal Revenue Code of 1986, as amended, payable over a
twelve-month period or approximately $84,273 per month. During the third
quarter of 1998, the Company recorded approximately $1.0 million of
severance expense to operations. On August 3, 1998, Francis X. Tansey, a
director of the Company, was appointed Chairman of the Board and Robert
L. Cox, a director and Executive Vice President and Chief Operating
Officer of the Company, was appointed acting Chief Executive Officer and
President of the Company.
4. Acquisition of Real Estate:
During the nine months ended September 30, 1998, the Company, through the
Operating Partnership, acquired the Blue Cross/Blue Shield office
complex, an approximately 126,000 square foot twin office building
located in the Northwest submarket of Phoenix, Arizona, for $16.9 million
and the 90 Broad Property, a 335,000 square foot, 25-story downtown New
York City office building located in the center of the city's financial
district, for approximately $34.3 million. In conjunction with these
acquisitions, the Company drew down funds from its Line of Credit.
5. Line of Credit:
Upon consummation of the Offering, the Company entered into Line of
Credit with Merrill Lynch Capital Corporation. The Line of Credit may be
used, among other things, to finance acquisitions of additional office
properties, to refinance existing indebtedness, and for general working
capital requirements. As of September 30, 1998, the Company has an
outstanding balance under the Line of Credit Facility of $62.4 million.
The funds were primarily drawn upon for the acquisitions of Blue
Cross/Blue Shield and the 90 Board Street Property and to fund capital
improvements for the Properties.
In conjunction with its Line of Credit, the Company must maintain certain
financial ratios:
i. Total outstanding indebtedness must not exceed 55% of Total Value
(as defined in the Line of Credit) during the first year of the
facility and must not exceed 50% thereafter.
ii. Collateral indebtedness must not exceed 40% of Total Value (as
defined) during the first year of the facility and 35% thereafter.
iii. Recourse indebtedness cannot exceed 5% of Total Value (as
defined).
11
<PAGE>
TOWER REALTY TRUST, INC.
NOTES TO CONDENSED CONSOLIDATED AND
COMBINED FINANCIAL STATEMENTS (Continued)
iv. Other financial covenants that must be met by the Company include
interest expense and fixed charges to debt ratios, among others.
As a general policy, the Company intends to maintain a debt policy
limiting the Company's total consolidated indebtedness plus its pro rata
share of joint venture debt to 50% of the Company's total market
capitalization. As of September 30, 1998, the debt to total market
capitalization, including the Company's 10% interest in the debt of 2800
North Central, was 46.3%. However, the Company may from time to time
modify its debt policy in light of current economic conditions, relative
costs of debt and equity capital, market values of its Properties,
general conditions in the market for debt and equity securities,
fluctuations in the market price for its Common Stock, growth and
acquisition opportunities and other factors. Accordingly there can be no
assurance that the Company may not increase its debt to total market
capitalization ratio beyond the limit described above.
The Company pays interest on the outstanding amounts on the Line of
Credit at LIBOR (London Interbank Offered Rate) plus 150 basis points
(weighted average of 7.3% for the nine months ended September 30, 1998).
Interest expense on the Line of Credit for the period ended September 30,
1998 amounted to approximately $2.4.
In connection with the acquisition of 810 Seventh Avenue, the Company
obtained a $100.0 million mortgage loan from Credit Suisse First Boston
Mortgage Capital LLC that matures on December 31, 1998. The Company
intends to refinance this mortgage during the fourth quarter of 1998. In
addition, the Company has obtained a $11.3 million construction loan from
KeyBank National Association ("KeyBank") in connection with the
development of a Development Parcel in Arizona, which loan matures on May
1, 2000. There are currently no amounts outstanding under the loan from
KeyBank.
During the nine months ended September 30, 1998, the Company has
capitalized approximately $1.1 million, of interest costs pursuant to
Statement of Financial Accounting Standards 34, "Capitalization of
Interest Cost," related to properties that are under development or in
construction and not ready for their intended use.
6. Distributions:
On September 18, 1998, the Company declared a cash distribution for the
third quarter of 1998 in the amount of $.4225 per share and OP Unit,
which was paid on October 15, 1998 to stockholders and OP Unitholders of
record on September 30, 1998. The distributions totalled approximately
$7.9 million.
On June 19, 1998, the Company declared a cash distribution for the second
quarter of 1998 in the amount of $.4225 per share and OP Unit, which was
paid on July 15, 1998 to stockholders and OP Unitholders of record on
June 30, 1998. The distributions totalled approximately $7.9 million.
On March 17, 1998, the Company declared a cash distribution for the first
quarter of 1998 in the amount of $.4225 per share and OP Unit, which was
paid on April 15, 1998 to stockholders and OP Unitholders of record on
March 31, 1998. The distributions totalled approximately $7.8 million.
On December 19, 1997, the Company declared a cash distribution for the
period from October 16, 1997 through December 31, 1997 in the amount of
$.3536 per share or OP Unit, which was paid on January 19, 1998 to
stockholders and OP Unitholders of record as of December 31, 1997. The
distributions totalled approximately $6.5 million.
12
<PAGE>
TOWER REALTY TRUST, INC.
NOTES TO CONDENSED CONSOLIDATED AND
COMBINED FINANCIAL STATEMENTS (Continued)
7. Supplemental Disclosure of Non-Cash Investing and Financing Activities:
The Company issued 129,032 OP Units on March 6, 1998 relating to the
contribution to the Operating Partnership of the entity that held the
management agreement on the 810 Seventh Avenue property.
During the second quarter of 1998, Lawrence H. Feldman transferred
approximately 28,900 OP Units and $200,000 of cash to the Company, and in
turn, the Company issued 28,900 shares of Common Stock and paid $200,000
of cash to four current and former employees for their efforts during the
time of the Offering. The transaction has been accounted for as a
contribution of capital with corresponding charge to compensation expense
in the accompanying financial statements.
In connection with the acquisition of the 90 Broad Property, the Company
assumed $280,000 of debt.
8. Recently Issued Accounting Standards:
Effective January 1, 1998, the Company adopted the Financial Accounting
Standard Board Statement of Financial Accounting Standards No. 130,
"Reporting Comprehensive Income" ("SFAS 130"). SFAS 130 specifies the
presentation and disclosure requirements for reporting comprehensive
income, which includes items which have been formerly reported as a
component of stockholders' equity. SFAS 130 does not have an impact on
the Company's financial statements.
In June 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 131, "Disclosures about Segments of
an Enterprise and Related Information" (SFAS 131"). SFAS 131 establishes
disclosure standards for information about operating segments in annual
financial statements and requires that enterprises report selected
information about operating segments in interim financial reports issued
to shareholders. Management expects to adopt this standard in connection
with the preparation of the 1998 annual financial statements. When
adopted, SFAS 131 will require the Company to report additional
geographic information based on the Company's major geographic areas of
focus.
In June 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities." This statement addresses the
accounting for derivative instruments including certain derivative
instruments embedded in other contacts and for hedging activities. This
statement is effective for years beginning after June 15, 1999. The
Company's management believes that this statement will not have a
material impact on the Company's financial statements.
In October 1998, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 134, "Accounting for
Mortgage Backed Securities Retained after the Securitization of Mortgage
Loans Held for Sale by a Mortgage Banking Enterprise." SFAS 134 addressed
the accounting for and disclosure of mortgage backed securities as either
held-to-maturity, held-for-sale, or trading security. The statement is
effective for the first fiscal quarter beginning after December 15, 1998.
SFAS 134 does not have an impact on the Company's financial statements.
During 1998, the Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants issued Statement of Position
98-5, "Reporting on the Costs of Start-Up Activities" ("SOP 98-5") and
Statement of Position 98-1, " Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use" ("SOP98-1), which are
effective for the fiscal years beginning after December 15, 1998. In
addition, the Emerging Issues Task Force of the Financial Accounting
Standards Board released Issue No. 97-11, "Accounting for Internal Costs
Relating to Real Estate Property Acquisitions" ("ET 97-11"). SOP 98-5
requires that certain costs incurred in conjunction with start-up
activities be expensed. SOP 98-1 provides guidance on whether the costs
of computer software developed or obtained for internal use should be
13
<PAGE>
TOWER REALTY TRUST, INC.
NOTES TO CONDENSED CONSOLIDATED AND
COMBINED FINANCIAL STATEMENTS (Continued)
capitalized or expensed. EITF 97-11 requires that the
internalpre-acquisition costs of identifying and acquiring operating
property be expensed as incurred. Management believes that, when adopted,
SOP 98-5 and SOP 98-1 will not have a significant impact on the Company's
Financial Statements. EITF 97-11 was adopted during the first quarter of
fiscal 1998 and resulted in the Company having to expense internal
property acquisition costs they would have otherwise capitalized.
9. Commitments and Contingencies:
The Company is party to and has become a successor party-in-interest to
certain legal proceedings arising in the ordinary course of business. The
Company believes it has adequate insurance and does not expect that these
proceedings, in the aggregate, will have a material adverse effect on the
operations, cash flows or financial position of the Company.
The Company has written agreements with several key members of management
of severance and stay bonuses. The amounts described in these agreements
will be triggered upon a change in control as defined in the agreements
and are of a significant nature. These amounts will have a material
adverse effect on the financial position, cash flows and operations of
the Company upon a change in control of the Company.
In the event of a termination of the Merger Agreement (as described in
Note 2) by the Company, the Company will be subject to a termination fee
pursuant to the terms of the Merger Agreement. This fee ranges from $1.75
million to $9.0 million to each of Reckson and Crescent and is dependent
on the reasons for termination.
On or about July 10, 1998, a complaint was filed in the U.S. District
Court for the Southern District of New York (the "July Complaint")
against a Tower Equities management company, the Company, three of the
Company's subsidiaries and one former officer and director of the Company
(collectively, the "Defendants") in which the plaintiff alleges she was
discriminated against in the terms and conditions of her employment on
the basis of her religion in violation of federal, state and city
statutes. The plaintiff was never employed by the Company and was not
employed by any of the other Defendants at the time of the formation of
the Company in March 1997. The Defendants deny the allegations and intend
to vigorously defend the action. An answer to the July Complaint is
scheduled to be filed on or about November 17, 1998. The Company does not
expect that this action will have a material adverse effect on its
operations, cash flows or financial position.
On or about September 29, 1998, a complaint was filed in the U.S.
District Court for the Southern District of New York (the "September
Complaint") against the Defendants in which the plaintiff alleges
unlawful retaliation in violation of federal, state and city statutes.
The plaintiff was never employed by the Company and was not employed by
any of the other Defendants at the time of the formation of the Company
in March 1997. The Defendants deny the allegations and intend to
vigorously defend the action. An answer to the September Complaint is
scheduled to be filed on or about November 17, 1998. The Company does not
expect that this action will have a material adverse effect on its
operations, cash flows or financial position.
In July 1998, David Miller, a purported stockholder of the Company,
commenced a putative class action against the Company and certain of its
then directors and officers in the Supreme Court of New York, New York
County, captioned Miller v. Adams, et al., Index No. 98-113363 (Sup. Ct.
N.Y. Co.) (the "Miller Action"). The Miller Action challenges, among
other things, the process employed by the Company and its directors in
reviewing an approving the Merger and the fairness of the terms of the
Merger to the Company's public stockholders. Among other things, the
Miller Action seeks injunctive relief of, in the alternative, rescission
and monetary damages of an unspecified amount. In view of the fact that
Crescent, Reckson and Metropolitan have indicated that they do not intend
to perform under the Merger Agreement, the Plaintiff in the Miller Action
has agreed to voluntarily withdraw the complaint, without prejudice.
14
<PAGE>
TOWER REALTY TRUST, INC.
NOTES TO CONDENSED CONSOLIDATED AND
COMBINED FINANCIAL STATEMENTS (Continued)
See Note 2 regarding contingencies with respect to the Merger.
10. Subsequent Events:
On November 2, 1998, the Company commenced an action in New York State
Supreme Court against Reckson, Crescent and Metropolitan alleging breach
of the of the Merger Agreement. The Company is seeking $75 million in
compensatory damages of not less than $75 million, declaratory and other
relief. As stated in the Company's press release on such date, such
action was filed after the Company had been informed by Crescent, Reckson
and Metropolitan that they would not proceed with the Merger Agreement.
11. Pro Forma Financial Information:
Due to the impact of the Offering and the Formation Transactions, the
Properties acquired concurrent with and subsequent to the Offering, the
historical results of operations are not indicative of future results of
operations. The following Pro Forma Information for the nine months ended
September 30, 1998 and September 30, 1997 are presented as if the
Offering and the Formation Transactions and all property acquisitions,
including the acquisitions of the Blue Cross/Blue Shield office complex
and the 90 Broad Property, which occurred subsequent to December 31,
1997, had occurred at January 1, 1998 and 1997. 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 January 1, 1998 and 1997, or to projected results for any future
periods.
<TABLE>
<CAPTION>
1998 1997
---------------- ----------------
in thousands,
(except per share data)
<S> <C> <C>
Total revenues $ 85,719 $ 76,407
Net income $ 10,561 $ 11,605
Net income per common share - basic and dilutive $ 0.62 $ 0.69
</TABLE>
12. Other:
The Company is obligated in accordance with its lease provisions, to
provide certain tenants with tenant improvements.
The Company maintains security deposits at September 30, 1998 and
December 31, 1997 of $5.9 million and $3.8 million, respectively. These
amounts are recorded as cash and cash equivalents.
13. Reclassification:
Certain prior-year amounts have been reclassified to conform to the
current year presentation.
15
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
Overview and Recent Developments
The Company was incorporated in the State of Maryland on March 27, 1997. The
Company operates so as to qualify as a REIT for federal income tax purposes. As
of October 16, 1997, the Company consummated the Offering of 13,817,250 shares
of Common Stock (including the exercise of the underwriters' over-allotment
option of 1,802,250 shares) and effected the Concurrent Private Placements of
1,153,845 shares of Common Stock at a price of $26.00 per share and realized net
proceeds therefrom of approximately $353.35 million. In addition, in connection
with the Formation Transactions relating to the Offering, including the
acquisition of certain property interests and the cancellation of certain
indebtedness, the Company issued 1,949,360 shares of Common Stock. Upon
consummation of the Offering, the Company acquired a sole 1% general partner
interest in the Operating Partnership, and a 90.4% limited partner interest in
the Operating Partnership. At September 30, 1998, the Company had a 1% general
partner interest and a 90.0% limited partner interest in the Operating
Partnership.
The Company was formed to continue and expand the commercial real estate
business of Tower Equities, including developing, acquiring, owning, renovating,
managing, and leasing office properties in the Manhattan, Phoenix, Tucson and
Orlando markets. Upon consummation of the Offering and the Formation
Transactions, the Operating Partnership owned or had interests in the Initial
Properties. On (i) December 31, 1997, the Company purchased the approximately
700,000 square foot office located at 810 Seventh Avenue in Midtown Manhattan
for approximately $150.0 million, including closing costs, (ii) January 16,
1998, the Company purchased the approximately 126,000 square foot Blue
Cross/Blue Shield office complex located in Phoenix, Arizona for $16.9 million,
and (iii) May 6, 1998, the Company purchased the approximately 335,000 square
foot 90 Broad Property for $34.3 million. The Company also owns or has an option
to acquire the Development Parcels, which can support 2.2 million rentable
square feet of development. In November 1997, the Company exercised its option
to purchase one of the optioned Development Parcels located in Phoenix, Arizona
for approximately $10.3 million.
On March 31, 1997, interests in certain partnerships, properties and limited
liability companies were contributed to the Operating Partnership in exchange
for OP Units in the Operating Partnership. Certain of these interests were owned
by the Operating Partnership after consummation of the Offering. Simultaneously
with such contributions of interests, the Company issued the MSAM Notes to
certain investors advised by MSAM. The MSAM Notes were collateralized by certain
interest in the Properties. Upon completion of the Offering, all MSAM Notes were
converted into Common Stock of the Company.
On July 9, 1998, the Company entered into the Merger Agreement relating to the
merger of the Company with Metropolitan Partners LLC, a newly formed joint
venture between Reckson and Crescent. The Merger Agreement and the Merger were
approved by the Company's Board of Directors on July 8, 1998.
Pursuant to the Merger Agreement, each share of the Company's Common Stock will
be exchanged, at the election of each company stockholder, for either $24 in
cash or .4615 of a share of Reckson Shares and .3523 of a share of Crescent
Shares (such fractions of shares being subject to downward adjustments if the
stock prices of Reckson Shares and Crescent Shares increase by more than 7%
after July 7, 1998) for up to an aggregate of 40% of the total consideration
payable in the transaction. In addition, if a stockholder of the Company elects
to receive Reckson Shares and the Crescent Shares, they will be entitled to
share in the benefit of up to, and including, a 7% increase in the value of each
share of Reckson Shares and the Crescent Shares after July 7, 1998. If however,
there has been an increase of more that 7% in the stock price of either Reckson
Shares or Crescent Shares, then the exchange ratio for the applicable common
stock will be adjusted downward in proportion to the increase in excess of 7%,
such that Company stockholders who receive Reckson Shares and Crescent Shares
will receive fewer shares. Accordingly, the benefit of any appreciation in the
stock value of either Reckson Shares or Crescent Shares is effectively limited
to 7%.
On November 2, 1998, the Company commenced an action in New York State Supreme
Court against Reckson, Crescent and Metropolitan alleging breach of the of the
Merger Agreement. The Company is seeking $75 million in compensatory damages of
not less than $75 million, declaratory and other relief. As stated in the
Company's press release on such date, such action was filed after the Company
had been informed by Crescent, Reckson and Metropolitan that they would not
proceed with the Merger Agreement.
16
<PAGE>
On August 3, 1998, Lawrence H. Feldman resigned from this positions as Chairman
of the Board, Chief Executive Officer and President of the Company. In
connection with his resignation, the Company expects to pay Mr. Feldman a
severance payment equal to 2.99 times his "base amount" as described in his
employment agreement and as defined in Section 280G of the Internal Revenue Code
of 1986, as amended, payable over a twelve-month period or approximately $84,273
per month. During the third quarter of 1998 the Company charged $1.0 million of
severance expense to operations. On August 3, 1998, Francis X. Tansey, a
director of the Company, was appointed Chairman of the Board and Robert L. Cox,
a director and Executive Vice President and Chief Operating Officer of the
Company, was appointed acting Chief Executive Officer and President of the
Company.
Results of Operations
The results of operations for the three and nine month periods ended September
30, 1998 and the three- and nine-month periods ended September 30, 1997 include
the operations of the Company and Tower Predecessor, respectively. Consequently,
the comparison of the periods provides only limited information regarding the
operations of the Company as currently constituted.
The results of operations of the Company for the three- and nine-month periods
ended September 30, 1997 consist primarily of the interest expense and interest
income related to the amounts borrowed from MSAM.
Comparison of the Three Months Ended September 30, 1998 (the Company) to the
Three Months Ended September 30, 1997 (Tower Predecessor)
Total revenues increased by $21.5 million or 302.8%, to $28.6 million for the
three months ended September 30, 1998 as compared to $7.1 million for the three
months ended September 30, 1997. Rental income increased by $21.5 million, or
307.1%, to $28.5 million for the three months ended September 30, 1998 as
compared to $7.0 million for the three months ended September 30, 1997,
primarily as a result of the Properties acquired concurrent with and subsequent
to the Offering, as described above. Rental income for the three months ended
September 30, 1998 included (i) $7.9 million of rental income from the
Properties previously held by DRA (these properties were reflected as an 18%
investment on the equity method of accounting by Tower Predecessor) and (ii)
rental revenues of $12.3 million from the 100 Wall, Century Plaza, 810 Seventh
Avenue, Blue Cross/Blue Shield and 90 Broad office buildings, properties which
were acquired concurrent with or subsequent to the Offering. The remaining
increase in rental income can be attributed to an increase in base rent,
primarily resulting from (i) an increase in leasing activity from the date of
the Offering and (ii) additional unbilled rent resulting from the effect of
re-straightlining the lease payments over the remaining lease terms from the
date of the Offering.
Total expenses for the three months ended September 30, 1998 increased by $18.3
million, or 210.3%, to $27.0 million from $8.7 million for the three months
ended September 30, 1997, primarily as a result of the inclusion of the DRA
Joint Venture properties and the properties purchased concurrent with the
subsequent to the Offering. Expenses, excluding interest and depreciation and
amortization, as a percentage of total revenue increased from 44.8% for the
three months ended September 30, 1997 to 60.1% for the three months ended
September 30, 1998, primarily as a result of an increase in general
administrative costs and severance and other compensation costs (including costs
incurred related to the Initiatives and the severance charge related to the
resignation of Lawrence H. Feldman (see Note 3 to the Financial Statements)
recorded during the third quarter of 1998). These costs impacted the results of
operations for the three months ended September 30, 1998 by $0.23 per common
share. Property operating and maintenance increased as a percentage of revenue
due to the inclusion of the properties located in Arizona, where utility costs
are typically higher. The decrease in real estate taxes as a percentage of
revenue is primarily due to the inclusion of 100 Wall Street, which has a lower
real estate tax assessment as compared to the Company's other New York City
based Properties. The components of expenses, excluding interest and
depreciation and amortization, as a percentage of total revenue are as follows:
17
<PAGE>
<TABLE>
<CAPTION>
Three Months
Ended September 30,
----------------------------
1998 1997
------------ -------------
<S> <C> <C>
Property operating and maintenance 26.3% 21.1 %
Real estate taxes 13.3 16.2
General and administrative 19.9 5.4
Ground rent/air rights 0.6 2.1
------------ -------------
Total 60.1% 44.8%
============ =============
</TABLE>
Interest expense increased by $1.5 million to $5.2 million for the three months
ended September 30, 1998 as compared to $3.6 million for the three months ended
September 30, 1997 as a result of utilization of the Line of Credit to fund new
acquisitions and capital expenditures and proceeds from the Term Loan.
Depreciation and amortization increased by $2.7 million, or 150%, to $4.5
million for the three months ended September 30, 1998 as compared to $1.8
million for the three months ended September 30, 1997 due to depreciation of
additional properties in 1998 as compared in 1997.
Equity in joint ventures and unconsolidated subsidiaries increased by
approximately $0.25 million primarily as a result of the operations of the
Management Company, which is accounted for as an unconsolidated subsidiary in
1998.
Minority interest, which did not exist at September 30, 1997, pertains to
interest in certain partnerships, Properties and Properties Atlantic which were
contributed to the Operating Partnership in exchange for OP Units concurrent
with and subsequent to the Offering.
Net income increased by $3.3 million to $1.8 million for the three months ended
September 30, 1998 as compared to a net loss of $1.5 million for the three
months ended September 30, 1997, as a result of the acquisition of properties
and other reasons.
Comparison of the Nine Months Ended September 30, 1998 (the Company) to the Nine
Months Ended September 30, 1997 (Tower Predecessor)
Total revenues increased by $61.8 million, or 288.8%, to $83.2 million for the
nine months ended September 30, 1998 as compared to $21.4 million for the nine
months ended September 30, 1997. Rental income increased by $62.1 million, or
302.9%, to $82.6 million for the nine months ended September 30, 1998 as
compared to $20.5 million for the nine months ended September 30, 1997,
primarily as a result of the Properties acquired concurrent with and subsequent
to the Offering. Rental income for the nine months ended September 30, 1998
included (i) $24.0 million of rental income from the Properties previously held
by DRA (these properties were reflected as an 18% investment on the equity
method of accounting by Tower Predecessor) and (ii) rental revenues of $34.4
million from 100 Wall, Century Plaza, 810 Seventh Avenue, Blue Cross/Blue Shield
and the 90 Broad office buildings, properties which were acquired concurrent
with or subsequent to the Offering. The remaining increase in rental income can
be attributed to an increase in base rent, primarily resulting from (i) an
increase in leasing activity from the date of the Offering and (ii) additional
unbilled rent resulting from the effect of re-straightlining the lease payments
over the remaining lease terms from the date of the Offering.
Management fee income decreased by $0.3 million, or 100.0% to $0 for the nine
months ended September 30, 1998. These fees relate to services provided to the
Properties (which have been eliminated since the consummation of the Offering)
as well as services to third-party properties (which fees are reflected in the
Management Company for the nine months ended September 30, 1998).
Total expenses for the nine months ended September 30, 1998 increased by $46.0
million, or 174.9%, to $72.3 million from $26.3 million for the nine months
ended September 30, 1997 primarily as a result of the inclusion of the DRA
properties and the properties purchased concurrent with and subsequent to the
Offering. Expenses,
18
<PAGE>
excluding interest and depreciation and amortization, as a percentage of total
revenue increased from 48.1% for the nine months ended September 30, 1997 to
52.8% for the nine months ended September 30, 1998, primarily as a result of an
increase in general and administrative costs and severance and other
compensation costs (including costs incurred related to the Initiatives and the
severance charges related to the resignations of Lawrence H. Feldman and Joseph
D. Kasman (see Note 3 to the Financial Statements) recorded during the third and
second quarters of 1998, respectively). In addition, management recorded
compensation expense of approximately $0.9 million relating to the issuance of
stock and cash to current and former employees of the Company for their efforts
during the Offering. These costs impacted the results of operations for the nine
months ended September 30, 1998 by $0.14 per common share. Property operating
and maintenance increased as a percentage of revenue due to the inclusion of the
properties located in Arizona, where utility costs are typically higher. The
decrease in real estate taxes as a percentage of revenue is primarily due to the
inclusion of 100 Wall Street, which has a lower real estate tax assessment as
compared to the Company's other New York City based Properties. The components
of expenses, excluding interest and depreciation and amortization, as a
percentage of total revenue are as follows:
<TABLE>
<CAPTION>
Nine Months
Ended September 30,
--------------------------
1998 1997
----------- -----------
<S> <C> <C>
Property operating and maintenance 23.4% 19.7%
Real estate taxes 13.3 16.3
General and administrative 15.5 10.0
Ground rent/air rights 0.6 2.1
----------- -----------
Total 52.8% 48.1%
=========== ===========
</TABLE>
Interest expense increased by $4.3 million to $15.1 million for the nine months
ended September 30, 1998 as compared to $10.8 million for the nine months ended
September 30, 1997 as a result of utilization of the Line of Credit to fund new
acquisitions and capital expenditures and proceeds from the Term Loan.
Depreciation and amortization increased by $7.8 million, or 147.2%, to $13.1
million for the nine months ended September 30, 1998 as compared to $5.3 million
for the nine months ended September 30, 1997 due to depreciation of additional
properties in 1998 as compared to 1997.
Equity in joint ventures and unconsolidated subsidiaries increased by
approximately $0.5 million primarily as a result of the operations of the
Management Company, which is accounted for as an unconsolidated subsidiary in
1998.
Minority interest, which did not exist at September 30, 1997, pertains to
interests in certain partnerships, Properties and Properties Atlantic which were
contributed to the Operating Partnership in exchange for OP Units concurrent
with and subsequent to the Offering.
Net income increased by $15.3 million to $10.5 million for the nine months ended
September 30, 1998 as compared to a net loss of $4.8 million (prior to the
extraordinary gain on early extinguishment of debt of $6.5 million) for the nine
months ended September 30, 1997, as a result of the acquisition of properties
and other factors discussed above.
Funds From Operations
The Company generally considers Funds from Operations ("FFO") an appropriate
measure of liquidity of an equity REIT because industry analysts have accepted
it as a performance measure of equity REITs. "Funds from Operations," as defined
by the National Association of Real Estate Investment Trusts, means net income
(computed in accordance with GAAP), excluding gains (or losses) from debt
restructurings and gains (losses) on sales of property, plus depreciation and
amortization on real estate assets, and after adjustments for unconsolidated
partnerships and joint ventures. The Company has also adjusted FFO to add back
compensation expense related to the issuance of stock to key employees for
services performed in conjunction with the Offering, the severance charges
related to the resignations of Joseph D. Kasman, Lawrence H. Feldman and costs
incurred related to the
19
<PAGE>
Merger and the Initiatives. The Company believes that in order to facilitate a
clear understanding of the historical operating results of the Company, FFO
should be considered in conjunction with net income (loss), determined in
accordance with GAAP, as presented in the unaudited consolidated and combined
financial statements of the Company and Tower Predecessor, respectively, and
notes thereto included elsewhere in this Quarterly Report on Form 10-Q. Funds
from Operations should not be considered as an alternative to net income,
determined in accordance with GAAP, as an indication of the Company's
performance or to cash flows from operating activities, determined in accordance
with GAAP, as a measure of liquidity or ability to make distributions.
The following is a reconciliation of Net Income to Funds from Operations for the
three and nine months ended September 30, 1998 and September 30, 1997.
<TABLE>
<CAPTION>
Tower
The Company The Company The Company Predecessor
(Consolidated) (Consolidated) (Consolidated) (Combined)
Three Months Three-Months Nine Months Nine Months
Ended Ended Ended Ended
September 30, September 30, September 30, September 30,
1998 1997 1998 1997
----------------- ----------------- ---------------- ----------------
<S> <C> <C> <C> <C>
Net income $ 1,783 $ (1,537) $ 10,496 $ 1,645
Add:
Real estate depreciation and
Amortization 4,506 1,761 13,149 5,255
Real estate depreciation and
Amortization of unconsolidated
Joint venture 8 8 24 24
Minority interest 173 - 1,027 -
Severance and other compensation
Costs 1,011 - 2,454 -
Sale of the Company 2,915 - 3,865 -
Less:
Gain on extinguishment of debt - (6,475) - (6,475)
----------------- ----------------- ---------------- ----------------
Funds from Operations $ 10,396 $ (6,243) $ 31,015 $ 449
================= ================= ================ ================
Funds from Operations
available for $ 9,460 $ 28,236
Stockholders
================= ================
</TABLE>
Liquidity and Capital Resources
Cash and cash equivalents were $7.2 million and $1.3 million at September 30,
1998 and December 31, 1998, respectively. Cash and cash equivalents include cash
on hand and short-term, highly liquid investments with original maturities of
three months or less. These financial instruments, which potentially subject the
Company to concentrations of credit risk, are invested primarily through
short-term obligations issued or guaranteed by the United States government or
its agencies. The Company believes that this mitigates their risk. Included in
cash and cash equivalents at September 30, 1998 and December 31, 1997 are
segregated security deposits amounting to approximately $5.9 million and $3.8
million. The significant increase in cash and cash equivalents is a result of
the net increase in amounts outstanding under the Line of Credit of $62.4
million and cash flows from operations of $31.4 million, net of approximately
$65.9 million for additions to real estate (primarily as a result of the $16.9
million purchase of Blue Cross/Blue Shield and the $34.3 million purchase of the
90 Broad Property), and $22.2 million relating to distributions to stockholders
and OP Unitholders.
The Company believes that its principal short-term liquidity needs are to fund
normal recurring expenses, debt service requirements, and deferred real estate
taxes. The Properties require periodic investment of capital for tenant-related
capital expenditures and for general capital improvements. In addition, the
Company has adopted a policy of paying regular quarterly distributions on its
Common Stock and OP Units. Based upon its cash and cash equivalents as of
September 30, 1998, its expected cash flows from operations and the funds
available under the Line of Credit,
20
<PAGE>
the Company expects to meet its cash requirements for the foreseeable future,
assuming a refinancing of the $100.0 million mortgage loan due on December 31,
1998 relating to the acquisition of 810 Seventh Avenue.
The Line of Credit has a three-year term and bears interest at the rate of
approximately 150 basis points over LIBOR (London Interbank Offered Rate). As of
September 30, 1998, $62.4 million was outstanding under the Line of Credit.
In conjunction with its Line of Credit the Company must maintain certain
financial ratios:
i. Total outstanding indebtedness must not exceed 55% of Total Value (as
defined in the Line of Credit) during the first year of the facility and
must not exceed 50% thereafter.
ii. Collateral indebtedness must not exceed 40% of Total Value (as defined)
during the first year of the facility and 35% thereafter.
iii. Recourse indebtedness cannot exceed 5% of Total Value (as defined).
iv. Other financial covenants that must be met by the Company include
interest expense and fixed charges to debt ratios, among others.
As a general policy, the Company intends to maintain a debt policy limiting the
Company's total consolidated indebtedness plus its pro rata share of joint
venture debt to 50% of the Company's total market capitalization. As of
September 30, 1998, the debt to total market capitalization, including the
Company's 10% interest in the debt of 2800 North Central, was 46.3%.
As a result of the acquisition of 810 Seventh Avenue, the Company has a $100
million mortgage loan form Credit Suisse First Boston Mortgage Capital LLC that
matures on December 31, 1998. The Company intends to refinance this mortgage
during the fourth quarter of 1998. In addition, the Company has obtained a $11.3
million revolving loan from KeyBank in connection with the development of a
Development Parcel in Arizona, which loan matures on May 1, 2000. There are
currently no amounts outstanding under the loan from KeyBank.
Inflation
The Company's leases with the majority of its tenants require the tenants to pay
most operating expenses, including insurance and real estate taxes, and
increases in common area maintenance expenditures which partially offsets the
Company's exposure to increases in costs and operating expenses resulting from
inflation.
Year 2000
The Company has conducted a comprehensive review of its computer systems to
identify the systems that could be affected by the Year 2000 issue. The Year
2000 issue is the result of computer programs being written using two digits
rather than four to determine the applicable year. Any programs that have time
sensitive software may recognize a date using "00" as the year 1900 rather than
the year 2000. The Company believes that the cost of remediation associated with
its computer systems will be minimal and the remediation is anticipated to be
completed in the first quarter of 1999.
The Company's Year 2000 compliance program focuses on addressing Year 2000
readiness in the following areas: (i) The Company's information technology
hardware and software; (ii) other material technology systems; and (iii) Year
2000 compliance of third parties with which the Company has a material
\relationship. In this regard, the Company has retained consultants to assist in
its efforts.
The Company has completed an initial assessment and remediation of its key
information technology systems, including its operating systems and critical
financial and nonfinancial applications. Remediation efforts as of the
21
<PAGE>
date hereof include addressing critical financial applications. Based on this
initial assessment and remediation efforts, the Company believes that these key
information technology systems will be "Year 2000 compliant" by the first
quarter of 1999. However, there can be no assurance that coding errors or other
defects will not be discovered in the future. The Company is currently
evaluating the remaining noncritical information technology systems for Year
2000 compliance.
As of September 30, 1998, The Company owned and operated a portfolio of 25
Properties. The Company is continually evaluating whether the material
non-information technology systems such as security control equipment, fire
suppression equipment and other physical plant and equipment at such properties
are Year 2000 compliant, and has been advised by its vendors that such systems
and equipment are or will be Year 2000 compliant. All of the Company's
Properties, as a part of general operating policy, are developing contingency
plans that will be deployed in the event key operational systems, such as
security control equipment, fail (e.g., when a power failure occurs).
The Company depends upon the proper functioning of third-party computer and
non-information technology systems. These third parties include tenants,
commercial banks and other lenders, construction contractors and vendors. The
Company has initiated communications with third parties with whom it has
important financial or operational relationships to determine the extent to
which they are vulnerable to the Year 2000 issue. The Company has not yet
received sufficient information from all parties about their remediation plans
to predict the outcome of their efforts.
If third parties with whom the Company or one of its affiliates interacts have
Year 2000 problems that are not remedied, the following problems could result:
(i) In the case of construction contractors and other vendors, the
delayed construction or re-development of properties;
(ii) In the case of vendors, disruption of important services upon
which the Company or its affiliates depends, such as professional
services, including accounting and legal services,
telecommunications and electrical power; and
(iii) In the case of banks and other lenders, the disruption of capital
flows potentially resulting in liquidity stress.
Due to the nature of the Company's tenants' respective businesses, the Company
does not believe the Year 2000 issue will materially impact each tenant's
ability to pay rent. However, financial difficulties of significant tenants as a
result of the Year 2000 issues could have a material adverse effect on the
Company's results of operations or financial position. Though the Company does
not expect the Year 2000 issue to have a material adverse effect on its result
of operations or financial position, there can be no assurances of that
position.
Environmental Matters
The Company is not aware of any environmental issues at any of its Properties.
The Company believes it has sufficient insurance coverage at each of its
Properties.
Subsequent Events
On November 2, 1998, the Company commenced an action in New York State Supreme
Court against Reckson, Crescent and Metropolitan alleging breach of the of the
Merger Agreement. The Company is seeking $75 million in compensatory damages of
not less than $75 million, declaratory and other relief. As stated in the
Company's press release on such date, such action was filed after the Company
had been informed by Crescent, Reckson and Metropolitan that they would not
proceed with the Merger Agreement.
22
<PAGE>
Recently Issued Accounting Standards
Effective January 1, 1998, the Company adopted the Financial Accounting Standard
Board Statement of Financial Accounting Standards No. 130, "Reporting
Comprehensive Income" ("SFAS 130"). SFAS 130 specifies the presentation and
disclosure requirements for reporting comprehensive income, which includes items
which have been formerly reported as a component of stockholders' equity. SFAS
130 does not have an impact on the Company's financial statements.
In June 1997, the financial accounting Standards Board issued Statement of
Financial Accounting Standards No. 131, "Disclosures about Segments of an
Enterprise and Related Information" (SFAS 131"). SFAS 131 establishes disclosure
standards for information about operating segments in annual financial
statements and requires that enterprises report selected information about
operating segments in interim financial reports issued to shareholders.
Management expects to adopt this standard in connection with the preparation of
the 1998 annual financial statements. When adopted, SFAS 131 will require the
Company to report additional geographic information based on the Company's major
geographic areas of focus.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities." This statement addresses the accounting for derivative
instruments including certain derivative instruments embedded in to their
contacts and for hedging activities. This statement is effective for years
beginning after June 15, 1999. The Company's management believes that this
statement will not have a material impact on the Company's financial statements.
In October 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 134, "Accounting for Mortgage Backed
Securities Retained after the Securitization of Mortgage Loans Held for Sale by
a Mortgage Banking Enterprise." SFAS 134 addressed the accounting for and
disclosure of mortgage backed securities as either held-to-maturity,
held-for-sale, or trading security. The statement is effective for the first
fiscal quarter beginning after December 15, 1998. SFAS 134 does not have an
impact on the Company's financial statements.
During 1998, the Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants issued Statement of Position 98-5,
"Reporting on the Costs of Start-Up Activities" ("SOP 98-5") and Statement of
Position 98-1, " Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use" ("SOP 98-1), which are effective for the fiscal years
beginning after December 15, 1998. In addition, the Emerging Issues Task Force
of the Financial Accounting Standards Board released Issue No. 97-11,
"Accounting for Internal Costs Relating to Real Estate Property Acquisitions"
("ET 97-11"). SOP 98-5 requires that certain costs incurred in conjunction with
start-up activities be expensed. SOP 98-1 provides guidance on whether the costs
of computer software developed or obtained for internal use should be
capitalized or expensed. EITF 97-11 requires that the internal pre-acquisition
costs of identifying and acquiring operating property be expensed as incurred.
Management believes that, when adopted, SOP 98-5 and SOP 98-1 will not have a
significant impact on the Company's financial statements. EITF 97-11 was adopted
during the first quarter of fiscal 1998 and resulted in the Company having to
expense internal property acquisition costs they would have otherwise
capitalized.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
Not applicable.
23
<PAGE>
PART II - OTHER INFORMATION
Item 1. Legal Proceedings.
The Company is party to and has become a successor party-in-interest to certain
legal proceedings arising in the ordinary course of business. The Company
believes it has adequate insurance and does not expect that these proceedings,
in the aggregate, will have a material adverse effect on the operations, cash
flows or financial position of the Company.
On or about July 10, 1998 a complaint was filed in the U.S. District Court for
the Southern District of New York (the "July Complaint") against a Tower
Equities management company, the Company, three of the Company's subsidiaries
and one former officer and director of the Company (collectively, the
"Defendants") in which the plaintiff alleges she was discriminated against in
the terms and conditions of her employment on the basis for her religion in
violation of federal, state and city statutes. The plaintiff is seeking actual,
compensatory and punitive damages. The plaintiff was never employed by the
Company and was not employed by any of the other Defendants at the time of the
formation of the company in March 1997. The Defendants deny the allegations and
intend to vigorously defend the action. An answer to the July Complaint is
currently scheduled to be filed on or about November 17, 1998. The Company does
not expect that this action will have a material adverse effect on its
operations, cash flows or financial position.
On or about September 29, 1998, a complaint was filed in the U.S. District Court
for the Southern District of New York (the "September Complaint") against the
Defendants in which the plaintiff alleges unlawful retaliation in violation of
federal, state and city statutes. The plaintiff was never employed by the
Company and was not employed by any of the other Defendants at the time of the
formation of the Company in March 1997. The Defendants deny the allegations and
intend to vigorously defend the action. An answer to the September Complaint is
currently scheduled to be filed on or about November 17, 1998. The Company does
not expect that this action will have a material adverse effect on its
operations, cash flows or financial position.
In July 1998, David Miller, a purported stockholder of the Company, commenced a
putative class action against the Company and certain of its then directors and
officers in the Supreme Court of New York, New York County, captioned Miller v.
Adams, et al., Index No. 98-113363 (Sup. Ct. N.Y. Co.) (the "Miller Action").
The Miller Action challenges, among other things, the process employed by the
Company and its directors in reviewing and approving the Merger and the fairness
of the terms of the Merger to the Company's public stockholders. Among other
things, the Miller Action seeks injunctive relief or, in the alternative,
rescission and monetary damages of an unspecified amount. In view of the fact
that Crescent, Reckson and Metropolitan have indicated that they do not intend
to perform under the Merger Agreement, the Plaintiff in the Miller Action has
agreed to voluntarily withdraw the complaint, without prejudice.
On November 2, 1998, the Company commenced an action in New York State Supreme
Court against Reckson, Crescent and Metropolitan alleging breach of the of the
Merger Agreement. The Company is seeking $75 million in compensatory damages of
not less than $75 million, declaratory and other relief. As stated in the
Company's press release on such date, such action was filed after the Company
had been informed by Crescent, Reckson and Metropolitan that they would not
proceed with the Merger Agreement.
Item 2. Changes in Securities and Use of Proceeds.
None.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders.
None.
24
<PAGE>
Item 5. Other Information.
None.
Item 6. Exhibits and Reports on Form 8-K.
a) Exhibits:
The exhibits listed in the Exhibit Index immediately preceding the
exhibits are filed as part of this Quarterly Report on Form 10-Q.
b) Reports on Form 8-K:
1. A current report on Form 8-K, dated July 9, 1998 and filed on
July 14, 1998, was filed by the Company in connection with the
signing of the Merger Agreement and for purposes of disclosing
the material terms of the Merger.
2. A current report on form 8-K, dated August 3, 1998 and filed on
August 11, 1998, was filed by the Company in connection with the
resignation of Lawrence H. Feldman as Chairman of the Board,
Chief Executive Officer and President of the Company and the
appointments of Robert L. Cox as Acting Chief Executive Officer
and President and Francis X. Tansey as Chairman of the Board of
the Company.
25
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
TOWER REALTY TRUST, INC.
Date: November 16, 1998 By: /s/ Lester S. Garfinkel
------------------------------
Name: Lester S. Garfinkel
Title: Executive Vice President --
Finance and Administration
and Chief Financial Officer
(Principal Financial Officer
and Chief Accounting Officer)
26
<PAGE>
Exhibit Index
The following exhibits are filed as part of this Quarterly Report on Form 10-Q.
Exhibit No. Description
- - ------------------- ---------------------------------------------------
27.1 Financial Data Schedule
27
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This Schedule contains summary financial information extracted from the
financial statements of Tower Realty Trust, Inc. for the period ended September
30, 1998
</LEGEND>
<S> <C>
<PERIOD-TYPE> 9-Mos
<FISCAL-YEAR-END> Dec-31-1999
<PERIOD-START> Jan-01-1998
<PERIOD-END> Sep-30-1998
<CASH> 7,175
<SECURITIES> 0
<RECEIVABLES> 8,767
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 686,697
<DEPRECIATION> 14,040
<TOTAL-ASSETS> 717,815
<CURRENT-LIABILITIES> 0
<BONDS> 0
0
0
<COMMON> 169
<OTHER-SE> 352,882
<TOTAL-LIABILITY-AND-EQUITY> 717,815
<SALES> 0
<TOTAL-REVENUES> 83,228
<CGS> 0
<TOTAL-COSTS> 72,262
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 15,144
<INCOME-PRETAX> 10,496
<INCOME-TAX> 0
<INCOME-CONTINUING> 10,496
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 10,496
<EPS-PRIMARY> 0.62
<EPS-DILUTED> 0.62
</TABLE>
