<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended JUNE 30, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission File Number: 1-13115
EQUITY OFFICE PROPERTIES TRUST
(Exact name of registrant as specified in its charter)
MARYLAND 36-4151656
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
TWO NORTH RIVERSIDE PLAZA, SUITE 2200, CHICAGO ILLINOIS 60606
(Address of principal executive offices) (Zip Code)
(312) 466-3300
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes No X
---- ----
APPLICABLE ONLY TO CORPORATE ISSUERS
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date:
At August 20, 1997, 152,180,770 of the Registrant's Common Shares of Beneficial
Interest were outstanding.
<PAGE> 2
EQUITY OFFICE PROPERTIES TRUST
BALANCE SHEETS
<TABLE>
<CAPTION>
JUNE 30,
1997 DECEMBER 31,
ASSETS (UNAUDITED) 1996
----------- ------------
<S> <C> <C>
Cash $ 25,000 $ 25,000
----------- ------------
Total Assets $ 25,000 $ 25,000
=========== ============
SHAREHOLDERS' EQUITY
Common Shares, $0.01 par value; 750,000,000 shares authorized,
1,000 shares issued and outstanding $ 10 $ 10
Additional Paid in Capital 24,990 24,990
----------- ------------
Total Shareholders' Equity $ 25,000 $ 25,000
=========== ============
</TABLE>
See accompanying notes.
2
<PAGE> 3
EQUITY OFFICE PROPERTIES TRUST
NOTES TO BALANCE SHEETS
(UNAUDITED)
1. ORGANIZATION
As used herein, "Company" means Equity Office Properties Trust, a Maryland
real estate investment trust, together with its subsidiaries (including EOP
Operating Limited Partnership, a Delaware limited partnership (the "Operating
Partnership")), and the predecessors thereof ("Equity Office Predecessors").
The Company was formed on October 9, 1996 to continue and expand the national
office property business organized by Mr. Samuel Zell, Chairman of the Board
of Trustees of the Company. The Company is a fully integrated
self-administered and self-managed real estate company and expects to qualify
as a real estate investment trust ("REIT") for federal income tax purposes.
As of June 30, 1997, Equity Office Predecessors owned or had an interest in 90
office properties (the "Office Properties") containing 32.2 million rentable
square feet and 14 stand-alone parking facilities (the "Parking Facilities"
and together with the Office Properties, the "Properties") containing
approximately 14,785 parking spaces, located in 47 submarkets in 35 markets
throughout the United States.
The Company's assets, which include investments in joint ventures, are
owned by, and its operations are conducted through the Operating Partnership.
The Company is the managing general partner of the Operating Partnership.
On July 11, 1997, the Company completed the consolidation of the
entities which comprise Equity Office Predecessors (the "Consolidation") and
its initial public offering (the "Offering"). See Note 10 for a description
of these transactions. These balance sheets should be read in
conjunction with the prospectus of the Company dated July 7, 1997 (the
"Prospectus") and the combined financial statements of Equity Office
Predecessors included elsewhere in this Form 10-Q.
2. COMMITMENTS AND CONTINGENCIES
The Company has become a party to various legal actions resulting from
the operating activities transferred to the Operating Partnership in
connection with the Consolidation and the Offering. These actions are
incidental to the transferred business and management does not believe that
these actions will have a material adverse effect on the Company.
Also, in connection with the Offering and the Consolidation, as of July 11,
1997 Equity Office Predecessors transferred approximately $2.2 billion of
their mortgage indebtedness to the Operating Partnership in connection with
the Consolidation and the Offering. The Company anticipates refinancing
approximately $236 million of mortgage indebtedness, for which it has not yet
obtained consents from the mortgage lenders. In the event that this
refinancing does not occur prior to December 31, 1997, the Company would be
required to obtain the consent of the existing mortgage lenders. The Company
believes that, inasmuch as most of the mortgage instruments given to secure
this indebtedness contemplated these transfers, such consents can be obtained
on reasonable terms and, in instances where such consents could not be
obtained, such loans could be refinanced.
3. USE OF ESTIMATES
The preparation of the balance sheets in accordance with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the balance sheet and
accompanying notes. Actual results could differ from those estimates.
4. UNAUDITED INTERIM STATEMENTS
The balance sheet as of June 30, 1997 is unaudited. In the opinion of
management, the balance sheet reflects all adjustments necessary for a fair
presentation of the results of the interim period.
3
<PAGE> 4
EQUITY OFFICE PROPERTIES TRUST
NOTES TO BALANCE SHEETS
(UNAUDITED)
5. INCOME TAXES
Commencing with the year ending December 31, 1997, the Company intends
to make an election to be taxed as a REIT under Sections 856 through 860 of
the Internal Revenue Code of 1986, as amended (the "Code"). As a REIT, the
Company generally will not be subject to federal income tax if it distributes
at least 95% of its taxable income for each tax year to its shareholders.
REITs are subject to a number of organizational and operational requirements.
If the Company fails to qualify as a REIT in any taxable year, the Company
will be subject to federal income tax (including any applicable alternative
minimum tax) on its taxable income at regular corporate tax rates. Even if
the Company qualifies for taxation as a REIT, the Company may be subject to
state and local income taxes and to federal income tax and excise tax on its
undistributed income.
6. STOCK OPTION AND RESTRICTED SHARE PLANS
The Company adopted the 1997 Employee Share Option and Restricted Share
Plan (the "Employee Plan") for the purpose of attracting and retaining highly
qualified executive officers, trustees, employees and consultants. The
Company reserved common shares of beneficial interest $.01 par value per
share ("Common Shares") for issuance pursuant to the Employee Plan in an
amount equal to approximately 6.8% of the total outstanding Common Shares,
calculated on a fully diluted basis immediately following the Offering and
Consolidation. Pursuant to the Employee Plan, the Company granted options
to purchase Common Shares to certain officers, trustees, employees and
consultants of the Company.
Grants under the Employee Plan have been and will continue to be exempt
under Rule 16b-3 under the Securities Exchange Act of 1934, as amended (the
"Exchange Act"). The Employee Plan will be administered by the Compensation
Committee and provide for the granting of share options, share appreciation
rights or restricted shares. At the closing of the Offering, the Company
granted share options to purchase 2.56% of the Company's outstanding Common
Shares (calculated on a fully diluted basis) to executives or other key
employees and consultants of the Company. Share options may be granted in the
form of "incentive stock options" (as defined in Section 422 of the Code), or
non-statutory share options, and are exercisable for up to 10 years following
the date of the grant. The exercise price of each option will be set by the
Compensation Committee; provided, however, that the price per share must be
equal to or greater than the fair market value of the Common Shares on the
grant date.
The Employee Plan also provides for the issuance of share appreciation
rights which will generally entitle a holder to receive cash or shares, as
determined by the Compensation Committee at the time of exercise, equal to
the difference between the exercise price and the fair market value of the
Common Shares. In addition, the Employee Plan permits the Company to issue
restricted Common Shares to executive or other key employees upon such terms
and conditions as shall be determined by the Compensation Committee in its
sole discretion.
7. SHAREHOLDERS' EQUITY
On June 13, 1997, the Declaration of Trust of the Company was amended to
authorize the issuance of 750,000,000 Common Shares and 100,000,000 preferred
shares of beneficial interest ("Preferred Shares"). The Company's Common
Shares and Preferred Shares issued and outstanding at June 30, 1997 were
1,000 and 0, respectively.
4
<PAGE> 5
EQUITY OFFICE PROPERTIES TRUST
NOTES TO BALANCE SHEETS
(UNAUDITED)
8. PRO FORMA STATEMENT OF OPERATIONS
The pro forma data presented below is included to illustrate the effect
on the Company's operations as result of the transactions described below.
The pro forma information for the six months ended June 30, 1997 and 1996
reflects: (a) the acquisition of nine Office Properties and five Parking
Facilities acquired between January 1, 1997 and August 11, 1997, and the
acquisition of 19 Office Properties and 12 Parking Facilities acquired between
January 1, 1996 and August 11, 1997, and the disposition of two properties, as
if these transactions had occurred as of January 1, 1997 and 1996,
respectively; (b) the anticipated $180 million Private Debt Offering (see
Note 10); (c) the Offering and the Consolidation; and (d) the decrease in
interest expense resulting from debt repaid at the time of the Offering and
the Consolidation, as if this debt repayment had occurred as of January 1,
1997 and 1996, respectively.
The pro forma information for the three months ended June 30, 1997
reflects: (a) the acquisition of nine Office Properties and five Parking
Facilities acquired between January 1, 1997 and August 11, 1997, and the
disposition of two properties, as if these transactions had occurred as of
January 1, 1997 ; (b) the anticipated $180 million Private Debt Offering (see
Note 10); (c) the Offering and the Consolidation; and (d) the decrease in
interest expense resulting from debt repaid at the time of the Offering and
the Consolidation, as if this debt repayment had occurred as of January 1,
1997.
In the opinion of management, all adjustments have been made that are
necessary to present fairly the pro forma data.
5
<PAGE> 6
EQUITY OFFICE PROPERTIES TRUST
NOTES TO BALANCE SHEETS
(UNAUDITED)
The pro forma combined statements of operations should be read in
conjunction with Equity Office Predecessors' Combined Financial Statements and
the Notes thereto. The summarized pro forma combined statements of operations
data are not necessarily indicative of the results that would have been
reported had such events actually occurred on the date specified, nor are they
indicative of the Company's future results.
<TABLE>
<CAPTION>
FOR THE THREE
MONTHS ENDED, FOR THE SIX MONTHS ENDED,
- --------------------------------------------------------------------------------------------
JUNE 30, JUNE 30, JUNE 30,
1997 1997 1996
- --------------------------------------------------------------------------------------------
(unaudited $ in thousands)
- --------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Revenues:
Rental $ 133,099 $ 264,532 $248,706
Tenant reimbursements 23,006 46,177 42,974
Parking 10,938 20,910 19,957
Other 2,903 6,752 8,263
Fees from noncombined affiliates 1,240 2,440 2,240
Interest 4,229 9,190 4,224
------------------------------------------------
Total revenues 175,415 350,001 326,364
------------------------------------------------
Expenses:
Property operating 64,249 129,628 127,959
Interest 28,975 56,840 53,020
Depreciation 34,735 68,128 64,967
Amortization 1,357 2,533 2,065
General and administrative 8,253 15,926 22,843
------------------------------------------------
Total expenses 137,569 273,055 270,854
------------------------------------------------
Income before allocation to
minority interests, income from
investments in unconsolidated
joint ventures, gain on sale of
real estate and extraordinary
items 37,846 76,946 55,510
Allocation to minority interests:
Operating Partnership (2,812) (5,702) (4,426)
Partially owned properties (350) (879) (1,698)
Income from investment in
unconsolidated joint ventures 1,554 3,134 2,393
Gain on sale of real estate - - 5,262
------------------------------------------------
Net Income $ 36,238 $73,499 $57,041
================================================
Net income per Common Share $.24 $.48 $.38
================================================
Number of Common Shares
outstanding (1) 151,678,030 151,678,030 151,678,030
(1) Excludes 502,740 Common Shares owned by the Operating Partnership which are
eliminated in Consolidation.
</TABLE>
6
<PAGE> 7
EQUITY OFFICE PROPERTIES TRUST
NOTES TO BALANCE SHEETS
(UNAUDITED)
9. CALCULATION OF NET INCOME PER WEIGHTED AVERAGE COMMON SHARE
In February 1997, the Financial Accounting Standards Board issued
Statement No. 128, Earnings per Share ("FASB 128"), which was adopted by
the Company. Under the new requirements for calculating primary earnings
per share, the dilutive effect of stock options will be excluded.
10. SUBSEQUENT EVENTS
1) On July 7, 1997 the Company's registration statement covering the
issuance of up to 28,750,000 Common Shares in the Offering was
declared effective by the Securities and Exchange Commission.
2) On July 8, 1997, the Company's Common Shares commenced trading on the
New York Stock Exchange under the symbol "EOP".
3) On July 11, 1997, the Company consummated the Offering having sold
28,750,000 Common Shares (including 3,750,000 Common Shares relating to
the underwriters overallotment option) at $21 per Common Share
generating gross proceeds of $603,750,000. The Company contributed the
net proceeds from the Offering (after deducting the underwriting
discount of $39,243,750) of $564,506,250 to the Operating Partnership in
exchange for 28,750,000 units of partnership interest in the Operating
Partnership ("Units").
The Company used the net proceeds of the Offering and available cash
reserves to repay debt. The table below summarizes the debt held by
Equity Office Predecessors prior to the Offering which was repaid at or
shortly after the closing of the Offering.
<TABLE>
<CAPTION>
Balance at June 30, 1997 Amount Repaid Balance After Repayment
--------------------------------------------------------------------------
(in thousands)
<S> <C> <C> <C>
Mortgage debt.................... $1,944,407 $598,394 $1,346,013
Line of credit................... 272,625 80,000 192,625
-------------------------------------------------------------------------
Total........................... $2,217,032 $678,394 $1,538,638
=========================================================================
</TABLE>
Concurrent with the Offering, the Company also completed the following
formation transactions which resulted in the Consolidation of the Equity
Office Predecessors into the Company:
- - Zell/Merrill Lynch Real Estate Opportunity Partners Limited Partnership
Zell/Merrill Lynch Real Estate Opportunity Partners Limited Partnership II,
Zell/Merrill Lynch Real Estate Opportunity Partners Limited Partnership III
and Zell/Merrill Lynch Real Estate Opportunity Partners Limited Partners IV
(collectively the "ZML Opportunity Partnerships"), the predecessor owners
of the Properties, contributed their interests in the Properties to the
Operating Partnership in exchange for 126,419,397 Units.
- - ZML Investors Inc., ZML Investors II, Inc., Zell/Merrill Lynch Real Estate
Opportunity Partners III Trust and Zell/Merrill Lynch Real Estate
Opportunity Partners IV Trust (collectively the "ZML REITs") merged into
the Company, with the Company succeeding to their interests in, and
becoming the managing general partner of each of the ZML Opportunity
Partnerships. Shareholders of the ZML REITs received 122,900,572 Common
Shares of the Company in exchange for their interests in the ZML REITs.
- - Equity Group Investments, Inc., an Illinois corporation ("EGI"), and
Equity Office Holdings, L.L.C., a Delaware limited liability company
("EOH" and together with EGI, the "Equity Group") contributed
substantially all of the interests in their office property and asset
management businesses and parking facilities management business
(collectively the "Management Business") to the Operating Partnership in
exchange for 8,358,822 Units.
7
<PAGE> 8
EQUITY OFFICE PROPERTIES TRUST
NOTES TO BALANCE SHEETS
(UNAUDITED)
- - The Operating Partnership transferred the portion of the office property
management business of EOH, the office property asset management business
and the parking asset management business of the Equity Group that relates
to property management of the properties owned by the Equity Group,
together with the 18 Properties held in partnerships or subject to
participation agreements with unaffiliated parties (the "Joint Venture
Properties") (collectively the "Managed Property Business") to Equity
Office Properties Management Corp., a Delaware corporation (the "Management
Corp.") in exchange for non-voting stock representing 95% of the economic
value in the Management Corp. and EOH contributed $150,000 to the
Management Corp. in exchange for voting stock representing 5% of the
economic value of the Management Corp.
- - ZML Partners Limited Partnership, ZML Partners Limited Partnership II, ZML
Partners Limited Partnership III and ZML Partners Limited Partnership IV
(collectively the "ZML Partners"), each of which is the general partner of
one of the ZML Opportunity Partnerships, transferred their 5% interest in
certain corporations which owned a 1% general partnership interest in
certain of the property title holding entities to a newly formed qualified
REIT subsidiary ("QRS") in exchange for 26,458 Common Shares.
- - The Operating Partnership transferred its 95% interest in certain
corporations which owned a 1% general partner interest in certain of the
property title holding entities to a newly formed QRS in exchange for
502,740 Common Shares.
The tables below summarize the ownership of the Company and the Operating
Partnership upon the completion of the transactions described above:
<TABLE>
<CAPTION>
NUMBER OF
OWNERSHIP OF EQUITY OFFICE PROPERTIES TRUST: COMMON SHARES PERCENTAGE
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C>
(Current Ownership)
Original capitalization (by Mr. Zell) 1,000 -
Shares sold in the Offering...................................... 28,750,000 18.9%
Shares issued to shareholders of ZML REITs....................... 122,900,572 80.8%
Shares issued to the ZML Partners................................ 26,458 -
Shares issued to the Operating Partnership....................... 502,740 .3%
--------------------------------
Total.......................................................... 152,180,770 100.0%
================================
(Assuming all Operating Partnership Units are converted to Common
Shares):
Shares sold in the Offering...................................... 28,750,000 17.6%
Shares issued to shareholders of ZML REITs....................... 122,928,030 75.2%
Operating Partnership Units convertible to Common Shares. 11,877,647 7.2%
--------------------------------
Total.......................................................... 163,555,677 100.0%
================================
</TABLE>
8
<PAGE> 9
EQUITY OFFICE PROPERTIES TRUST
NOTES TO BALANCE SHEETS
(UNAUDITED)
<TABLE>
<CAPTION>
OWNERSHIP OF EOP OPERATING LIMITED PARTNERSHIP: NUMBER OF UNITS PERCENTAGE
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Equity Office Properties Trust (held directly)....................... 28,777,458 17.6%
Equity Office Properties Trust (held through its interests in the ZML
Opportunity Partnerships)............................................ 122,900,572 75.1%
---------------------------------
Equity Office Properties Trust subtotal.............................. 151,678,030 92.7%
ZML Partners (held through its interests in ZML Opportunity
Partnerships)........................................................ 3,229,001 2.0%
Other limited partner (held through its interest in ZML Opportunity
Partnership)......................................................... 289,824 0.2%
Equity Group Investments, Inc........................................ 3,737,438 2.3%
Equity Office Holdings, L.L.C........................................ 4,621,384 2.8%
---------------------------------
Total.............................................................. 163,555,677 100.0%
=================================
</TABLE>
4) On July 15, 1997, the Operating Partnership obtained a $600
million unsecured revolving credit facility (the "Line of Credit").
Amounts were drawn on the Line of Credit to repay the outstanding
balance on the previous line of credit which was terminated when the
Line of Credit was obtained. The Line of Credit carries an interest
rate equal to LIBOR plus 110 basis points. The Line of Credit
agreement states the interest rate will be reduced on a sliding scale,
and a competitive bid option will become available upon the Company's
ability to achieve an investment grade unsecured debt rating. The
Line of Credit matures on July 15, 2000.
5) In July, 1997, the Company purchased the unaffiliated joint
venture partners' 3% interest in First Union Center for approximately
$750,000. The Company now effectively owns 100% of First Union
Center.
6) On August 11, 1997, the Operating Partnership, through its
subsidiaries, purchased from an unaffiliated party, Adams & Wabash, a
parking facility, located in Chicago, Illinois. The purchase price
of approximately $25 million was paid from available cash reserves.
7) In August, 1997, the Company entered into a definitive
agreement with an unaffiliated party to purchase LL&E Tower, a
36-story, 545,000 square-foot office building, Texaco Center, a
32-story, 588,700 square-foot office building, and 601 Tchoupitoulas
Garage, a 9.5 story parking facility with 766 parking spaces. All
three properties are centrally located in downtown New Orleans,
Louisiana. The purchase price is approximately $140 million, of
which $91 million is debt to be assumed by the Company and $49
million will be paid in Units at a price of $29 per Unit. This
transaction is contingent upon the satisfactory completion of the
Company's due diligence and certain other terms and conditions.
There can be no assurance that this transaction will be consummated
as described above.
8) In August, 1997, the Company's Board of Trustees approved the
acquisition of the following office properties from an unaffiliated
party:
- Destec Tower, a 25-story, 573,456 square-foot
office tower in Houston, Texas;
- Brookhollow Central I, II, and III, a 795,455
square-foot office complex in suburban Houston, Texas;
- 8080 Central, a 17-story, 283,707 square-foot
office building near Dallas, Texas; and
- 1700 Market, a 32-story, 840,908 square-foot office
building in Philadelphia, Pennsylvania.
The purchase price of these properties is approximately $290 million.
These transactions are contingent upon the satisfactory completion of
the Company's due diligence and certain other terms and conditions.
There can be no assurance that this transaction will be consummated
as described above. In a separate transaction, the seller of the
foregoing properties will purchase $145 million in restricted Common
Shares for $24.50 per share.
9
<PAGE> 10
EQUITY OFFICE PROPERTIES TRUST
NOTES TO BALANCE SHEETS
(UNAUDITED)
9) In August, 1997, the Company's Board of Trustees approved the
acquisition from an unaffiliated party, of the following portfolio of
office buildings in suburban Philadelphia, Pennsylvania:
- Four Falls Corporate Center, consisting of 254,355 square-feet;
- Oak Hill Plaza, consisting of 165,575 square-feet;
- Walnut Hill Plaza, consisting of 149,716 square-feet;
- One Valley Square, consisting of 70,289 square-feet;
- Two Valley Square, consisting of 70,530 square-feet;
- Three Valley Square, consisting of 84,865 square-feet;
- Four Valley Square, consisting of 49,757 square-feet;
- Five Valley Square, consisting of 18,511 square-feet;
- One Devon Square, consisting of 77,630 square-feet;
- Two Devon Square, consisting of 63,226 square-feet;
- Three Devon Square, consisting of 6,000 square-feet.
The purchase price is approximately $144.7 million, $20 million will
be paid in Units at a price of $28.775 per Unit, the remainder will be
comprised of a combination of cash and the assumption of debt. This
transaction is contingent upon the satisfactory completion of the
Company's due diligence and certain other terms and conditions. There
can be no assurance that this transaction will be consummated as
described above.
10) The Company has entered into negotiations with an unaffiliated
party for a private debt offering of $180 million (the "Private Debt
Offering"). The terms of the Private Debt Offering consist of four
traunches with maturities from seven to ten years which will be priced
at an interest rate spread over the corresponding Treasury Rate. The
Company intends to use the proceeds of the Private Debt Offering to
repay a portion of the Line of Credit. This transaction is subject to
the satisfaction of certain conditions and contingencies. There can
be no assurance that this transaction will be consummated as described
above.
10
<PAGE> 11
EQUITY OFFICE PREDECESSORS
COMBINED BALANCE SHEETS
<TABLE>
<CAPTION>
June 30, December 31,
1997 (Unaudited) 1996
--------------- --------------
(in thousands)
<S> <C> <C>
ASSETS
Investment in real estate $ 4,074,997 $ 3,549,708
Accumulated depreciation (301,963) (257,893)
------------- ------------
3,773,034 3,291,815
Cash and cash equivalents 242,985 410,420
Rents and other receivables (net of allowance for doubtful
accounts of $3,831 and $2,724, respectively) 62,789 58,661
Escrow deposits and restricted cash 30,740 32,593
Investment in unconsolidated joint ventures 73,073 26,910
Other assets (net of accumulated amortization of $28,349 and
$21,806, respectively) 95,737 92,166
------------- ------------
TOTAL ASSETS $ 4,278,358 $ 3,912,565
============= ============
LIABILITIES AND OWNERS' EQUITY
Mortgage debt $ 1,944,407 $ 1,837,767
Revolving line of credit 272,625 127,125
Accounts payable and accrued expenses 66,213 81,995
Due to affiliates 2,831 2,074
Distribution payable 66,893 96,500
Other liabilities 31,112 29,022
------------- ------------
TOTAL LIABILITIES 2,384,081 2,174,483
------------- ------------
Commitments and contingencies (Note 10)
Minority interests 8,552 11,080
Owners' equity 1,885,725 1,727,002
------------- ------------
TOTAL LIABILITIES AND OWNERS' EQUITY $ 4,278,358 $ 3,912,565
============= ============
</TABLE>
See accompanying notes.
11
<PAGE> 12
EQUITY OFFICE PREDECESSORS
COMBINED STATEMENTS OF OPERATIONS
(Unaudited)
<TABLE>
<CAPTION>
Three months ended June 30, Six months ended June 30,
--------------------------- -------------------------
1997 1996 1997 1996
------------ ------------ ----------- -----------
(in thousands)
<S> <C> <C> <C> <C>
Revenues:
Rental $ 125,318 $ 89,585 $ 241,736 $ 176,970
Tenant reimbursements 21,069 13,561 40,256 27,136
Parking 10,420 6,387 19,950 12,229
Other 2,934 3,599 6,270 4,442
Fees from noncombined affiliates 1,240 1,468 2,440 2,240
Interest 4,238 2,370 9,134 4,103
--------- ---------- ---------- ----------
Total revenues 165,219 116,970 319,786 227,120
--------- ---------- ---------- ----------
Expenses:
Interest 39,946 27,744 76,301 54,011
Depreciation 27,656 19,679 52,661 38,334
Amortization 4,672 2,680 7,748 5,198
Real estate taxes and insurance 16,421 13,239 34,489 27,081
Repairs and maintenance 23,688 17,221 43,128 31,176
Property operating 21,852 16,650 42,492 32,673
General and administrative 7,653 5,214 14,726 11,270
--------- ---------- ---------- ----------
Total expenses 141,888 102,427 271,545 199,743
--------- ---------- ---------- ----------
Income before allocation to minority interests, income
from investment in unconsolidated joint ventures,
gain on sale of real estate and extraordinary items 23,331 14,543 48,241 27,377
Minority interests (350) (1,088) (879) (1,698)
Income from unconsolidated joint ventures 1,103 585 2,025 1,077
Gain on sale of real estate 6,769 - 12,510 5,262
--------- ---------- ---------- ----------
Income before extraordinary items 30,853 14,040 61,897 32,018
Extraordinary items - - (275) -
--------- ---------- ---------- ----------
Net income $ 30,853 $ 14,040 $ 61,622 $ 32,018
========= ========== ========== ==========
</TABLE>
See accompanying notes.
12
<PAGE> 13
EQUITY OFFICE PREDECESSORS
COMBINED STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
<CAPTION>
Six months ended June 30,
---------------------------
1997 1996
----------- -----------
(in thousands)
<S> <C> <C>
OPERATING ACTIVITIES:
Net income $ 61,622 $ 32,018
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 60,409 43,532
(Income) from unconsolidated joint ventures (2,025) (1,077)
(Gain) on sale of real estate (12,510) (5,262)
Extraordinary loss from early extinguishments of debt 275 -
Provision for doubtful accounts 1,168 205
Allocation to minority interests 879 1,698
Changes in assets and liabilities:
(Increase) in rents receivable (5,390) (3,994)
(Increase) in other assets (820) (342)
(Decrease) in accounts payable and accrued expenses (15,782) (8,122)
Increase in due to affiliates 757 277
Increase (decrease) in other liabilities 2,090 (4,288)
---------- -----------
Net cash provided by operating activities 90,673 54,645
---------- -----------
INVESTING ACTIVITIES:
Property acquisitions (531,968) (185,636)
Payments for capital and tenant improvements (61,352) (44,709)
Proceeds from sale of real estate 72,078 14,502
(Investments in) distributions from unconsolidated joint ventures (44,138) 686
Payments of lease acquisition costs (9,106) (7,285)
Decrease in escrow deposits and restricted cash 1,853 348
---------- -----------
Net cash (used for) investing activities (572,633) (222,094)
---------- -----------
FINANCING ACTIVITIES:
Capital contributions 287,949 74,175
Capital distributions (220,455) (12,367)
(Distributions to) minority interest partners (3,407) (21,024)
Proceeds from mortgage notes 154,090 325,548
Proceeds from revolving lines of credit 218,000 -
Principal payments on mortgage notes (47,450) (72,653)
Principal payments on revolving line of credit (72,500) (76,000)
Payments of loan costs (1,427) (1,702)
Prepayment penalties on early extinguishments of debt (275) -
---------- -----------
Net cash provided by financing activities 314,525 215,977
---------- -----------
Net (decrease) increase in cash and cash equivalents (167,435) 48,528
Cash and cash equivalents at the beginning of the period 410,420 111,121
---------- -----------
Cash and cash equivalents at the end of the period $ 242,985 $ 159,649
========== ===========
Supplemental information:
Interest paid during the period, including capitalized interest of
$3,476 and $1,837, respectively $ 77,589 $ 55,552
========== ===========
</TABLE>
See accompanying notes.
13
<PAGE> 14
EQUITY OFFICE PREDECESSORS
NOTES TO COMBINED FINANCIAL STATEMENTS
(UNAUDITED)
1. BUSINESS AND ORGANIZATION
Business
Equity Office Predecessors was engaged in acquiring, owning, managing,
leasing, and renovating office properties and parking facilities throughout the
United States. The Management Business included activities related to both the
management of Properties owned by Equity Office Predecessors as well as
properties which were owned by entities affiliated with Equity Office
Predecessors. The Company is the successor to the business of Equity Office
Predecessors.
Organization
Equity Office Predecessors is not a legal entity, but rather a combination
of the Properties of the ZML Opportunity Partnerships together with their
limited and general partners (collectively, the "ZML Funds" which includes ZML
Fund I, ZML Fund II, ZML Fund III and ZML Fund IV), and the Management Business
of the Equity Group that were combined into the Company pursuant to the
Consolidation and the Offering. The combined financial statements include all
the direct and indirect costs of the business of Equity Office Predecessors.
The business of the apartment and retail properties owned by the ZML Funds (the
"Non-Office Properties") have not been included in these combined financial
statements.
2. BASIS OF PRESENTATION
The combined financial statements have been presented on a combined basis,
at historical cost, because the ZML Funds and the Management Business were
under the common control and management of the owners of the Equity Group
through general partnership interests in the ZML Funds and through their
ownership of the Management Business. Minority interests have been recorded
for those entities that were not wholly owned by the ZML Funds. Where
controlling interests were not held by the ZML Funds, the entities were
accounted for as investments in unconsolidated joint ventures utilizing equity
accounting. All significant intercompany transactions and balances have been
eliminated in combination.
These unaudited combined financial statements of Equity Office
Predecessors have been prepared pursuant to the Securities and Exchange
Commission ("SEC") rules and regulations. The following notes to combined
financial statements highlight significant changes to the notes to the December
31, 1996 audited combined financial statements included in the Prospectus and
present interim disclosures as required by the SEC.
3. USE OF ESTIMATES
The preparation of the combined financial statements in accordance with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the amounts reported in the balance sheets and
accompanying notes. Actual results could differ from those estimates.
14
<PAGE> 15
EQUITY OFFICE PREDECESSORS
NOTES TO COMBINED FINANCIAL STATEMENTS
(UNAUDITED)
4. UNAUDITED INTERIM STATEMENT
The combined financial statements as of June 30, 1997 and for the three and
six months ended June 30, 1997 and 1996 are unaudited. In the opinion of
management, such financial statements reflect all adjustments necessary for a
fair presentation of the results of the interim periods. All such adjustments
are of a normal, recurring nature.
5. INVESTMENT IN RENTAL PROPERTY AND UNCONSOLIDATED JOINT VENTURES
During the quarter ended June 30, 1997, Equity Office Predecessors
acquired the six Properties listed below. Each Property was purchased from an
unaffiliated party. The cash portion of these transactions was funded
primarily from amounts drawn on a line of credit.
<TABLE>
<CAPTION>
Total Total
Date Square Acquisition Cost
Acquired Property Location Feet (1) (in thousands)
- ----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
4/16/97 Oakbrook Terrace Tower Oakbrook Terrace, IL 772,928 $130,107,800
4/16/97 50% Interest in Civic St. Louis, MO 7,464 (2) 45,024,100
Parking, L.L.C.
4/21/97 One Maritime Plaza San Francisco, CA 523,929 99,388,800
4/28/97 Smith Barney Tower San Diego, CA 186,607 35,148,400
4/30/97 201 Mission Street San Francisco, CA 483,289 74,706,500
6/13/97 30 N. LaSalle Chicago, IL 925,950 100,706,500
------------
Total $485,082,100
============
</TABLE>
(1) Total square feet of Office Properties acquired in the three months ended
June 30, 1997, excluding any Parking Facilities, was 2,892,703.
(2) Represents the number of parking spaces.
6. DISPOSITION OF RENTAL PROPERTIES
On May 12, 1997, Equity Office Predecessors sold 8383 Wilshire, an Office
Property located in Beverly Hills, California for a sales price of
approximately $59 million. The gain for financial reporting purposes was
approximately $6.6 million.
15
<PAGE> 16
EQUITY OFFICE PREDECESSORS
NOTES TO COMBINED FINANCIAL STATEMENTS
(UNAUDITED)
7. INVESTMENT IN UNCONSOLIDATED JOINT VENTURES
Equity Office Predecessors acquired a mortgage receivable secured by the
500 Orange Tower office property ("500 Orange") and purchased land underlying
and adjacent to 500 Orange in July 1994, and acquired a 50% limited partnership
interest in Civic Parking, L.L.C. in April 1997. The transactions were
accounted for utilizing the equity method of accounting. Under this method of
accounting, the net equity investment of Equity Office Predecessors is
reflected on the combined balance sheets, and the combined statements of
operations include Equity Office Predecessors' share of net income or loss
from 500 Orange and Civic Parking, L.L.C. The Company's share of net income or
loss from 500 Orange and Civic Parking, L.L.C. is 100% and 50%, respectively.
Selected balance sheets and statements of operations data for Equity Office
Predecessors' interest in 500 Orange and Civic Parking, L.L.C. are as follows:
<TABLE>
<CAPTION>
-----------------------------------------------------------
500 ORANGE TOWER CIVIC PARKING, L.L.C.
-----------------------------------------------------------
JUNE 30, DEC. 31, JUNE 30, DEC. 31,
1997 1996 1997 1996
-----------------------------------------------------------
(IN THOUSANDS) (Note A)
ASSETS:
<S> <C> <C> <C> <C>
Investment in real estate, net............................ $26,825 $26,555 $45,595 -
Cash and cash equivalents................................. (4) 147 1,398 -
Rents and other receivables............................... 50 150 97 -
Other assets.............................................. 646 720 26 -
-----------------------------------------------------------
TOTAL ASSETS............................................ $27,517 $27,572 $47,116 -
===========================================================
LIABILITIES AND OWNERS' EQUITY:
Accounts payable and accrued expenses..................... $ 920 $ 364 $ 254 -
Due to affiliates......................................... 24 19 35 -
Other liabilities......................................... 310 279 17 -
-----------------------------------------------------------
TOTAL LIABILITIES....................................... 1,254 662 306 -
-----------------------------------------------------------
Owners' equity............................................ 26,263 26,910 46,810 -
-----------------------------------------------------------
TOTAL LIABILITIES AND OWNERS' EQUITY.................... $27,517 $27,572 $47,116 -
===========================================================
</TABLE>
16
<PAGE> 17
EQUITY OFFICE PREDECESSORS
NOTES TO COMBINED FINANCIAL STATEMENTS
(UNAUDITED)
<TABLE>
<CAPTION>
500 ORANGE TOWER CIVIC PARKING, L.L.C.
--------------------------------------------------------------
THREE MONTHS ENDED THREE MONTHS ENDED
--------------------------------------------------------------
JUNE 30, JUNE 30, JUNE 30, JUNE 30,
1997 1996 1997 1996
--------------------------------------------------------------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Revenues: (Note A)
Rental......................... $1,273 $1,264 $ 125 -
Tenant reimbursements.......... (90) 40 - -
Parking........................ - - 973 -
Other.......................... 19 3 - -
--------------------------------------------------------------
Total revenues............... 1,202 1,307 1,098 -
--------------------------------------------------------------
Expenses:
Interest....................... 23 - - -
Depreciation................... 329 239 215 -
Amortization................... 60 32 - -
Real estate taxes and
insurance.................... 109 102 97 -
Repairs and
maintenance.................. 185 176 1 -
Property operating............. 178 173 - -
--------------------------------------------------------------
Total expenses............... 884 722 313 -
--------------------------------------------------------------
Net income....................... $ 318 $ 585 $ 785 -
==============================================================
<CAPTION>
500 ORANGE TOWER CIVIC PARKING, L.L.C.
--------------------------------------------------------------
SIX MONTHS ENDED SIX MONTHS ENDED
--------------------------------------------------------------
JUNE 30, JUNE 30, JUNE 30, JUNE 30,
1997 1996 1997 1996
--------------------------------------------------------------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Revenues: (Note A)
Rental......................... $2,506 $2,338 $ 125 -
Tenant reimbursements.......... (83) 59 - -
Parking........................ - - 973 -
Other.......................... 26 10 - -
--------------------------------------------------------------
Total revenues............... 2,449 2,407 1,098 -
--------------------------------------------------------------
Expenses:
Interest....................... 23 - - -
Depreciation................... 514 401 215 -
Amortization................... 85 39 - -
Real estate taxes and
insurance.................... (70) 255 97 -
Repairs and maintenance........ 334 324 1 -
Property operating............. 323 311 - -
--------------------------------------------------------------
Total expenses............... 1,209 1,330 313 -
--------------------------------------------------------------
Net income....................... $1,240 $1,077 $ 785 -
==============================================================
</TABLE>
Note A: The balance sheet data as of December 31, 1996 and operational data
for the three and six months ended June 30, 1996 is not applicable since
Civic Parking, L.L.C. was not owned by Equity Office Predecessors at or
during these periods.
17
<PAGE> 18
EQUITY OFFICE PREDECESSORS
NOTES TO COMBINED FINANCIAL STATEMENTS
(UNAUDITED)
8. OWNERS' EQUITY
As of June 30, 1997, the capital partners of the four ZML Funds previously
committed to contribute approximately $2,113,947,500, of which approximately
$2,031,285,800 had been cumulatively contributed by capital partners and
approximately $82,661,700 of the commitment had been canceled. In April, 1997,
the capital partners contributed approximately $136,390,000, which is included
in the $2,031,285,800 cumulative contributions.
As of June 30, 1997, the ZML Funds had cumulatively declared or
distributed approximately $305,939,200 to their capital partners.
9. MORTGAGE NOTES PAYABLE AND LINE OF CREDIT
In May, 1997, Equity Office Predecessors obtained financing for the
Capital Commons Garage in the amount of $4,500,000. The term of the loan is 10
years with a fixed interest rate of 7.83% and with scheduled principal and
interest payments due monthly. Also in May, 1997, Equity Office Predecessors
repaid the outstanding mortgage indebtedness and accrued interest of
approximately $14,941,800 which collateralized the Denver Corporate Center
Towers II and III.
As of June 30, 1997, Equity Office Predecessors had outstanding mortgage
indebtedness of approximately $1.9 billion encumbering 76 of the Properties.
The carrying value of such Properties (net of accumulated depreciation of $280
million) was approximately $2.9 billion. In addition, Equity Office
Predecessors had $272.6 million outstanding on its line of credit facility.
Subsequent to June 30, 1997, the Company repaid $598.4 million of mortgage
indebtedness on 28 of the Properties and $80 million on the line of credit from
proceeds of the Offering and available cash reserves.
In order to limit the market risk associated with variable rate debt,
Equity Office Predecessors entered into several interest rate protection
agreements. These agreements effectively convert floating rate debt to a fixed
rate basis, as well as hedge anticipated financing transactions. Net amounts
paid or received under these agreements are recognized as an adjustment to
interest expense when such amounts are incurred or earned. Settlement amounts
paid or received under these agreements are deferred and amortized over the
term of the related financing transaction on the straight-line method which
approximates the effective yield method. In June, 1997, Equity Office
Predecessors executed various interest rate protection agreements for $700
million of indebtedness. The agreements are composed of various traunches with
various interest rates and maturities. The weighted average interest rate is
approximately 6.71% and the weighted average maturity is 5.21 years.
10. COMMITMENTS AND CONTINGENCIES
ZML-Chicago Parking Limited Partnership ("ZCP") and ZML-North Loop/Theatre
District Parking Limited Partnership ("NLT"), were named as defendants in an
action (the "Action") brought by an investor (the "Plaintiff") in an
unaffiliated entity owning an interest in NLT. The Action was brought in the
Circuit Court of Cook County, Illinois, Chancery Division, on August 15, 1995.
NLT is the owner of two Parking Facilities, North Loop Transportation Center
and Theatre District Self Park ("Theatre District Garage"). The Plaintiff
demands rescission of certain transactions related to the acquisition by NLT of
the Theatre District Garage. A sustained judgment in favor of the Plaintiff
could result in the loss of the Company's interest in the Theatre
District Garage. This action is in its discovery stage. Although the outcome
cannot be predicted with any certainty, the Company believes that ZCP and NLT
have meritorious defenses to all asserted claims and that Equity Office
Predecessors will not incur a loss in connection with the Action.
18
<PAGE> 19
EQUITY OFFICE PREDECESSORS
NOTES TO COMBINED FINANCIAL STATEMENTS
(UNAUDITED)
Except as described above, management of the Company does not believe
there is any litigation threatened against the Company other than routine
litigation arising out of the ordinary course of business, some of which is
expected to be covered by liability insurance, and none of which is expected to
have a material adverse effect on the combined financial statements of the
Company.
11. SUBSEQUENT EVENTS
1) On July 7, 1997, the Company's registration statement covering the
issuance of up to 28,750,000 Common Shares in the Offering was
declared effective by the SEC.
2) On July 8, 1997, the Company's Common Shares commenced
trading on the New York Stock Exchange under the symbol "EOP".
3) On July 11, 1997, the Company consummated the Offering having
sold 28,750,000 Common Shares (including 3,750,000 Common Shares
relating to the underwriters' overallotment option) at $21 per
Common Share generating gross proceeds of $603,750,000. The Company
contributed the net proceeds from the Offering (after deducting the
underwriting discount of $39,243,750) of $564,506,250 to the
Operating Partnership in exchange for 28,750,000 Units.
19
<PAGE> 20
EQUITY OFFICE PREDECESSORS
PART I - FINANCIAL INFORMATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
The following discussion and analysis of the combined financial condition
and results of operations should be read in conjunction with the Combined
Financial Statements of the Equity Office Predecessors and Notes thereto
contained herein. All references to the historical activities of the Company
contained in this "Management's Discussion and Analysis of Financial Condition
and Results of Operations" refer to the activities of the Equity Office
Predecessors. Statements contained in this "Management's Discussion and
Analysis of Financial Conditions and Results of Operations," which are not
historical facts may be forward-looking statements. Such statements are subject
to certain risks and uncertainties which could cause actual results to differ
materially from those projected. Readers are cautioned not to place undue
reliance on these forward-looking statements which speak only as of the date
hereof.
GENERAL
The following discussion is based primarily on the Combined Financial
Statements of the Equity Office Predecessors as of June 30, 1997 and December
31, 1996 and the three and six month periods ended June 30, 1997 and 1996.
The Company receives income primarily from rental revenue from Office
Properties (including reimbursements from tenants for certain operating costs),
parking revenue from Office Properties and stand alone Parking Facilities, and,
to a lesser extent, from fees from noncombined affiliates for the management of
properties not owned by the Company (the "Managed Properties").
As of June 30, 1997, the Company owned or had an interest in 90 Office
Properties totaling approximately 32.2 million square feet, and 14 stand alone
Parking Facilities with approximately 14,785 spaces (the "Total Portfolio"). Of
the Total Portfolio, 71 of these Office Properties totaling approximately 22.6
million square feet and three Parking Facilities were acquired prior to January
1, 1996; 10 Office Properties totaling approximately 6.1 million square feet
and seven Parking Facilities were acquired in 1996; and nine Office Properties
totaling approximately 3.5 million square feet and an interest in four Parking
Facilities were acquired during the six months ended June 30, 1997. As a
result of this rapid growth in the size of the Total Portfolio, the financial
data presented shows large increases in revenues and expenses from year to
year. For the foregoing reasons, the Company does not believe its period to
period financial data are comparable. Therefore, the analysis below shows
changes resulting from Properties that were held during the entire period for
the periods being compared (the "Core Portfolio") and the changes in Total
Portfolio. The Core Portfolio for the comparison between the six months ended
June 30, 1997 and 1996 consists of 71 Office Properties and three Parking
Facilities acquired prior to January 1, 1996. The Core Portfolio for the
comparison between the three months ended June 30, 1997 and 1996 consists of
the 72 Office Properties and three Parking Facilities acquired prior to April
1, 1996. In both cases the Core Portfolio excludes Barton Oaks Plaza II, a
118,529 square foot Office Property, which was sold in January 1997, and 8383
Wilshire, a 417,463 square foot Office Property, which was sold in May
1997.
20
<PAGE> 21
EQUITY OFFICE PREDECESSORS
PART I - FINANCIAL INFORMATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
COMPARISON OF THREE MONTHS ENDED JUNE 30, 1997 TO THREE MONTHS ENDED
JUNE 30, 1996.
The table below presents selected operating information for the Total
Portfolio and for the Core Portfolio.
<TABLE>
<CAPTION>
Total Portfolio Core Portfolio
---------------------------------------------- ----------------------------------------------
Increase/ % Increase/ %
1997 1996 (Decrease) Change 1997 1996 (Decrease) Change
---------------------------------------------- ----------------------------------------------
($ in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Property Revenues $ 159,741 $ 113,132 $46,609 41.2% $ 112,396 $ 109,977 $ 2,419 2.2%
Interest income 4,238 2,370 1,868 78.8% n/a n/a n/a n/a
Fees from noncombined affiliates 1,240 1,468 (228) (15.5%) n/a n/a n/a n/a
---------------------------------------------- ----------------------------------------------
Total revenues 165,219 116,970 48,249 41.2% 112,396 109,977 2,419 2.2%
---------------------------------------------- ----------------------------------------------
Interest expense 39,946 27,744 12,202 44.0% 29,618 27,499 2,119 7.7%
Depreciation and amortization 32,328 22,359 9,969 44.6% 23,995 21,227 2,768 13.0%
Property Operating Expenses 61,961 47,110 14,851 31.5% 45,142 45,542 (400) (0.9%)
General and administrative 7,653 5,214 2,439 46.8% n/a n/a n/a n/a
---------------------------------------------- ----------------------------------------------
Total expenses 141,888 102,427 39,461 38.5% 98,755 94,268 4,487 4.8%
---------------------------------------------- ----------------------------------------------
Income before allocation to
minority interests, income from
investment in unconsolidated
joint ventures, gain on sale of
real estate and extraordinary items 23,331 14,543 8,788 60.4% 13,641 15,709 (2,068) (13.2%)
Minority interests (350) (1,088) 738 67.8% (350) (1,088) 738 67.8%
Income from unconsolidated joint
ventures 1,103 585 518 88.5% 317 585 (268) (45.8%)
Gain on sale of real estate and
extraordinary items 6,769 - 6,769 - - - - -
---------------------------------------------- ----------------------------------------------
Net Income $ 30,853 $ 14,040 $16,813 119.8% $ 13,608 $ 15,206 $(1,598) (10.5%)
============================================== ==============================================
Property Revenues less Property
Operating Expenses $ 97,780 $ 66,022 $31,758 48.1% $ 67,254 $ 64,435 $ 2,819 4.4%
============================================== ==============================================
</TABLE>
Property Revenues
The increase in rental revenues, tenant reimbursements, parking income and
other income ("Property Revenues") in the Core Portfolio resulted from a
combination of occupancy and rental rate increases. The weighted average
occupancy of the Core Portfolio increased from approximately 90.0% at April 1,
1996 to 94.3% as of June 30, 1997. This increase represents approximately 1.0
million square feet of additional occupancy in the Core Portfolio between April
1, 1996 and June 30, 1997. Included in Property Revenues for the Core
Portfolio are lease termination fees of $0.4 million and $3.0 million for the
three months ended June 30, 1997 and 1996, respectively (these are included in
the other revenues category on the combined statement of operations). These
fees are related to specific tenants who have paid a fee to terminate their
lease obligations before the end of the contractual term of the lease.
Although the Company has historically experienced similar levels of such
termination fees, there is no way of predicting the timing or amounts of future
lease termination fees. Certain of the Company's Properties provide for tenant
occupancy during periods for which no rent is due or where minimum rent
payments increase during the term of the lease. The Company records rental
revenue for the full term of each lease on a straight-line basis. The
straight-line rent adjustment which is included in rental revenues for the Core
Portfolio
21
<PAGE> 22
EQUITY OFFICE PREDECESSORS
PART I - FINANCIAL INFORMATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
for the three months ended June 30, 1997 and 1996, was approximately
$1.6 million and $4.3 million, respectively. The straight-line rent adjustment
which is included in rental revenues for the Total Portfolio for the three
months ended June 30, 1997 and 1996 is approximately $3.8 million and 4.3
million, respectively.
Interest Income
Interest income for the Total Portfolio increased by $1.8 million to $4.2
million for the three months ended June 30, 1997, compared to $2.4 million for
the three months ended June 30, 1996. This increase in interest income is due
primarily to having a larger amount of cash invested in short term investments
pending the purchase of new acquisitions. Prior to the Consolidation, each of
the entities involved in the Consolidation needed to maintain separate cash
reserves which in the aggregate were higher than cash reserves the Company
anticipates maintaining going forward. Due to the availability of the Line of
Credit obtained by the Operating Partnership on July 15, 1997, and other
changes in the capital structure of the Company, the Company anticipates that
it will maintain cash reserves of $25 to $50 million (although the cash
balance may at times be more or less in anticipation of pending acquisitions or
other transactions). Cash available above this reserve amount will be used to
repay the Line of Credit. The lower cash balance will result in lower interest
income in future periods, however, this loss in income should be offset by
savings on the Line of Credit.
Fees from Non-combined Affiliates
Fees from non-combined affiliates decreased slightly and are expected to
decrease in future periods as the Managed Properties are sold.
Interest Expense
Interest expense increased $12.2 million for the Total Portfolio to $39.9
million for the three months ended June 30,1997 compared to $27.7 million for
the three months ended June 30, 1996. This increase was primarily the result
of increased debt obtained to finance acquisitions. At or shortly after the
closing of the Offering, the Company repaid approximately $598.4 million of
mortgage debt (of which $544 million was secured by properties in the Core
Portfolio) and repaid $80 million on a line of credit. Interest expense related
to the $598.4 million of secured debt repaid was approximately $10.2 million
and $10.0 million for the three months ended June 30, 1997 and 1996,
respectively. Interest expense related to the $80 million repaid on a line of
credit was approximately $1.6 million (an equivalent amount was not outstanding
for the prior period). Due to these debt repayments, interest expense is
initially expected to decrease in future periods, and then anticipated to
increase as the Company acquires additional properties and incurs additional
financing.
Depreciation and Amortization
The increase in depreciation and amortization in the Core Portfolio was related
to depreciation of capital and tenant improvements made at the Core Portfolio
Properties in 1996 and 1997, and the amortization of leasing commissions and
loan fees paid during that time period.
Property Operating Expenses
The decrease in real estate taxes and insurance, repairs and maintenance, and
property operating expenses ("Property Operating Expenses") in the Core
Portfolio relates primarily to a decrease in real estate taxes, which resulted
from real estate tax refunds recorded in the three months ended June 30, 1997,
partially offset by an increase in maintenance expenses.
General and Administrative Expenses
General and administrative expenses
increased by approximately $2.5 million, to $7.7 million for the three months
ended June 30, 1997, compared to $5.2 million for the three months ended June
30, 1996. General and administrative expenses as a percentage of total
revenues was approximately 4.6% and 4.5% for the three months ended June 30,
1997 and 1996, respectively. The reasons for the increase in general and
administrative expenses are the significant increase in the size of the
Company's portfolio and increased expenses associated with becoming a public
company. While general and administrative expenses will continue to increase
as the size of the Company's portfolio increases, it is anticipated that
general and administrative expenses as a percentage of total revenue will
initially remain stable, (or increase slightly), as the full costs of running a
public company are reflected in operations, and then decrease over time as the
Company realizes increased economies of scale.
22
<PAGE> 23
EQUITY OFFICE PREDECESSORS
PART I - FINANCIAL INFORMATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
COMPARISON OF SIX MONTHS ENDED JUNE 30, 1997 TO SIX MONTHS ENDED JUNE 30, 1996.
The table below presents selected operating information for the Total Portfolio
and for the Core Portfolio.
<TABLE>
<CAPTION>
Total Portfolio Core Portfolio
---------------------------------------- -----------------------------------------
Increase/ % Increase/ %
1997 1996 (Decrease) Change 1997 1996 (Decrease) Change
---------------------------------------- ------------------------------------------
($ in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Property Revenues $ 308,212 $ 220,777 $ 87,435 39.6% $ 219,228 $ 210,039 $ 9,189 4.4%
Interest income 9,134 4,103 5,031 122.6% n/a n/a n/a n/a
Fees from noncombined affiliates 2,440 2,240 200 8.9% n/a n/a n/a n/a
---------------------------------------- -----------------------------------------
Total revenues 319,786 227,120 92,666 40.8% 219,228 210,039 9,189 4.4%
---------------------------------------- -----------------------------------------
Interest expense 76,301 54,011 22,290 41.3% 57,975 53,401 4,574 8.6%
Depreciation and amortization 60,409 43,532 16,877 38.8% 45,047 40,976 4,071 9.9%
Property Operating Expenses 120,109 90,930 29,179 32.1% 87,390 85,721 1,669 1.9%
General and administrative 14,726 11,270 3,456 30.7% n/a n/a n /a n/a
---------------------------------------- -----------------------------------------
Total expenses 271,545 199,743 71,802 35.9% 190,412 180,098 10,314 5.7%
---------------------------------------- -----------------------------------------
Income before allocation to minority interests,
income from investment in unconsolidated
joint ventures, gain on sale of real estate and
extraordinary items 48,241 27,377 20,864 76.2% 28,816 29,941 (1,125) (3.8%)
Minority interests (879) (1,698) 819 48.2% (715) (1,698) 983 57.9%
Income from unconsolidated joint ventures 2,025 1,077 948 88.0% 1,239 1,077 162 15.0%
Gain on sale of real estate and extraordinary
items 12,235 5,262 6,973 132.5% - - - -
---------------------------------------- -----------------------------------------
Net Income $ 61,622 $32,018 $ 29,604 92.5% $ 29,340 $ 29,320 $ 20 0.1%
======================================== =========================================
Property Revenues less Property Operating
Expenses $ 188,103 $ 129,847 $ 58,256 44.9% $ 131,838 $124,318 $ 7,520 6.0%
======================================== =========================================
</TABLE>
Property Revenues
The increase in Property Revenues in the Core Portfolio resulted from a
combination of occupancy and rental rate increases. The weighted average
occupancy of the Core Portfolio increased from approximately 88.5% at January
1, 1996 to 94.3% as of June 30, 1997. This increase represents approximately
1.3 million square feet of additional occupancy in the Core Portfolio between
January 1, 1996 and June 30, 1997. Included in Property Revenues for the Core
Portfolio are lease termination fees of $2.6 million and $3.3 million for the
six months ended June 30, 1997 and 1996, respectively (these amounts are
included in the other revenue category on the combined statement of
operations). These fees are related to specific tenants who have paid a fee to
terminate their lease obligations before the end of the contractual term of the
lease. Although the Company has historically experienced similar levels of
such termination fees, there is no way of predicting the timing or amounts of
future lease termination fees. The straight-line rent adjustment which is
included in rental revenues for the Core Portfolio for the six months ended June
30, 1997 and 1996, was approximately $3.7 million and $6.4 million,
respectively. The straight-line rent adjustment which is included in rental
revenues for the Total Portfolio for the six months ended June 30, 1997 and
1996, was approximately $7.7 million and $8.0 million, respectively.
Interest Income
Interest income for the Total Portfolio increased by $5.0 million to $9.1
million for the six months ended June 30, 1997, compared to $4.1 million for
the six months ended June 30, 1996. This increase in interest income is due
primarily to having a larger amount of cash invested in short term investments
pending the purchase of new acquisitions. Prior to the Consolidation, each of
the entities involved in the Consolidation needed to maintain separate cash
reserves which in the aggregate were higher than cash reserves the Company
anticipates maintaining going forward. Due to the availability of borrowings
under the Line of Credit and other changes in the capital
23
<PAGE> 24
EQUITY OFFICE PREDECESSORS
PART I - FINANCIAL INFORMATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
structure of the Company, the Company anticipates that it will maintain cash
reserves of $25 to $50 million (although the cash balance may at times be more
or less in anticipation of pending acquisitions or other transactions). The
lower cash balance will result in lower interest income in future periods,
however, this loss in income should be offset by savings on the Line of Credit.
Fees from Non-combined Affiliates
Although fees from non-combined affiliates increased slightly, they are
expected to decrease in future periods as the Managed Properties are sold.
Interest Expense
Interest expense increased $22.3 million for the Total Portfolio to $76.3
million for the six months ended June 30, 1997 compared to $54 million for the
six months ended June 30, 1996. This increase was primarily the result of
increased debt obtained to finance acquisitions. At or shortly after the
closing of the Offering, the Company repaid approximately $598.4 million of
mortgage debt (of which $544 million was secured by Properties in the Core
Portfolio) and repaid $80 million on the Line of Credit. Interest expense
related to the $598.4 million of secured debt repaid was approximately $20.2
million and $19.9 million for the six months ended June 30, 1997 and 1996,
respectively. Interest expense related to the $80 million repaid on the Line
of Credit was approximately $3.2 million (an equivalent amount was not
outstanding for the prior period). Due to these debt repayments, interest
expense is initially expected to decrease in future periods, and then
anticipated to increase as the Company acquires additional properties and
incurs additional financing.
Depreciation and Amortization
The increase in depreciation and amortization in the Core Portfolio was related
to depreciation of capital and tenant improvements made at the Core Portfolio
Properties in 1996 and 1997, and the amortization of leasing commissions and
loan fees paid during that time period.
Property Operating Expenses
The increase in Property Operating Expenses relates primarily to an increase
in maintenance expenses offset in part by a decrease in real estate taxes,
which was caused by real estate tax refunds recorded in the six months ended
June 30, 1997.
General and Administrative General and administrative expenses increased by
approximately $3.4 million to $14.7 million for the six months ended June 30,
1997, compared to $11.3 million for the six months ended June 30, 1996.
General and administrative expenses as a percentage of total revenues was
approximately 4.6% and 5.0% for the six months ended June 30, 1997 and 1996,
respectively. The primary reasons for the increase in general and
administrative expenses are the significant increase in the size of the
Company's portfolio and increased expenses associated with becoming a public
company. While general and administrative expenses will continue to increase
as the size of the Company's portfolio increases, it is anticipated that
general and administrative expenses as a percentage of total revenues will
initially remain stable, (or increase slightly), as the full costs of running
a public company are reflected in operations, and then decrease over time as
the Company realizes increased economies of scale.
24
<PAGE> 25
EQUITY OFFICE PREDECESSORS
PART I - FINANCIAL INFORMATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
PARKING OPERATIONS
Included in the numbers above are results of operations from Parking
Facilities, the summarized information for which is presented below.
Comparison of three months ended June 30, 1997 to three months ended June 30,
1996.
<TABLE>
<CAPTION>
Total Parking Portfolio Core Parking Portfolio
------------------------------------- -------------------------------------
Increase/ % Increase/ %
1997 1996 (Decrease) Change 1997 1996 (Decrease) Change
------------------------------------- -------------------------------------
($ in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Property Revenues $5,322 $2,446 $2,876 117.6% $2,526 $2,446 $ 80 3.3%
Interest income 49 31 18 58.1% n/a n/a n/a n/a
------------------------------------- -------------------------------------
Total revenues 5,371 2,477 2,894 116.8% 2,526 2,446 80 3.3%
------------------------------------- -------------------------------------
Interest expense 813 412 401 97.3% 696 412 284 68.9%
Depreciation and amortization 819 333 486 145.9% 352 333 19 5.7%
Property Operating Expenses 1,204 849 355 41.8% 731 849 (118) (13.9%)
------------------------------------- -------------------------------------
Total expenses 2,836 1,594 1,242 77.9% 1,779 1,594 185 11.6%
------------------------------------- -------------------------------------
Income before allocation to
minority interests and
income from investment in
unconsolidated joint
ventures 2,535 883 1,652 187.1% 747 852 (105) (12.3%)
Minority interests (62) (42) (20) (47.6%) (62) (42) (20) (47.6%)
Income from unconsolidated
joint ventures 786 - 786 - - - - -
------------------------------------- -------------------------------------
Net Income $3,259 $ 841 $2,418 287.5% $ 685 $ 810 $ (125) (15.4%)
===================================== =====================================
Property Revenues less
Property Operating Expenses $4,118 $1,597 $2,521 157.9% $1,795 $1,597 $ 198 12.4%
===================================== =====================================
</TABLE>
25
<PAGE> 26
EQUITY OFFICE PREDECESSORS
PART I - FINANCIAL INFORMATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Comparison of six months ended June 30, 1997 to six months ended June 30, 1996.
<TABLE>
<CAPTION>
Total Parking Portfolio Core Parking Portfolio
------------------------------------- ------------------------------------
Increase/ % Increase/ %
1997 1996 (Decrease) Change 1997 1996 (Decrease) Change
------------------------------------- ------------------------------------
($ in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Property Revenues $ 9,972 $4,936 $5,036 102.0% $5,000 $4,936 $ 64 1.3%
Interest income 114 53 61 115.1% n/a n/a n/a n/a
------------------------------------- ------------------------------------
Total revenues 10,086 4,989 5,097 102.2% 5,000 4,936 64 1.3%
------------------------------------- ------------------------------------
Interest expense 2,071 826 1,245 150.7% 1,275 826 449 54.4%
Depreciation and amortization 1,635 667 968 145.1% 699 667 32 4.8%
Property Operating Expenses 2,387 1,584 803 50.7% 1,443 1,584 (141) (8.9%)
------------------------------------- ------------------------------------
Total expenses 6,093 3,077 3,016 98.0% 3,417 3,077 340 11.0%
------------------------------------- ------------------------------------
Income before allocation to
minority interests, and
income from investment in
unconsolidated joint
ventures 3,993 1,912 2,081 108.8% 1,583 1,859 (276) (14.8%)
Minority interests (122) (206) 84 40.8% (122) (206) 84 40.8%
Income from unconsolidated
joint ventures 786 - 786 - - - - -
------------------------------------- ------------------------------------
Net Income $ 4,657 $1,706 $2,951 173.0% $1,461 $1,653 $ (192) (11.6%)
===================================== ====================================
Property Revenues less
Property Operating Expenses $ 7,585 $3,352 $4,233 126.3% $3,557 $3,352 $ 205 6.1%
===================================== ====================================
</TABLE>
26
<PAGE> 27
EQUITY OFFICE PREDECESSORS
PART I - FINANCIAL INFORMATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
DISPOSITIONS OF PROPERTY
The Company sold two Office Properties in 1997: Barton Oaks Plaza II (118,529
net rentable square feet) was sold in January, 1997 and 8383 Wilshire (417,463
net rentable square feet) was sold in May, 1997. In January, 1996, the Company
sold the condominium portion, comprised of a 210 room hotel at Three
Lakeway, a mixed-use property. Below is a summary of the operations of these
properties for the three and six months period ended June 30, 1997 and 1996.
<TABLE>
<CAPTION>
Three months ended Six months ended
June 30, June 30,
------------------------ ------------------------
1997 1996 1997 1996
------------------------ ------------------------
($ in thousands)
<S> <C> <C> <C> <C>
Property Revenues $ 984 $2,445 $ 3,186 $4,920
------------------------ ------------------------
Interest expense - 150 36 658
Depreciation and amortization - 551 451 1,115
Property Operating Expenses 457 1,261 1,415 2,466
------------------------ ------------------------
Total expenses 457 1,962 1,902 4,239
Income (loss) before allocation to minority interests,
and gain on sale of real estate and extraordinary items 527 483 1,284 681
Minority interests
Gain on sale of real estate and extraordinary - - (164) -
items 6,769 - 12,235 5,262
------------------------ ------------------------
Net Income $ 7,296 $ 483 $13,355 $5,943
========================================================
Property Revenues less Property Operating Expenses $ 527 $1,184 $ 1,771 $2,454
======================== ========================
</TABLE>
Liquidity and Capital Resources
Liquidity: Net cash provided from operations represents the primary
source of liquidity to fund distributions, debt service, recurring capital
costs and non-revenue enhancing tenant improvements. Historically, the Company
made annual distributions equal to approximately 100% of taxable income. Cash
generated in excess of taxable income (resulting primarily from non-cash items
such as depreciation and amortization) was retained for working capital and to
fund capital improvements and non-revenue enhancing tenant improvements. The
Company intends to make regular quarterly distributions to holders of Common
Shares and Units. The Company will establish its initial distribution based
upon its estimate of annualized cash flow.
The Company intends to fund recurring capital costs and non-revenue
enhancing tenant improvements from cash from operations and draws under its
Line of Credit. The Company has no contractual obligations for material
capital costs, other than in connection with customary tenant improvements in
the ordinary course of business. The Company also expects that the Line of
Credit will provide for temporary working capital, unanticipated cash needs,
and funding of acquisitions.
The anticipated size of the Company's distributions will not allow the
Company, using only cash from operations, to retire all of its debt as it comes
due and, therefore, the Company will be required to repay maturing debt with
funds from debt and/or equity financing.
Mortgage Financing: The table below summarizes the mortgage debt and line
of credit outstanding at June 30, 1997 and December 31, 1996, as well as the
amount of debt outstanding after reflecting the debt repaid in connection with
the Offering.
27
<PAGE> 28
EQUITY OFFICE PREDECESSORS
PART I - FINANCIAL INFORMATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
<TABLE>
<CAPTION>
Debt Summary: Post - Offering June 30, 1997 December 31, 1996
--------------- ------------- -----------------
<S> <C> <C> <C>
Balance ($ in thousands):
Fixed Rate $1,131,011 $1,384,090 $1,304,075
Variable Rate 407,627 832,942 660,817
-----------------------------------------------
Total $1,538,638 $2,217,032 $1,964,892
===============================================
Percentage of Total Debt
Fixed Rate 73.5% 62.4% 66.4%
Variable Rate 26.5% 37.6% 33.6%
-----------------------------------------------
Total 100.0% 100.0% 100.0%
===============================================
Weighted Average Interest
Rate at End of Period
Fixed Rate 7.55% 7.79% 7.89%
Variable Rate 7.16% 7.34% 7.33%
-----------------------------------------------
Total 7.45% 7.63% 7.70%
===============================================
</TABLE>
The variable rate debt shown above bore interest at the 30 day LIBOR-based
floating interest rate. The 30-day LIBOR at June 30, 1997 was 5.69% resulting
in a weighted average spread over LIBOR at June 30, 1997 of 1.65%.
The Company used the net proceeds of the Offering of approximately $564.5
million and approximately $33.9 million of available cash reserves to repay
$253.1 million of fixed rate debt, and $345.3 million of the variable rate debt
included in the table above. An additional $12.9 million was incurred for
prepayment penalties. In addition, the Company paid down $80 million on a Line
of Credit (as defined below) with available cash reserves in July, 1997. After
such repayments, the remaining $1.5 billion of debt, excluding a discount of
approximately $20.3 million expected to be recorded in connection with the
Offering and Consolidation, will mature as follows:
<TABLE>
<CAPTION>
in thousands
--------------
<S> <C>
1997 $ 6,375
1998 45,218
1999 168,372
2000 337,407
2001 192,074
2002 60,333
Thereafter 728,859
----------
Total $1,538,638
==========
</TABLE>
The instruments encumbering the Properties contain customary restrictions
and requirements such as transferability restrictions, payment of taxes on the
Property, maintenance of the Property in good condition, maintenance of
insurance on the Property, prohibition on liens, and obtaining lender consent to
leases with material tenants.
Lines of Credit: ZML Fund IV entered into an acquisition/term loan
facility (the "$475 Million Line") in September, 1996. As of June 30, 1997,
there were $272.6 million of outstanding six-month borrowings under the $475
Million Line, all of which were unsecured. On July 15, 1997, the Operating
Partnership obtained a $600 million unsecured revolving credit facility (the
"Line of Credit"). Amounts were subsequently drawn on the Line of Credit to
repay the outstanding balance on the $475 Million Line which
28
<PAGE> 29
EQUITY OFFICE PREDECESSORS
PART I - FINANCIAL INFORMATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
was terminated when the Line of Credit was obtained. The Line of Credit will
carry an interest rate equal to LIBOR plus 110 basis points. The Line of Credit
agreement states the interest rate will be reduced on a sliding scale and a
competitive bid option will become available upon the Company's ability to
achieve an investment grade unsecured debt rating. The Line of Credit matures
on July 15, 2000.
Unsecured Notes: The Company has entered into negotiations with an
unaffiliated party for a private debt offering of $180 million (the "Private
Debt Offering"). The terms of the Private Debt Offering consist of four
tranches with maturities of 7 to 10 years which will be priced at an interest
rate spread over the corresponding Treasury rate. The Company intends to use
the proceeds of the Private Debt Offering to repay a portion of the Line of
Credit.
It is currently anticipated that the Company will issue between $750
million to $1 billion of senior unsecured notes (the "Senior Notes Offering") in
either the third or fourth quarter of 1997. Proceeds from the Senior Notes
Offering will be used to repay approximately $236 million of existing mortgage
financing, to pay down the outstanding balance on the Line of Credit and to fund
property acquisitions. The Company expects the Senior Notes Offering will
contain a number of tranches with terms of 5 to 12 years and varying interest
rates some of which are expected to be fixed at closing based upon an agreed
spread over U.S. Treasury rates and others of which are expected to float at an
agreed spread over LIBOR.
Although the Company is currently negotiating the terms of the Senior Notes
Offering and believes that it will be realized as contemplated, a binding
commitment does not exist. In the event that the commitment is not obtained
prior to December 31, 1997, the Company would be required to obtain the consent
to the transfers implemented in connection with the Consolidation of the
existing mortgage lenders whose $236 million in mortgage indebtedness is
expected to be satisfied from the proceeds of the Senior Notes Offering. The
Company believes that, inasmuch as most of the mortgage instruments given to
secure this indebtedness contemplated these transfers, such consents could be
obtained on reasonable terms and, in instances where such consents could not be
obtained, such loans could be refinanced.
Interest Rate Protection Agreements: In order to limit the market risk
associated with variable rate debt, the Company entered into several interest
rate protection agreements. These agreements effectively convert floating rate
debt to a fixed rate basis, as well as hedge anticipated financing transactions.
Net amounts paid or received under these agreements are recognized as an
adjustment to interest expense when such amounts are incurred or earned.
Settlement amounts paid or received under these agreements are deferred and
amortized over the term of the related financing transaction on the
straight-line method which approximates the effective yield method. A summary
of the various interest rate hedge agreements is as follows: (1) In anticipation
of the Private Debt Offering and the Senior Notes Offering and the expectation
that its interest terms will be tied to U.S. Treasury rates, the Company has
entered into interest rate protection agreements for $700 million of
indebtedness. As a result of this arrangement, the Company has essentially
"locked into" U.S. Treasury rates in effect as of June 4, 1997, for the expected
Senior Notes Offering (or, were such offering not to occur, for $700 million in
other indebtedness). In August, 1997, the Company terminated $150 million of
the $700 million of hedge agreements at a cost of $3.9 million. The terminated
agreements pertained to the Private Debt Offering. The portion of the Private
Debt Offering protected by these agreements consisted of three tranches with
maturities of eight, nine and ten years, respectively. The cost of the
terminated hedge agreements will be amortized to interest expense over the
respective terms of each tranche. The Company intends to terminate the remaining
hedge agreements at such time as it incurs its contemplated fixed rate
indebtedness. Upon the occurrence of such termination, the Company will either
owe money or be entitled to receive money depending on whether U.S. Treasury
rates have increased (resulting in a payment to the Company) or decreased
(resulting in a payment obligation of the Company) subsequent to the date of the
hedge, June 4, 1997. The counterparties to these arrangements are major U.S.
financial institutions. (2) Equity Office Predecessors entered into an interest
rate swap agreement in October, 1995 which effectively fixed the interest rate
on a $93.6 million loan at 6.94% through the maturity of the loan on June 30,
2000. (3) Equity Office Predecessors sold several interest rate protection
agreements (aggregating $173 million of LIBOR based agreements) in June, 1997 at
a cost of approximately $1.1 million.
The Line of Credit, the anticipated Private Debt Offering, and the
anticipated notes issued in the Senior Notes Offering are expected to contain
certain customary restrictions and requirements such as total debt to assets
ratios, secured debt to total assets ratios, debt service coverage ratios,
minimum ratios of unencumbered assets to unsecured debt, and other limitations.
29
<PAGE> 30
EQUITY OFFICE PREDECESSORS
PART I - FINANCIAL INFORMATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Cash Flows
Six Months ended June 30, 1997 and 1996
Cash and cash equivalents decreased by approximately $167.4 million, to
approximately $243.0 million at June 30, 1997, compared to $410.4 million at
December 31, 1996. This decrease was the result of $90.7 million of cash
generated by operations, $314.5 million generated from financing activities
reduced by $572.6 million invested in new acquisitions, capital and tenant
improvements, and payment of leasing commissions, net of proceeds from sale of
real estate. Net cash provided by operating activities increased by $36.1
million from $54.6 million to $90.7 million primarily due to the additional cash
flow generated by the increase in the number of Properties owned. Net cash used
for investing activities increased by $350.5 million from $222.1 million to
$572.6 million mainly due to an increase in the amount of real estate assets
purchased during the six months ended June 30, 1997 compared to the six months
ended June 30, 1996. Net cash provided by financing activities increased by
$98.5 million from $216.0 million to $314.5 million due to an increase in
capital contributions, a decrease in principal payments on mortgage notes and
a line of credit, and an increase in proceeds from mortgage notes and a line of
credit offset in part by an increase in capital distributions.
Capital Improvements
The Company has a history of acquiring and repositioning undercapitalized
and poorly managed properties, many of which have required significant capital
improvements due to deferred maintenance and/or required substantial renovation
to enable them to compete effectively. A number of the Properties also have
had significant amounts of shell space requiring build out at the time of
acquisition. The Company takes these capital improvements and revenue
enhancing tenant improvements into consideration at the time of acquisition in
determining the amount of equity and debt financing required to purchase the
Property and fund the improvements. Therefore, capital improvements up to the
first five years after acquisition of these Properties are treated separately
from typical recurring capital expenditures, non-revenue enhancing tenant
improvements and leasing commissions required once these Properties have
reached stabilized occupancy, and deferred maintenance and renovations planned
at the time of acquisition have been completed. Capital improvements
(including tenant improvements and leasing commissions for shell space) for the
six months ended June 30, 1997, was approximately $54 million or $1.68 per
square foot. These amounts include approximately $20.5 million for the six
months ended June 30, 1997, for the redevelopment of the 28 State Street
Building.
The Company considers capital expenditures to be recurring expenditures
relating to the daily maintenance of the Office Properties. The table below
summarizes capital expenditures for the six months ended June 30, 1997. The
capital expenditures set forth below are not necessarily indicative of future
capital expenditures.
<TABLE>
<CAPTION>
1997
(through June 30)
-----------------
<S> <C>
Number of Office Properties 90
Rentable Square Feet (in millions) 32.2
Annual Capital Expenditures per square foot $.03
</TABLE>
30
<PAGE> 31
EQUITY OFFICE PREDECESSORS
PART I - FINANCIAL INFORMATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Tenant Improvements and Leasing Commission Costs
The Company distinguishes its tenant improvements and leasing commissions
between those that are revenue enhancing (which are required for space which is
vacant at the time of acquisition or that has been vacant for nine months or
more) and non-revenue enhancing (which are required to maintain the revenue
being generated from currently leased space). The table below summarizes the
revenue enhancing and non-revenue enhancing tenant improvements and leasing
commissions for the six months ended June 30, 1997. The tenant improvement and
leasing commission costs set forth below are presented on an aggregate basis
and do not reflect significant regional variations and, in any event, are not
necessarily indicative of future tenant improvement and leasing commission
costs:
<TABLE>
<CAPTION>
For the six months ended June 30, 1997
-----------------------------------------
<S> <C>
Number of Office Properties (as of June 30, 1997) 90
Rentable square feet (in millions) (as of June 30, 1997) 32.2
Revenue enhancing tenant improvements and leasing commissions:
Annual (in thousands) $4,114,000
Per square foot improved $14.47 (1)
Per total square foot $.26 (1) (2)
Non-revenue enhancing tenant improvements and leasing commissions
Renewal space
Annual (in thousands) $7,149,000
Per square foot improved $6.04 (1)
Per total square foot $.44 (1) (2)
Retenanted space
Annual (in thousands) $5,192,000
Per square foot improved $15.95 (1)
Per total square foot $.32 (1) (2)
-----------------------------------------
Total non-revenue enhancing $12,341,000
Per square foot improved $8.18
Per total square foot $.76 (1) (2)
</TABLE>
(1) The per square foot calculations as of June 30, 1997 are calculated
taking the total dollars anticipated to be expended on tenant improvements
in process as of June 30, 1997, divided by the total square footage being
improved or total building square footage. The actual amounts expended as
of June 30, 1997 for revenue enhancing and non-revenue enhancing renewal
and released space were $2.9 million, $4.5 million and $2.9 million,
respectively.
(2) The amounts shown have been annualized to reflect a full year of
comparable operation. The actual costs per total square foot as of June
30, 1997 for revenue enhancing and non-revenue enhancing renewal and
released space were $.13, $.22 and $.16, respectively.
Inflation
Substantially all of the office leases require the tenant to pay, as
additional rent, a portion of any increases in real estate taxes and operating
expenses over a base amount. In addition, many of the office leases provide
for fixed increases in base rent or indexed escalations (based on the Consumer
Price Index or other measures). The Company believes that inflationary
increases in expenses will be offset, in part, by the expense reimbursements
and contractual rent increases described above.
31
<PAGE> 32
EQUITY OFFICE PREDECESSORS
PART I - FINANCIAL INFORMATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Funds From Operations
Management of the Company believes Funds from Operations, as defined by
the National Association of Real Estate Investment Trusts, Inc. ("NAREIT"), to
be an appropriate measure of performance for an equity REIT. While Funds from
Operations is a relevant and widely used measure of operating performance of
equity REITs, it does not represent cash flow from operations or net income as
defined by generally accepted accounting principles ("GAAP"), and it should not
be considered as an alternative to these indicators in evaluating liquidity or
operating performance of the Company.
The following table reflects the calculation of the Company's Funds from
Operations for the three and six month periods ended June 30, 1997 and
1996:
<TABLE>
<CAPTION>
Three months ended June 30, Six months ended June 30,
-----------------------------------------------------------------------------------
Historical Cost Historical Cost
--------------------- -----------------------------
Pro Forma Pro Forma
1997 1997 1996 1997 1997 1996
-----------------------------------------------------------------------------------
(in thousands)
-----------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Income before income from
investment in unconsolidated
joint ventures, gain on sale of
real estate, extraordinary items and
minority interest $37,846 $ 23,331 $ 14,543 $ 76,946 $ 48,241 $ 27,377
Add back (deduct):
(Income) allocated to minority interests (350) (350) (1,088) (879) (879) (1,698)
Income from investment in
unconsolidated joint ventures 1,554 1,103 585 3,134 2,025 1,077
Depreciation and amortization
(real estate related) 35,316 31,542 21,962 69,148 58,994 42,567
Pro forma amortization of loan discount 1,357 - - 2,533 - -
-----------------------------------------------------------------------------------
Funds from Operations before effect of
adjusting straight-line rental revenue
and expense included in Funds from
Operations to a cash basis (1) 75,723 55,626 36,002 150,882 108,381 69,323
-----------------------------------------------------------------------------------
Deferred rental revenue (7,675) (3,791) (4,257) (15,459) (7,690) (7,967)
Deferred rental expense 549 549 - 1,098 1,098 -
-----------------------------------------------------------------------------------
Funds from Operations
excluding straight-line rental
revenue and expense adjustments $68,597 $ 52,384 $ 31,745 $ 136,521 $ 101,789 $ 61,356
====================================================================================
Cash Flow Provided By (Used For):
Operating Activities - $ 49,586 $ 52,238 - $ 90,673 $ 54,645
Investing Activities - $(463,127) $ (185,978) - $ (572,633) $ (222,094)
Financing Activities - $ 280,405 $ 152,077 - $ 314,525 $ 215,977
Common Shares / Units Outstanding at the
Offering (2) 163,555,677 - - 163,555,677 - -
</TABLE>
32
<PAGE> 33
EQUITY OFFICE PREDECESSORS
PART I - FINANCIAL INFORMATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
1) The White Paper on Funds from Operations approved by the Board of
Governors of NAREIT in March 1995 defines Funds from Operations as net
income (loss) (computed in accordance with GAAP), excluding gains (or
losses) from debt restructuring and sales of properties, plus real estate
related depreciation and amortization and after adjustments for
unconsolidated partnerships and joint ventures. The Company believes that
Funds from Operations is helpful to investors as a measure of the
performance of an equity REIT because, along with cash flow from operating
activities, financing activities and investing activities, it provides
investors with an indication of the ability of the Company to incur and
service debt, to make capital expenditures and to fund other cash needs.
The Company computes Funds from Operations in accordance with standards
established by NAREIT which may not be comparable to Funds from Operations
reported by other REITs that do not define the term in accordance with the
current NAREIT definition or that interpret the current NAREIT definition
differently than the Company. 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 (determined in
accordance with GAAP) as an indication of the Company's financial
performance or to cash flow from operating activities (determined in
accordance with GAAP) as a measure of the Company's liquidity, nor is it
indicative of funds available to fund the Company's cash needs, including
its ability to make cash distributions.
2) Represents the Common Shares/Units outstanding, assuming all outstanding
units are redeemed for common shares, excluding 502,740 common shares held
by the Operating Partnership which are eliminated in consolidation.
33
<PAGE> 34
EQUITY OFFICE PREDECESSORS
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The discussion in Note 10 of "Notes to Combined Financial Statements" is
incorporated herein by reference.
34
<PAGE> 35
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.
EQUITY OFFICE PROPERTIES TRUST
Date: August 21, 1997 By: /s/ Stanley M. Stevens
--------------- -------------------------------------
Stanley M. Stevens
Executive Vice President,
Chief Legal Counsel and
Secretary
Date: August 21, 1997 By: /s/ Richard D. Kincaid
--------------- -------------------------------------
Richard D. Kincaid
Executive Vice President,
Chief Financial Officer
35
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> JUN-30-1997
<CASH> 273,725
<SECURITIES> 0
<RECEIVABLES> 62,789
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 168,810
<PP&E> 4,074,997
<DEPRECIATION> 301,963
<TOTAL-ASSETS> 4,278,358
<CURRENT-LIABILITIES> 167,049
<BONDS> 2,217,032
0
0
<COMMON> 0
<OTHER-SE> 1,894,277
<TOTAL-LIABILITY-AND-EQUITY> 4,278,358
<SALES> 0
<TOTAL-REVENUES> 334,321
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 196,123
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 76,301
<INCOME-PRETAX> 0
<INCOME-TAX> 0
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 275
<CHANGES> 0
<NET-INCOME> 61,622
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
</TABLE>
