<PAGE> 1
================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
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 MARCH 31, 1999 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 60606
SUITE 2200, CHICAGO, ILLINOIS (Zip Code)
(Address of principal executive offices)
(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 [X] No [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS
On April 30, 1999, 257,887,806 of the Registrant's Common Shares were
outstanding.
================================================================================
<PAGE> 2
PART I
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
EQUITY OFFICE PROPERTIES TRUST
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1999 1998
(Dollars in thousands, except per share data) -------------- ----------- ------------
(UNAUDITED)
<S> <C> <C>
ASSETS:
Investment in real estate................................. $13,718,021 $13,349,627
Developments in process................................... 155,070 268,373
Land available for development............................ 78,264 65,819
Accumulated depreciation.................................. (435,171) (352,259)
----------- -----------
Investment in real estate, net of accumulated
depreciation......................................... 13,516,184 13,331,560
Cash and cash equivalents................................. 41,966 67,080
Tenant and other receivables (net of allowance for
doubtful accounts of $983 and $1,013, respectively)..... 46,409 36,193
Deferred rent receivable.................................. 103,655 87,115
Escrow deposits and restricted cash....................... 28,566 159,576
Investment in unconsolidated joint ventures............... 387,407 378,534
Deferred financing costs (net of accumulated amortization
of $8,281 and $6,242, respectively)..................... 58,659 53,181
Deferred leasing costs (net of accumulated amortization of
$12,573 and $9,714, respectively)....................... 72,600 65,090
Prepaid expenses and other assets......................... 86,409 82,962
----------- -----------
Total Assets....................................... $14,341,855 $14,261,291
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY:
Mortgage debt (including a net premium of $16,247 and
$13,517, respectively).................................. $ 2,090,716 $ 2,350,088
Unsecured notes (including a net premium of $996 and
$4,317, respectively)................................... 3,455,996 2,459,317
Lines of credit........................................... 528,000 1,216,000
Accounts payable and accrued expenses..................... 278,351 347,970
Due to affiliates......................................... 1,396 1,136
Dividend/distribution payable............................. 109,438 5,080
Other liabilities......................................... 106,883 93,022
----------- -----------
Total Liabilities.................................. 6,570,780 6,472,613
----------- -----------
Commitments and contingencies.............................
Minority Interests:
Operating Partnership................................... 703,071 709,355
Partially owned properties.............................. 28,762 28,360
----------- -----------
Total Minority Interests........................... 731,833 737,715
----------- -----------
Shareholders' Equity:
Preferred Shares, 100,000,000 authorized:
8.98% Series A Cumulative Redeemable Preferred Shares,
liquidation preference $25.00 per share, 8,000,000
issued and outstanding................................ 200,000 200,000
5.25% Series B Convertible, Cumulative Redeemable
Preferred Shares, liquidation preference $50.00 per
share, 6,000,000 issued and outstanding............... 300,000 300,000
8.625% Series C Cumulative Redeemable Preferred Shares,
liquidation preference $25.00 per share, 4,600,000
issued and outstanding................................ 115,000 115,000
Common Shares, $0.01 par value; 750,000,000 shares
authorized, 260,097,418 and 259,901,657 issued and
outstanding, respectively............................... 2,601 2,599
Additional paid in capital................................ 6,489,243 6,483,569
Dividends in excess of accumulated earnings............... (67,602) (50,205)
----------- -----------
Total Shareholders' Equity......................... 7,039,242 7,050,963
----------- -----------
Total Liabilities and Shareholders' Equity......... $14,341,855 $14,261,291
=========== ===========
</TABLE>
See accompanying notes.
2
<PAGE> 3
EQUITY OFFICE PROPERTIES TRUST
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
FOR THE THREE MONTHS ENDED
MARCH 31,
---------------------------
1999 1998
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) -------------- ------------ ------------
<S> <C> <C>
REVENUES:
Rental.................................................... $ 369,139 $ 289,213
Tenant reimbursements..................................... 68,159 52,989
Parking................................................... 27,459 21,214
Other..................................................... 5,474 6,177
Fee income................................................ 1,862 1,157
Interest/dividends........................................ 3,041 3,070
------------ ------------
Total revenues.................................... 475,134 373,820
------------ ------------
EXPENSES:
Interest:
Expense incurred....................................... 104,480 69,884
Amortization of deferred financing costs............... 746 2,145
Depreciation.............................................. 82,912 64,540
Amortization.............................................. 2,901 1,107
Real estate taxes......................................... 61,801 50,034
Insurance................................................. 2,322 2,243
Repairs and maintenance................................... 51,384 41,977
Property operating........................................ 48,208 41,973
Ground rent............................................... 1,846 1,638
General and administrative................................ 18,250 13,948
------------ ------------
Total expenses.................................... 374,850 289,489
------------ ------------
Income before allocation to minority interests, income from
investment in unconsolidated joint ventures and
extraordinary items....................................... 100,284 84,331
Minority Interests:
Operating Partnership..................................... (8,670) (7,726)
Partially owned properties................................ (545) (538)
Income from investment in unconsolidated joint ventures..... 1,835 3,634
------------ ------------
Income before extraordinary items........................... 92,904 79,701
Extraordinary items......................................... (3,183) (6,959)
------------ ------------
Net income.................................................. 89,721 72,742
Preferred distributions..................................... (10,881) (6,271)
------------ ------------
Net income available for Common Shares...................... $ 78,840 $ 66,471
============ ============
Net income available per weighted average Common Share
outstanding -- Basic...................................... $ 0.30 $ 0.27
============ ============
Weighted average Common Shares outstanding -- Basic......... 259,965,816 249,766,440
============ ============
Net income available per weighted average Common Share
outstanding --
Diluted................................................... $ 0.30 $ 0.27
============ ============
Weighted average Common Shares outstanding -- Diluted....... 291,433,553 280,327,761
============ ============
</TABLE>
See accompanying notes.
3
<PAGE> 4
EQUITY OFFICE PROPERTIES TRUST
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
FOR THE THREE MONTHS ENDED
MARCH 31,
---------------------------
(DOLLARS IN THOUSANDS) 1999 1998
- ------------------------------------------------------------ ----------- -------------
<S> <C> <C>
OPERATING ACTIVITIES:
Net income before preferred distributions................. $ 89,721 $ 72,742
Adjustments to reconcile net income before preferred
distributions to net cash provided by operating
activities:
Depreciation and amortization........................... 86,559 67,792
Amortization of premiums/discounts on unsecured notes
and terminated interest rate protection agreements..... 893 440
Compensation related to restricted shares issued to
employees.............................................. 1,314 474
Income from investment in unconsolidated joint
ventures............................................... (1,835) (3,634)
Extraordinary items..................................... 3,183 6,959
Provision for doubtful accounts......................... 291 (111)
Allocation to minority interests........................ 9,215 8,264
Changes in assets and liabilities:
(Increase) in tenant and other receivables............ (10,507) (666)
(Increase) in deferred rent receivable................ (16,540) (17,119)
(Increase) in prepaid expenses and other assets....... (3,489) (2,624)
(Decrease) in accounts payable and accrued expenses... (69,619) (69,511)
Increase (decrease) in due to affiliates.............. 260 (559)
Increase in other liabilities......................... 13,466 48,318
--------- -----------
Net cash provided by operating activities.......... 102,912 110,765
--------- -----------
INVESTING ACTIVITIES:
Property acquisitions..................................... (101,704) (260,850)
Payments for capital and tenant improvements.............. (45,142) (28,048)
Distributions from unconsolidated joint ventures.......... 3,977 31,162
Investments in unconsolidated joint ventures.............. (11,015) --
Payments of lease acquisition costs....................... (10,369) (9,060)
Decrease (increase) in escrow deposits and restricted
cash.................................................... 10,320 (4,151)
--------- -----------
Net cash (used for) investing activities........... (153,933) (270,947)
--------- -----------
FINANCING ACTIVITIES:
Proceeds from exercise of share options................... 355 4,868
Dividends/distributions to shareholders and unitholders... (1,599) (392)
Payment of preferred distributions........................ (11,100) (4,478)
Proceeds from sale of preferred shares, net of offering
costs................................................... -- 290,250
Payment of offering costs................................. (417) (117)
Distributions to minority interest in partially owned
properties.............................................. (143) (950)
Proceeds from mortgage debt............................... 233 --
Proceeds from unsecured notes............................. 996,675 1,504,452
Proceeds from lines of credit............................. 163,000 333,000
Principal payments on mortgage debt....................... (262,335) (3,186)
Principal payments on lines of credit..................... (851,000) (2,131,300)
Payments of loan costs.................................... (7,762) (10,860)
Termination of interest rate protection agreements........ -- (38,277)
--------- -----------
Net cash provided by (used for) financing
activities....................................... 25,907 (56,990)
--------- -----------
Net (decrease) in cash and cash equivalents................. (25,114) (217,172)
Cash and cash equivalents at the beginning of the period.... 67,080 228,853
--------- -----------
Cash and cash equivalents at the end of the period.......... $ 41,966 $ 11,681
========= ===========
SUPPLEMENTAL INFORMATION:
Interest paid during the period, including capitalized
interest of $3,125 and $3,452, respectively............ $ 114,733 $ 64,777
========= ===========
</TABLE>
See accompanying notes.
4
<PAGE> 5
EQUITY OFFICE PROPERTIES TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
DEFINITION OF TERMS. Capitalized terms used but not defined herein are as
defined in the Company's Annual Report on Form 10-K for the year ended December
31, 1998 (the "Form 10-K").
The consolidated financial statements of the Company have been prepared
pursuant to the Securities and Exchange Commission ("SEC") rules and
regulations. The following notes highlight significant changes to the notes to
the December 31, 1998 audited consolidated and combined financial statements of
Equity Office Properties Trust and Equity Office Predecessors and should be read
in conjunction with the financial statements and notes thereto included in the
Form 10-K and present interim disclosures as required by the SEC.
NOTE 1 -- BUSINESS AND FORMATION OF THE COMPANY
As used herein, "Company" means Equity Office Properties Trust, a Maryland
real estate investment trust, together with its subsidiaries including the
Operating Partnership and 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,
and to complete the Consolidation of the Equity Office Predecessors. The Company
completed its IPO on July 11, 1997. The Company is a fully integrated and
self-managed real estate company engaged in acquiring, owning, managing, leasing
and renovating office properties and parking facilities. The Company elected to
be taxed as a REIT for federal income tax purposes and generally will not be
subject to federal income tax if it distributes 100% of its taxable income and
complies with a number of organizational and operational requirements.
As of March 31, 1999, the Company owned or had an interest in 287 office
properties (the "Office Properties") containing approximately 76.3 million
rentable square feet of office space and 19 stand-alone parking facilities (the
"Parking Facilities" and, together with the Office Properties, the "Properties")
containing approximately 18,059 parking spaces. The weighted average occupancy
of the Office Properties at March 31, 1999 was approximately 94.1%. The Office
Properties are located in 81 submarkets in 36 markets in 24 states and the
District of Columbia. The Office Properties, by rentable square feet, are
located approximately 53% in CBDs and 47% in suburban markets.
NOTE 2 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The Company's assets, which include investments in joint ventures, are
primarily owned by, and its operations are substantially conducted through, the
Operating Partnership. The Company is the managing general partner of the
Operating Partnership. Due to the Company's ability as managing general partner
to control the Operating Partnership and various other property holding
subsidiaries, each such entity has been consolidated with the Company for
financial reporting purposes.
Use of Estimates
The preparation of the consolidated financial statements of the Company in
conformity with generally accepted accounting principles requires management to
make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting periods. Actual results could differ from those estimates.
Unaudited Interim Statements
The consolidated financial statements of the Company as of and for the
three months ended March 31, 1999 and 1998 and related footnote disclosures 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
<PAGE> 6
EQUITY OFFICE PROPERTIES TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Reclassifications
Certain reclassifications have been made to the previously reported 1998
statements in order to provide comparability with the 1999 statements reported
herein. These reclassifications have not changed the 1998 results or
shareholders' equity.
NOTE 3 -- INVESTMENT IN REAL ESTATE
During the three months ended March 31, 1999, the Company acquired the
Office Properties listed below. Each Office Property was purchased from an
unaffiliated party and was funded from credit facilities and working capital.
<TABLE>
<CAPTION>
DATE RENTABLE TOTAL
ACQUIRED PROPERTY LOCATION SQUARE FEET ACQUISITION COST(1)
- -------- -------- -------- ----------- ----------------------
(Dollars in thousands)
<S> <C> <C> <C> <C>
1/7/99 Texas Commerce Tower Irving, TX 369,134 $ 55,254
1/7/99 Computer Associates Tower Irving, TX 360,815 51,294
1/28/99 City Center Bellevue Bellevue, WA 472,587 115,915(2)
--------- --------
Total 1,202,536 $222,463
========= ========
</TABLE>
- ---------------
(1) Total acquisition cost includes the purchase price specified in the purchase
contract, closing costs, acquisition costs and accounting adjustments
recorded in accordance with GAAP.
(2) The total acquisition cost includes a vacant land parcel valued at $12.4
million.
NOTE 4 -- INVESTMENT IN UNCONSOLIDATED JOINT VENTURES
The Company has several investments in unconsolidated joint ventures
consisting of Office Properties, Parking Facilities and a management company.
Combined summarized financial information of the unconsolidated joint ventures
is as follows:
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
(DOLLARS IN THOUSANDS) 1999 1998
- ------------------------------------------------------------ --------- ------------
<S> <C> <C>
Balance Sheets:
Real estate, net.......................................... $508,280 $488,997
Other assets.............................................. 81,529 78,623
======== ========
Total Assets...................................... $589,809 $567,620
======== ========
Mortgage debt............................................. $256,511 $243,096
Other liabilities......................................... 18,216 16,059
Partners' and shareholders' equity........................ 315,082 308,465
-------- --------
Total Liabilities and Partners' and Shareholders'
Equity.......................................... $589,809 $567,620
======== ========
Company's share of equity................................... $169,376 $159,092
Excess of cost of investments over the net book value of
underlying net assets, net of accumulated depreciation of
$7,265 and $5,854, respectively........................... 218,031 219,442
-------- --------
Carrying value of investments in unconsolidated joint
ventures.................................................. $387,407 $378,534
======== ========
Company's share of unconsolidated mortgage debt............. $135,291 $124,282
======== ========
</TABLE>
6
<PAGE> 7
EQUITY OFFICE PROPERTIES TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
FOR THE THREE MONTHS ENDED
MARCH 31,
---------------------------
(DOLLARS IN THOUSANDS) 1999 1998
- ------------------------------------------------------------ ---------- -------------
<S> <C> <C>
Statements of Operations:
Revenues.................................................. $ 25,383 $ 28,448
-------- --------
Expenses:
Interest expense....................................... 4,447 3,775
Depreciation and amortization.......................... 4,103 5,677
Operating expenses..................................... 10,607 9,150
-------- --------
Total expenses.................................... 19,157 18,602
-------- --------
Net income................................................ $ 6,226 $ 9,846
======== ========
Company's share of net income............................. $ 1,835 $ 3,634
======== ========
Company's share of interest expense....................... $ 2,201 $ 1,907
======== ========
Company's share of depreciation and amortization (real
estate related)........................................ $ 3,483 $ 3,941
======== ========
</TABLE>
NOTE 5 -- MORTGAGE DEBT
The Company repaid the mortgage debt encumbering the following Properties
with proceeds from the $1.0 Billion Notes Offering:
<TABLE>
<CAPTION>
PAYOFF
DATE PROPERTY PAYOFF AMOUNT
- ------- -------- -------------
(Dollars in thousands)
<S> <C> <C>
1/27/99 Boston Harbor Garage.................................. $ 34,571
1/28/99 150 Federal Street.................................... 56,086
1/29/99 1700 Higgins.......................................... 3,385
1/29/99 Northwest Center...................................... 6,475
1/29/99 Franklin Plaza........................................ 34,141
1/29/99 One Crosswoods Center................................. 3,455
1/29/99 One Columbus Building................................. 29,432
1/29/99 One Lakeway........................................... 9,712
1/29/99 Two Lakeway........................................... 14,715
1/29/99 Three Lakeway......................................... 17,045
2/5/99 Tabor Center.......................................... 47,734
--------
Total.......................................................... $256,751
========
</TABLE>
NOTE 6 -- UNSECURED NOTES
On January 26, 1999, the Company issued $1.0 billion of unsecured notes
(the "$1.0 Billion Notes") in three tranches (the "$1.0 Billion Notes
Offering"). The $1.0 Billion Notes were issued at a discount of approximately
$3.3 million which is being amortized over the terms of the respective tranches
as an adjustment to interest expense. Net proceeds to the Company after offering
costs were approximately
7
<PAGE> 8
EQUITY OFFICE PROPERTIES TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
$989.2 million. The net proceeds were used to repay mortgage debt and amounts
outstanding on the $1.0 Billion Credit Facility. The terms of the tranches are
as follows:
<TABLE>
<CAPTION>
TRANCHE AMOUNT STATED RATE EFFECTIVE RATE(1)
- ------- ------ ----------- -----------------
(Dollars in thousands)
<S> <C> <C> <C>
3 Year Notes due 2002................... $ 200,000 6.4% 6.6%
5 Year Notes due 2004................... 300,000 6.5% 6.7%
10 Year Notes due 2009.................. 500,000 6.8% 6.9%
---------- --- ---
Subtotal...................... 1,000,000 6.6% 6.8%
=== ===
Net discount (net of accumulated
amortization of $86).................. (3,239)
----------
Total......................... $ 996,761
==========
</TABLE>
- ---------------
(1) Includes offering and transaction costs and the discount on the unsecured
notes.
NOTE 7 -- SHAREHOLDERS' EQUITY
Common Shares
The following table presents the changes in the Company's issued and
outstanding Common Shares since December 31, 1998 (excluding Units of 28,465,147
and 28,645,699 outstanding at March 31, 1999 and December 31, 1998 respectively,
which are convertible into Common Shares on a one-for-one basis, or the cash
equivalent thereof, subject to certain restrictions):
<TABLE>
<S> <C>
OUTSTANDING AT DECEMBER 31, 1998...................... 259,901,657
Issued through exercise of options.................... 15,209
Issued through redemption of Units.................... 180,552
-----------
OUTSTANDING AT MARCH 31, 1999......................... 260,097,418
===========
</TABLE>
Ownership of Operating Partnership
The Company's ownership in the Operating Partnership was approximately
90.1% as of March 31, 1999 and December 31, 1998.
Dividends/Distributions
The following table summarizes the distributions paid or declared on Common
Shares/Units and preferred shares during the three months ended March 31, 1999:
<TABLE>
<CAPTION>
DISTRIBUTION
AMOUNT DATE PAID RECORD DATE
------------ --------- -----------
<S> <C> <C> <C>
Common Share/Unit................................. $ 0.37 4/12/99 3/31/99
Series A Preferred Share.......................... $0.56125 3/15/99 3/1/99
Series B Preferred Share.......................... $0.65625 2/16/99 2/1/99
Series C Preferred Share(1)....................... $0.58099 3/15/99 3/1/99
</TABLE>
- ---------------
(1) The distribution on the Series C Preferred Shares represents a pro-rated
distribution from December 8, 1998 (the closing date of the Series C
Preferred Share Offering) through March 14, 1999.
8
<PAGE> 9
EQUITY OFFICE PROPERTIES TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 8 -- EXTRAORDINARY ITEMS
The Company incurred an extraordinary loss of approximately $3.2 million
during the three months ended March 31, 1999 due to the write-off of unamortized
mark-to-market adjustments in connection with the repayment of certain mortgage
debt. The mortgage debt was repaid with proceeds from the $1.0 Billion Notes
Offering.
The Company incurred an extraordinary loss of approximately $7.0 million
during the three months ended March 31, 1998 due to fees related to the
termination of $300 million of interest rate protection agreements in connection
with the issuance of the Series B Preferred Shares.
NOTE 9 -- EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted
earnings per Common Share:
<TABLE>
<CAPTION>
FOR THE THREE MONTHS ENDED
MARCH 31,
--------------------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) 1999 1998
- ---------------------------------------------------------- ----------- -----------
<S> <C> <C>
NUMERATOR:
Net income available for Common Shares before
extraordinary items.................................. $ 82,023 $ 73,430
Extraordinary items..................................... (3,183) (6,959)
----------- -----------
Numerator for basic earnings per share -- net income
available for Common Shares.......................... 78,840 66,471
Minority interest in Operating Partnership.............. 8,670 7,726
----------- -----------
Numerator for diluted earnings per share -- net income
available for Common Shares.......................... $ 87,510 $ 74,197
=========== ===========
DENOMINATOR:
Denominator for basic earnings per share -- weighted
average Common Shares................................ 259,965,816 249,766,440
----------- -----------
Effect of dilutive securities:
Redemption of Units to Common Shares................. 28,589,044 29,031,371
Share options and put options........................ 2,878,693 1,529,950
----------- -----------
Dilutive potential Common Shares........................ 31,467,737 30,561,321
----------- -----------
Denominator for diluted earnings per share -- adjusted
weighted average shares and assumed conversions...... 291,433,553 280,327,761
=========== ===========
BASIC EARNINGS AVAILABLE FOR COMMON SHARES PER WEIGHTED
AVERAGE COMMON SHARE:
Net income before extraordinary items................... $ 0.32 $ 0.29
Extraordinary items..................................... (0.02) (0.02)
----------- -----------
Net income.............................................. $ 0.30 $ 0.27
=========== ===========
DILUTED EARNINGS AVAILABLE FOR COMMON SHARES PER WEIGHTED
AVERAGE COMMON SHARE:
Net income before extraordinary items................... $ 0.31 $ 0.29
Extraordinary items..................................... (0.01) (0.02)
----------- -----------
Net income.............................................. $ 0.30 $ 0.27
=========== ===========
</TABLE>
Options to purchase 3,453,098 Common Shares at a weighted average exercise
price of $30.15 per Common Share, warrants to purchase 5,000,000 Common Shares
at an exercise price of $39.375 per Common
9
<PAGE> 10
EQUITY OFFICE PROPERTIES TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Share and the Series B Preferred Shares at a conversion price of $35.70 per
Common Share were outstanding during the three months ended March 31, 1999, and
were not included in the computation of diluted earnings per share for the three
months ended March 31, 1999, since they would have an antidilutive effect.
Options to purchase 726,500 Common Shares at a weighted-average exercise
price of $32.93 per Common Share, warrants to purchase 5,000,000 Common Shares
at an exercise price of $39.375 per Common Share and the Series B Preferred
Shares at a conversion price of $35.70 per Common Share were outstanding during
the three months ended March 31, 1998, were not included in the computation of
diluted earnings per share for the three months ended March 31, 1998, since they
would have an antidilutive effect.
NOTE 10 -- SEGMENT INFORMATION
As discussed in Note 1, the Company's primary business is the ownership and
operation of Office Properties. The Company's long-term tenants are in a variety
of businesses and no single tenant is significant to the Company's business.
Information related to this segment for the three months ended March 31, 1999
and 1998 is below:
<TABLE>
<CAPTION>
FOR THE THREE MONTHS ENDED MARCH 31, 1999
-------------------------------------------
OFFICE CORPORATE
(DOLLARS IN THOUSANDS) PROPERTIES AND OTHER CONSOLIDATED
- ---------------------------------------------- ------------ ---------- -------------
<S> <C> <C> <C>
Property Operating Revenues................... $ 461,168 $ 9,063 $ 470,231
Property Operating Expenses................... (161,691) (2,024) (163,715)
----------- -------- -----------
Net operating income........................ 299,477 7,039 306,516
----------- -------- -----------
Adjustments to arrive at net income:
Other revenues.............................. 631 4,272 4,903
Interest expense(1)......................... (37,601) (66,879) (104,480)
Depreciation and amortization............... (83,719) (2,840) (86,559)
Ground rent................................. (1,833) (13) (1,846)
General and administrative.................. (136) (18,114) (18,250)
----------- -------- -----------
Total adjustments to arrive at net income... (122,658) (83,574) (206,232)
----------- -------- -----------
Income before allocation to minority
interests, income from investment in
unconsolidated joint ventures and
extraordinary items......................... 176,819 (76,535) 100,284
Minority interests............................ (310) (8,905) (9,215)
Income from investment in unconsolidated joint
ventures.................................... 1,793 42 1,835
Extraordinary items........................... (3,183) -- (3,183)
----------- -------- -----------
Net income.................................... $ 175,119 $(85,398) $ 89,721
=========== ======== ===========
Capital and tenant improvements............... $ 41,811 $ 3,331 $ 45,142
=========== ======== ===========
Total Assets.................................. $13,840,662 $501,193 $14,341,855
=========== ======== ===========
</TABLE>
10
<PAGE> 11
EQUITY OFFICE PROPERTIES TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
FOR THE THREE MONTHS ENDED MARCH 31, 1998
-------------------------------------------
OFFICE CORPORATE
(DOLLARS IN THOUSANDS) PROPERTIES AND OTHER CONSOLIDATED
- ---------------------------------------------- ------------ ---------- -------------
<S> <C> <C> <C>
Property Operating Revenues................... $ 362,622 $ 6,971 $ 369,593
Property Operating Expenses................... (134,242) (1,985) (136,227)
----------- -------- -----------
Net operating income........................ 228,380 4,986 233,366
----------- -------- -----------
Adjustments to arrive at net income:
Other revenues.............................. 332 3,895 4,227
Interest expense(1)......................... (34,027) (35,857) (69,884)
Depreciation and amortization............... (64,337) (3,455) (67,792)
Ground rent................................. (1,626) (12) (1,638)
General and administrative.................. (7) (13,941) (13,948)
----------- -------- -----------
Total adjustments to arrive at net income... (99,665) (49,370) (149,035)
----------- -------- -----------
Income before allocation to minority
interests, income from investment in
unconsolidated joint ventures and
extraordinary items......................... 128,715 (44,384) 84,331
Minority interests............................ (469) (7,795) (8,264)
Income from investment in unconsolidated joint
ventures.................................... 2,507 1,127 3,634
Extraordinary items........................... -- (6,959) (6,959)
----------- -------- -----------
Net income.................................... $ 130,753 $(58,011) $ 72,742
=========== ======== ===========
Capital and tenant improvements............... $ 26,477 $ 1,571 $ 28,048
=========== ======== ===========
Total Assets.................................. $11,415,894 $388,100 $11,803,994
=========== ======== ===========
</TABLE>
- ---------------
(1) Interest expense for the Office Properties does not include an allocation of
interest expense on corporate unsecured debt.
NOTE 11 -- NON-CASH INVESTING ACTIVITY
For the three months ended March 31, 1999, approximately $120.8 million of
escrow deposits was used to acquire the three Office Properties in the first
quarter of 1999.
NOTE 12 -- COMMITMENTS AND CONTINGENCIES
Concentration of Credit Risk
The Company maintains its cash and cash equivalents at financial
institutions. The combined account balances at each institution typically exceed
FDIC insurance coverage and, as a result, there is a concentration of credit
risk related to amounts on deposit in excess of FDIC insurance coverage.
Management of the Company believes that the risk is not significant. The Company
from time to time enters into interest rate protection agreements to effectively
convert floating rate debt to a fixed rate basis, as well as to hedge
anticipated financing transactions. The Company believes it has limited exposure
to the risk of non-performance by the swap counterparties since each
counterparty is a major U.S. financial institution; management does not
anticipate any such non-performance. Currently, the Company has one interest
rate protection agreement 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.
Environmental
The Company, as an owner of real estate, is subject to various
environmental laws of federal and local governments. Compliance by the Company
with existing laws has not had a material adverse effect on the Company's
financial condition and results of operations, and management does not believe
it will have such an impact in the future. However, the Company cannot predict
the impact of new or changed laws or regulations on its current Properties or on
properties that it may acquire in the future.
11
<PAGE> 12
EQUITY OFFICE PROPERTIES TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Litigation
The Company has become a party to various legal actions resulting from the
operational activities transferred to the Operating Partnership in connection
with the Consolidation and the Beacon Merger. 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.
Neither the Company nor any of the Properties is presently subject to any
material litigation nor, to the Company's knowledge, is any litigation
threatened against the Company or any of the Properties, other than actions
which the Company does not believe to be material, or routine actions for
negligence and other claims and administrative proceedings arising in the
ordinary course of business, some of which are expected to be covered by
liability insurance and all of which collectively are not expected to have a
material adverse effect on the liquidity, business, results of operations or
financial condition of the Company.
Geographical
The Company carries earthquake insurance on all of the Properties,
including those located in California, subject to coverage limitations which the
Company believes are commercially reasonable. In light of the California
earthquake risk, California building codes since the early 1970s have
established construction standards for all new buildings. The current and
strictest construction standards were adopted in 1987. Of the 44 Properties
located in California, 13 have been built since January 1, 1988 and the Company
believes that all of the Properties were constructed in full compliance with the
applicable standards existing at the time of construction. No assurance can be
given that material losses in excess of insurance proceeds will not occur in the
future.
Commitments
In February 1998, the Company entered into a contract to purchase the 517
Marquette Garage (formerly known as "Rand Tower Garage") in Minneapolis,
Minnesota upon completion of the parking structure. This parking facility was
acquired on April 30, 1999 for approximately $19.0 million.
In March 1998, the Board of Trustees of the Company approved the purchase
of Prominence, an office building development in Atlanta, Georgia. The property
will consist of approximately 425,706 square feet of office space and 1,350
parking spaces, and is expected to be acquired upon its completion in the third
quarter of 1999. The purchase price for the described assets and amounts to be
incurred for tenanting the property are expected to be approximately $87.0
million. A vacant land parcel will be purchased with the property for an
additional $7.0 million. This transaction is contingent upon certain terms and
conditions as set forth in the purchase agreement. There can be no assurance
that this transaction will be consummated as described above.
In July 1998, the Company entered into an agreement to purchase the World
Trade Center project in Seattle, Washington. The property will consist of
approximately 186,787 square feet of office space, is scheduled for shell
completion in the second quarter of 1999 and is 100% preleased to a single
tenant. After the tenant takes full occupancy in early 2000, the Company is
expected to purchase the building for approximately $39.0 million. This
transaction is contingent upon certain terms and conditions as set forth in the
purchase agreement. There can be no assurance that this transaction will be
consummated as described above.
In accordance with the agreement governing the Company's investment in
WRALP, the Company agreed to make available to WRALP up to $20.0 million in
additional financing or credit support for future development. As of March 31,
1999, no amounts have been funded pursuant to this agreement.
Contingencies
Effective as of August 13, 1998, the Company amended a pre-existing put
option agreement with certain sellers of the Wright Runstad Properties (the "WR
Holders"). The WR Holders have the option on August 13, 1999 to require the
Company to purchase all or a portion of the 3,435,688 Common Shares, issued at
acquisition, at a price equal to $31.50 per Common Share. Prior to August 13,
1999, if the WR Holders sell
12
<PAGE> 13
EQUITY OFFICE PROPERTIES TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
all or a portion of their Common Shares to a third party for a price less than
$29.10625 per Common Share, then the Company shall pay to the WR Holders an
amount equal to the difference between such sales price and $29.10625 multiplied
by the number of Common Shares sold, not to exceed $3.00 per Common Share. Any
amounts paid by the Company as a result of such sale, calculated as the
difference between the sales price and $29.10625 not exceeding $3.00 per Common
Share, shall be recorded as a reduction of shareholders' equity. For options
exercised on August 13, 1999, any amounts paid up to $29.10625 per Common Share
would be reflected as a reduction to shareholders' equity; the portion of any
amounts paid in excess of $29.10625 per Common Share (not to exceed $31.50 per
Common Share) would be expensed by the Company. The portion expensed would not
exceed $2.39375 per Common Share. As of March 31, 1999, the WR Holders have not
exercised their option under the put option agreement.
Effective as of September 3, 1998, the Company amended its pre-existing put
option agreement with the seller of the Columbus America Properties (the "CA
Holder") related to 1,692,546 Units issued at acquisition. The CA Holder has the
option at any time after January 1, 1999 until the earlier of (a) September 3,
2000 or (b) the date the CA Holder has converted all of its Units to Common
Shares, to require the Company to purchase the Units at a price equal to $29.00
per Unit. Under the terms of the agreement, prior to September 3, 1999, the
option shall be limited to an aggregate of 846,273 Units. In the event of any
option exercise, the Company will recognize any cash paid as a reduction of
minority interest. As of March 31, 1999, the CA Holder has not exercised its
option to require the Company to purchase the Units.
In connection with the acquisition of Worldwide Plaza on October 1, 1998,
the Company issued a transferable put option on Units exercisable only on the
third anniversary of closing with an estimated fair value of approximately $27.4
million. This option entitles its holder to additional Common Shares, the number
of which shall be determined using a formula based on the extent, if any, that
the Common Shares are then trading at less than $29.05 per share.
NOTE 13 -- SUBSEQUENT EVENTS
(1) On April 1, 1999, the Company repaid a $240.0 million mortgage note
encumbering ten Office Properties and incurred a prepayment penalty of
approximately $13.6 million. The Company used the proceeds from the $1.0 Billion
Notes Offering to repay the mortgage note and to pay the prepayment penalty.
(2) In April 1999, the Board of Trustees of the Company declared a second
quarter distribution for the Series B Preferred Shares of $0.65625 per share.
The distribution will be paid on May 17, 1999 to holders of record as of May 3,
1999.
(3) On April 19, 1999, the Company issued $200 million of unsecured notes
due April 19, 2029 (the "$200 Million Notes") in an offering to institutional
investors (the "200 Million Notes Offering"). The net proceeds after discount
and offering expenses were approximately $196.6 million and were used to repay
amounts outstanding on the $1.0 Billion Credit Facility. The $200 Million Notes
bear interest at a stated rate of 7.5% per annum and have an effective annual
rate of 7.6%.
(4) Pursuant to the Consolidation, certain Common Shares were placed in
escrow and are subject to release pursuant to the provisions of the Merger
Agreement, Plan of Liquidation and Escrow Agreements entered into at the time of
the Consolidation. On April 26, 1999, 2,284,940 Common Shares were released from
escrow and 2,242,954 of such Common Shares were cancelled and retired by Equity
Office Properties Trust. Inasmuch as the retired shares represent interest in
the Operating Partnership which were re-allocated from Equity Office Properties
Trust to other unitholders, the number of outstanding Units did not change as a
result of this reallocation.
13
<PAGE> 14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
OVERVIEW
The following discussion and analysis of the consolidated financial
condition and results of operations should be read in conjunction with the
Consolidated Financial Statements of the Company and Notes thereto contained
herein. Terms employed herein as defined terms, but without definition, shall
have the meaning set forth in the financial statements. Statements contained in
this "Management's Discussion and Analysis of Financial Condition and Results of
Operations" including without limitation, the "Developments" and "Year 2000"
disclosures, which are not historical facts may be forward-looking statements
within the meaning of Section 21E of the Securities Exchange Act of 1934 (the
"Exchange Act"). The Company intends such forward-looking statements to be
covered by the safe harbor provisions for forward looking statements contained
in Section 21E of the Exchange Act. Such statements are subject to certain risks
and uncertainties which could cause actual results to differ materially from
those projected or anticipated. Readers are cautioned not to place undue
reliance on these forward-looking statements which speak only as of March 31,
1999. Among the factors about which the Company has made assumptions are the
following:
- Future economic conditions which may impact upon the demand for office
space and tenant ability to pay rent, either at current or increased
levels.
- Prevailing interest rates.
- The extent of any inflation on operating expenses.
- The Company's ability to reduce various expenses as a percentage of
revenues.
- The Company's continuing ability to pay amounts due to its noteholders
and preferred shareholders prior to any distribution to holders of its
Common Shares.
- The cost to complete and lease-up pending developments.
- The continued availability of the $1.0 Billion Credit Facility.
During the three months ended March 31, 1999, the Company acquired an
additional three Office Properties containing approximately 1.2 million square
feet. The aggregate purchase price for these acquisitions was approximately
$222.5 million. In addition, the Company issued the $1.0 Billion Notes in three
tranches with an effective interest rate of 6.8% per annum.
14
<PAGE> 15
RESULTS OF OPERATIONS
GENERAL
The following discussion is based primarily on the consolidated financial
statements of the Company as of March 31, 1999 and December 31, 1998 and for the
three months ended March 31, 1999 and 1998.
The Company receives income primarily from rental revenue from the Office
Properties (including reimbursements from tenants for certain operating costs)
and from parking revenue from Office Properties and Parking Facilities.
Below is a summary of the Company's acquisition and disposition activity
since December 31, 1997:
<TABLE>
<CAPTION>
OFFICE PROPERTIES PARKING FACILITIES
------------------------ ------------------
TOTAL SQUARE
BUILDINGS FEET GARAGES SPACES
--------- ------------ -------- -------
<S> <C> <C> <C> <C>
Properties owned as of:
December 31, 1997........................... 258 65,291,790 17 16,749
Acquisitions............................. 28 10,425,595 2 1,310
Developments placed in service........... 3 257,528 -- --
Dispositions............................. (5) (986,391) -- --
Building remeasurements.................. -- 112,205 -- --
--- ---------- -- ------
December 31, 1998........................... 284 75,100,727 19 18,059
Acquisitions............................. 3 1,202,536 -- --
Building remeasurements.................. -- 8,818 -- --
--- ---------- -- ------
March 31, 1999 ("Total Portfolio").......... 287 76,312,081 19 18,059
=== ========== == ======
</TABLE>
As a result of the growth in the size of the Total Portfolio and the
disposition of properties, the financial data presented shows large changes in
revenues and expenses from period to period. 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 the Total Portfolio.
15
<PAGE> 16
COMPARISON OF THE THREE MONTHS ENDED MARCH 31, 1999 TO MARCH 31, 1998
The table below represents selected operating information for the Total
Portfolio and for the Core Portfolio consisting of 252 Office Properties and 17
Parking Facilities acquired or placed in service prior to January 1, 1998.
<TABLE>
<CAPTION>
TOTAL PORTFOLIO CORE PORTFOLIO
----------------------------------------- -----------------------------------------
INCREASE/ % INCREASE/ %
(DOLLARS IN THOUSANDS) 1999 1998 (DECREASE) CHANGE 1999 1998 (DECREASE) CHANGE
- ------------------------------------ -------- -------- ---------- ------ -------- -------- ---------- ------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Property revenues................... $470,231 $369,593 $100,638 27.2% $381,763 $362,920 $18,843 5.2%
Fee income.......................... 1,862 1,157 705 60.9 -- -- -- --
Interest/dividend income............ 3,041 3,070 (29) (0.9) 581 364 217 59.6
-------- -------- -------- ----- -------- -------- ------- ------
Total revenues.............. 475,134 373,820 101,314 27.1 382,344 363,284 19,060 5.2
-------- -------- -------- ----- -------- -------- ------- ------
Interest expense.................... 104,480 69,884 34,596 49.5 35,205 37,907 (2,702) (7.1)
Depreciation and amortization....... 86,559 67,792 18,767 27.7 70,729 64,792 5,937 9.2
Property operating expenses......... 163,715 136,227 27,488 20.2 133,673 133,547 126 0.1
Ground rent......................... 1,846 1,638 208 12.7 1,746 1,626 120 7.4
General and administrative.......... 18,250 13,948 4,302 30.8 136 7 129 1842.9
-------- -------- -------- ----- -------- -------- ------- ------
Total expenses.............. 374,850 289,489 85,361 29.5 241,489 237,879 3,610 1.5
-------- -------- -------- ----- -------- -------- ------- ------
Income before allocation to minority
interests, income from investment
in unconsolidated joint ventures
and extraordinary items........... 100,284 84,331 15,953 18.9 140,855 125,405 15,450 12.3
Minority interests.................. (9,215) (8,264) (951) 11.5 (545) (538) (7) 1.3
Income from unconsolidated joint
ventures.......................... 1,835 3,634 (1,799) (49.5) 2,202 2,795 (593) (21.2)
Extraordinary items................. (3,183) (6,959) 3,776 (54.3) (3,183) -- (3,183) --
-------- -------- -------- ----- -------- -------- ------- ------
Net income.......................... $ 89,721 $ 72,742 $ 16,979 23.3% $139,329 $127,662 $11,667 9.1%
======== ======== ======== ===== ======== ======== ======= ======
Property revenues less property
operating expenses before
depreciation and amortization,
general and administrative, ground
rent and interest expense......... $306,516 $233,366 $ 73,150 31.3% $248,090 $229,373 $18,717 8.2%
======== ======== ======== ===== ======== ======== ======= ======
</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 93.9% at January 1,
1998 to 94.8% as of March 31, 1999. This increase represents approximately 0.7
million square feet of additional occupancy in the Core Portfolio between
January 1, 1998 and March 31, 1999.
Property Revenues for the Total Portfolio include lease termination fees of
approximately $2.1 million and $2.9 million for the three months ended March 31,
1999 and 1998, respectively, and Property Revenues for the Core Portfolio
include lease termination fees of approximately $2.0 million and $2.9 million
for the three months ended March 31, 1999 and 1998, respectively (included in
the "other revenue" category on the consolidated statements 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 their 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.
Property Revenues for the Total Portfolio includes a straight-line rent
adjustment of approximately $16.5 million and $17.1 million for the three months
ended March 31, 1999 and 1998, respectively. Property Revenues for the Core
Portfolio includes a straight-line rent adjustment of approximately $13.1
million and $16.7 million for the three months ended March 31, 1999 and 1998,
respectively.
16
<PAGE> 17
Interest Expense
Interest expense increased for the Total Portfolio as a result of having
more debt outstanding during the three months ended March 31, 1999 than in the
three months ended March 31, 1998. The increase in total debt and the related
increase in interest expense were directly attributable to property
acquisitions. The Company's total debt as a percentage of total assets increased
from approximately 33.8% of total assets at March 31, 1998 to 42.4% of total
assets at March 31, 1999, and the Company's interest coverage ratio decreased
from approximately 3.2 times in 1998 to 2.8 times in 1999. The weighted average
interest rate on the Company's debt decreased from approximately 7.2% at March
31, 1998 to approximately 7.0% at March 31, 1999. The decrease in interest
expense in the Core Portfolio is primarily due to the replacement of secured
debt with unsecured debt which is not allocated to the Core Portfolio.
Depreciation and Amortization
Depreciation and amortization expense for the Total Portfolio increased as
a result of Properties acquired and capital and tenant improvements made during
1999 and 1998. Depreciation and amortization expense for the Core Portfolio
increased as a result of capital and tenant improvements made to the Properties.
Property Operating Expenses
Real estate taxes, insurance, repairs and maintenance and other property
operating expenses ("Property Operating Expenses") increased slightly for the
Core Portfolio. Repairs and maintenance expense increased approximately $1.5
million from the prior period partially offset by a decrease in real estate
taxes, insurance and other property operating expenses.
General and Administrative Expenses
The primary reason for the increase in general and administrative expenses
is the increase in the size of the Company's portfolio and increased expenses
associated with being a public company. While general and administrative
expenses will continue to increase as the size of the Company's portfolio
increases, it is currently anticipated that the Company's general and
administrative expenses as a percentage of total revenues will remain stable
with future growth. General and administrative expense was approximately 3.8%
and 3.7% of total revenues for the three months ended March 31, 1999 and 1998,
respectively.
17
<PAGE> 18
PARKING OPERATIONS
The Total Portfolio and Core Portfolio selected operating information for
the three months ended March 31, 1999 and 1998 presented above includes results
of operations from the Parking Facilities. Summarized information for the
Parking Facilities is presented below.
COMPARISON OF THE THREE MONTHS ENDED MARCH 31, 1999 TO MARCH 31, 1998
The table below represents selected operating information for the Total
Portfolio and the Core Portfolio consisting of 17 Parking Facilities acquired
prior to January 1, 1998.
<TABLE>
<CAPTION>
TOTAL PORTFOLIO CORE PORTFOLIO
------------------------------------- -------------------------------------
INCREASE/ % INCREASE/ %
(DOLLARS IN THOUSANDS) 1999 1998 (DECREASE) CHANGE 1999 1998 (DECREASE) CHANGE
- ----------------------------------------- ------ ------ ---------- ------ ------ ------ ---------- ------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Property revenues........................ $9,063 $6,971 $2,092 30.0% $8,153 $6,971 $1,182 17.0%
Interest/dividend income................. 3 33 (30) (90.9) 3 33 (30) (90.9)
------ ------ ------ ----- ------ ------ ------ -----
Total revenues................... 9,066 7,004 2,062 29.4 8,156 7,004 1,152 16.5
------ ------ ------ ----- ------ ------ ------ -----
Interest expense......................... 928 1,368 (440) (32.2) 887 1,368 (481) (35.2)
Depreciation and amortization............ 1,450 1,402 48 3.4 1,450 1,402 48 3.4
Property operating expenses.............. 2,024 1,985 39 2.0 1,992 1,985 7 .4
Ground rent.............................. 13 12 1 8.3 13 12 1 8.3
------ ------ ------ ----- ------ ------ ------ -----
Total expenses................... 4,415 4,767 (352) (7.4) 4,342 4,767 (425) (8.9)
------ ------ ------ ----- ------ ------ ------ -----
Income before allocation to minority
interests and income from investment in
unconsolidated joint ventures.......... 4,651 2,237 2,414 108.0 3,814 2,237 1,577 70.5
Minority interests....................... (235) (69) (166) 240.6 (235) (69) (166) 240.6
Income from unconsolidated joint
ventures............................... 409 681 (272) (39.9) 409 681 (272) (39.9)
------ ------ ------ ----- ------ ------ ------ -----
Net income............................... $4,825 $2,849 $1,976 69.4% $3,988 $2,849 $1,139 40.0%
====== ====== ====== ===== ====== ====== ====== =====
Property revenues less property operating
expenses before depreciation and
amortization, general and
administrative, ground rent and
interest expense....................... $7,039 $4,986 $2,053 41.2% $6,161 $4,986 $1,175 23.6%
====== ====== ====== ===== ====== ====== ====== =====
</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. In order to qualify as a REIT for
federal income tax purposes, the Company must distribute 95% of its REIT taxable
income (excluding capital gain) annually. Accordingly, the Company currently
intends to continue to make, but has not contractually bound itself to make,
regular quarterly distributions to holders of Common Shares/Units and preferred
shares. The Company has established annual distribution rates as follows: $1.48
per annum per Common Share/Unit, 8.98% per annum ($2.245 per share) for each
Series A Preferred Share, 5.25% per annum ($2.625 per share) for each Series B
Preferred Share and 8.625% per annum ($2.15625 per share) for each Series C
Preferred Share.
The Company intends to continue to fund distributions, debt service,
recurring capital costs and non-revenue enhancing tenant improvements from cash
from operations and draws under the $1.0 Billion Credit Facility. The Company
also expects that the $1.0 Billion Credit Facility will provide for temporary
working capital, the funding of capital improvements and revenue enhancing
tenant improvements, unanticipated cash needs and funding of acquisitions and
development costs.
Since 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, the Company will be required to repay maturing debt with funds from
debt and/or equity financing.
18
<PAGE> 19
DEBT FINANCING
The table below summarizes the mortgage debt, unsecured notes and lines of
credit indebtedness outstanding at March 31, 1999 and December 31, 1998,
including a net premium on mortgage debt and unsecured notes (net of accumulated
amortization of approximately $1.3 million and $2.7 million) of approximately
$17.2 million and $17.8 million, respectively, recorded in connection with the
Consolidation, debt assumed in connection with certain of the Company's
acquisitions, and issuance of unsecured notes.
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
(DOLLARS IN THOUSANDS) 1999 1998
- ------------------------------------------------------------ ---------- ------------
<S> <C> <C>
DEBT SUMMARY:
BALANCE
Fixed rate................................................ $5,476,093 $4,739,018
Variable rate............................................. 598,619 1,286,387
---------- ----------
Total............................................. $6,074,712 $6,025,405
========== ==========
PERCENT OF TOTAL DEBT:
Fixed rate................................................ 90.1% 78.7%
Variable rate............................................. 9.9% 21.3%
---------- ----------
Total............................................. 100.0% 100.0%
========== ==========
EFFECTIVE INTEREST RATE AT END OF PERIOD:
Fixed rate................................................ 7.2% 7.3%
Variable rate............................................. 5.7% 6.4%
---------- ----------
Effective interest rate........................... 7.0% 7.1%
========== ==========
</TABLE>
A majority of the variable rate debt shown above bears interest at an
interest rate based on LIBOR.
MORTGAGE FINANCING
As of March 31, 1999, the Company's total mortgage debt (excluding the
Company's share of unconsolidated debt of approximately $135.3 million)
consisted of approximately $2.0 billion of fixed rate debt with an effective
interest rate of approximately 7.6% and $70.6 million of variable rate debt
based on various spreads over LIBOR. The Company's mortgage debt at March 31,
1999 will mature as follows:
<TABLE>
<CAPTION>
(Dollars in thousands)
- --------------------------------------------------------------------------
<S> <C>
1999........................................................ $ 17,349
2000........................................................ 183,257
2001........................................................ 437,953
2002........................................................ 75,111
2003........................................................ 186,565
Thereafter.................................................. 1,174,234
----------
Subtotal.................................................... 2,074,469
Net premium (net of accumulated amortization of $1.5
million).................................................. 16,247
----------
Total............................................. $2,090,716
==========
</TABLE>
In the first quarter of 1999, the Company repaid approximately $256.8
million of mortgage debt and on April 1, 1999 the Company repaid $240.0 million
of mortgage debt with proceeds from the $1.0 Billion Notes Offering. The debt
maturity schedule above reflects the $240.0 million of mortgage debt maturing in
the year 2001, its contractual maturity date.
The instruments encumbering the Properties restrict transfer of the
mortgaged Properties subject to the terms of the mortgage indebtedness, prohibit
additional liens and require payment of taxes on the mortgaged Properties,
maintenance of the mortgaged Properties in good condition, maintenance of
insurance on the mortgaged Properties and obtaining lender consent to leases
with material tenants.
19
<PAGE> 20
CREDIT FACILITIES
Line of Credit
The $1.0 Billion Credit Facility matures on May 29, 2001. The interest rate
is based on the Company's investment grade credit rating on its unsecured debt
and is currently LIBOR plus 60 basis points with a facility fee equal to 20
basis points in respect to the entire facility, payable quarterly. In addition,
a competitive bid option, whereby the lenders participating in the facility bid
on the interest rate to be charged, is available for up to $350 million of the
facility. Subsequent to March 31, 1999 the Company borrowed $100.0 million on
the $1.0 Billion Credit Facility.
Term Loan Facilities
The $328 Million Credit Facility is priced at 90-day LIBOR plus 80 basis
points and is prepayable on any interest payment date and matures on August 15,
2000.
The $200 Million Credit Facility bears interest at either a money market
rate or LIBOR plus 50 basis points with a facility fee equal to 20 basis points
per annum, at the Company's option. As of March 31, 1999, the Company elected
the money market rate which equated to 5.6%. The interest rate may be reset
after the first twelve months for an additional six months and again after
eighteen months for an additional six months for a ten basis point fee.
UNSECURED NOTES
The table below summarizes the Company's unsecured notes as of April 30,
1999:
<TABLE>
<CAPTION>
TRANCHE AMOUNT STATED RATE EFFECTIVE RATE(1)
- ------- ------ ----------- -----------------
(Dollars in
thousands)
<S> <C> <C> <C>
3 Year Notes due 2002(2).................... $ 200,000 6.4% 6.6%
4 Year MOPPRS due 2002(3)................... 250,000 6.4% 6.3%
5 Year Notes due 2003....................... 300,000 6.4% 6.8%
5 Year Notes due 2004(2).................... 300,000 6.5% 6.7%
6 Year Notes due 2004....................... 250,000 6.5% 6.7%
7 Year Notes due 2004....................... 30,000 7.2% 7.3%
7 Year Notes due 2005....................... 400,000 6.6% 7.0%
8 Year Notes due 2005....................... 50,000 7.4% 7.7%
9 Year Notes due 2006....................... 50,000 7.4% 7.7%
9 Year Notes due 2007(4).................... 300,000 6.8% 6.8%
10 Year Notes due 2007....................... 50,000 7.4% 7.7%
10 Year Notes due 2008....................... 300,000 6.8% 7.0%
10 Year Notes due 2009(2).................... 500,000 6.8% 6.9%
20 Year Notes due 2018....................... 250,000 7.3% 7.6%
30 Year Notes due 2028....................... 225,000 7.3% 7.3%
30 Year Notes due 2029(5).................... 200,000 7.5% 7.6%
---------- --- ---
Total.............................. $3,655,000 6.8% 7.0%
========== === ===
</TABLE>
- ---------------
(1) Includes the cost of terminated interest rate protection agreements,
offering and transaction costs, the premium on the warrants and the discount
on unsecured notes.
20
<PAGE> 21
(2) These notes were issued on January 26, 1999. The net proceeds of
approximately $989.2 million were used to repay mortgage debt and amounts
outstanding on the $1.0 Billion Credit Facility.
(3) The MOPPRS are subject to mandatory redemption in 2002 but do not mature
until 2012.
(4) These notes were issued along with 300,000 warrants to purchase an
additional $300 million in unsecured notes at a later date. Each warrant
entitles its holder thereof to purchase a new $1,000 note at par on December
15, 1999 (or in certain circumstances on January 18, 2000) at a stated rate
of 6.763%, which will mature on June 15, 2008 and will have other terms
substantially similar to the $300 million nine year notes due 2007.
(5) These notes were issued in April 1999. The net proceeds of approximately
$196.6 million were used to repay amounts outstanding on the $1.0 Billion
Credit Facility.
The Company filed a shelf registration statement, which was declared
effective on July 22, 1998, relating to the potential issuance from time to time
of up to $2.0 billion of unsecured debt securities and warrants exercisable for
debt securities in amounts, at initial prices and on terms to be determined at
the time of offering. The securities may be issued separately or together, in
separate series and in amounts, at prices and on terms to be described in one or
more supplements to the prospectus. The Company sold $1.0 billion of unsecured
notes in January 1999 and $200 million of unsecured notes in April 1999 under
this registration statement.
Restrictions and Covenants
Agreements or instruments relating to the unsecured notes and lines of
credit contain certain restrictions and requirements regarding total debt to
assets ratios, secured debt to total assets ratios, debt service coverage
ratios, minimum ratio of unencumbered assets to unsecured debt and other
limitations.
EQUITY SECURITIES
During the three months ended March 31, 1999, there were 15,209 share
options exercised and 180,552 Units redeemed into Common Shares on a one-for-one
basis.
CAPITAL IMPROVEMENTS
The Company takes 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 made in the year of
acquisition and the two following years 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 three months ended
March 31, 1999 were approximately $4.6 million or $0.06 per square foot. These
amounts exclude capital and tenant improvements of approximately $21.2 million
for developments.
The Company considers capital expenditures to be recurring expenditures
relating to the ongoing maintenance of the Office Properties. The table below
summarizes capital expenditures for the three months ended March 31, 1999. The
capital expenditures set forth below are not necessarily indicative of future
capital expenditures.
<TABLE>
<S> <C>
Number of Office Properties................................. 287
Rentable square feet (in millions).......................... 76.3
Capital expenditures per square foot........................ $0.04
</TABLE>
21
<PAGE> 22
TENANT IMPROVEMENTS AND LEASING COMMISSION COSTS
The Company distinguishes its tenant improvements and leasing commissions
between those that are revenue enhancing (i.e., 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 (i.e., 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 three months ended March 31, 1999, excluding amounts attributable to
developments. 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 improvements and leasing commission costs:
<TABLE>
<CAPTION>
FOR THE THREE MONTHS ENDED
MARCH 31, 1999(1)
--------------------------
<S> <C>
Number of Office Properties................................. 287
Rentable square feet (in millions).......................... 76.3
Revenue enhancing tenant improvements and leasing
commissions:
Amounts (in thousands).................................... $ 5,570
Per square foot improved.................................. $ 18.54
Per total square foot..................................... $ 0.29
Non-revenue enhancing tenant improvements and leasing
commissions:
Renewal space:
Amounts (in thousands).................................... $ 8,997
Per square foot improved.................................. $ 7.37
Per total square foot..................................... $ 0.47
Retenanted space:
Amounts (in thousands).................................... $11,559
Per square foot improved.................................. $ 13.23
Per total square foot..................................... $ 0.61
-------
Total non-revenue enhancing (in thousands).................. $20,556
Per square foot improved.................................... $ 9.81
Per total square foot....................................... $ 1.08
</TABLE>
- ---------------
(1) The per square foot calculations as of March 31, 1999 are calculated taking
the total dollars anticipated to be incurred on tenant improvements for
tenants taking occupancy during the three months ended March 31, 1999,
divided by the total square footage being improved or total building square
footage. The actual amounts incurred for the three months ended March 31,
1999 for revenue enhancing, non-revenue enhancing renewal and retenanted
space are summarized below:
<TABLE>
<CAPTION>
(Dollars in thousands)
- ----------------------
<S> <C>
Revenue enhancing................................ $4,460
Non-revenue enhancing renewal.................... $4,027
Non-revenue enhancing retenanted................. $6,408
</TABLE>
DEVELOPMENTS
In connection with the Beacon Merger and other acquisitions, the Company
acquired certain Properties that are currently in various stages of development
or pre-development. The Company funds these developments with proceeds from
working capital and the credit facilities. Specifically identifiable direct and
indirect acquisition, development and construction costs are capitalized
including, where applicable, salaries and related costs, real estate taxes,
interest and certain pre-construction costs essential to the development of a
property. As of March 31, 1999, the Company had incurred approximately $156.8
million of costs in
22
<PAGE> 23
connection with the Properties being developed. The Properties under development
as of March 31, 1999 are as follows:
<TABLE>
<CAPTION>
ESTIMATED
RENTABLE TOTAL
ESTIMATED PLACE IN PERCENT SQUARE ESTIMATED
PROPERTY LOCATION SERVICE DATE(A) LEASED FOOTAGE COSTS INCURRED COSTS(A)
- -------- -------- ------------------ ------- --------- -------------- ---------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Reston Town Center Reston, VA 4Q/1999 N/A (b) $ 3,818 $ 13,000
Garage
150 California San Francisco, CA IQ/2000 0% 201,554 21,390 66,000
John Marshall III McLean, VA IQ/2000 100% 180,000 24,939 46,000
Riverside Center Newton, MA 2Q/2000 0% 494,710 39,694 112,000
Other Projects(c) Various -- -- -- 66,272 --
------- -------- --------
Total 876,264 $156,113(d) $237,000
======= ======== ========
</TABLE>
In addition, the Company has entered into agreements to acquire the
following properties upon completion:
<TABLE>
<CAPTION>
ESTIMATED
RENTABLE TOTAL
ESTIMATED PLACE IN PERCENT SQUARE ESTIMATED
PROPERTY LOCATION SERVICE DATE(A) LEASED FOOTAGE COSTS INCURRED COSTS(A)
- -------- -------- ------------------ ------- --------- -------------- ---------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
517 Marquette Garage Minneapolis, MN 2Q/1999 N/A (e) $ 98 $ 19,000
Prominence(f) Atlanta, GA 3Q/1999 1% 425,706 596 87,000
World Trade Center(g) Seattle, WA 1Q/2000 100% 186,787 34 39,000
------- ---- --------
Total 612,493 $728 $145,000
======= ==== ========
</TABLE>
The above transactions are contingent upon certain terms and conditions as
set forth in their respective purchase agreements. There can be no assurance
that these transactions will be consummated as described above.
In addition, the Company has entered into separate joint ventures to
develop the following properties:
<TABLE>
<CAPTION>
ESTIMATED
RENTABLE TOTAL
ESTIMATED PLACE IN PERCENT SQUARE ESTIMATED
PROPERTY LOCATION SERVICE DATE(A) LEASED FOOTAGE COSTS INCURRED COSTS(A)
- -------- -------- ------------------ ------- --------- -------------- ---------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Metropoint II(h) Denver, CO 2Q/1999 36% 150,181 $ 9,032 $ 17,000
Sunset North Corporate Bellevue, WA 4Q/1999 42% 460,663 39,779 81,000
Campus(i)
Three Bellevue Center(j) Bellevue, WA 1Q/2000 0% 471,635 9,567 72,000
--------- ------- --------
Total 1,082,479 $58,378 $170,000
========= ======= ========
</TABLE>
- ---------------
(a) The Estimated Place in Service Date represents the date the certificate of
occupancy has been or is anticipated to be obtained. Subsequent to
obtaining the certificate of occupancy, the Property will undergo a lease
up period. The Total Estimated Costs include amounts attributable to
tenanting the Property.
(b) This property is a parking facility that will consist of approximately 530
parking spaces and 34,700 square feet of retail space.
(c) Represents various land parcels where the Company has obtained zoning and
entitlement approvals, but has not finalized a specific development plan.
The Company has taken the necessary steps to continue the development
process while it evaluates its alternatives with respect to these projects.
(d) Includes $1,771 related to deferred leasing costs. Deferred leasing costs
are classified separately on the Company's balance sheet.
23
<PAGE> 24
(e) This parking facility (formerly known as "Rand Tower Garage") consists of
approximately 589 parking spaces and was acquired on April 30, 1999.
(f) The estimated cost of this property excludes a vacant land parcel valued at
approximately $7.0 million, that will be purchased with the building.
(g) The Company expects to acquire this property upon lease up in 2000. The
building is scheduled to be completed in April 1999.
(h) The Costs Incurred and Total Estimated Costs reflect the Company's 70%
interest in this project. The total cost of the project including the joint
venture partner's share is approximately $24 million.
(i) The Costs Incurred and Total Estimated Costs reflect the Company's 80%
interest in this project including the Company's pro-rata share of the
development loan. The total cost of the project including the joint venture
partner's share is approximately $101 million of which up to $68 million
will be funded by a development loan. The Company's share of the
development loan outstanding at March 31, 1999 is approximately $14.6
million.
(j) The Costs Incurred and Total Estimated Costs reflect the Company's 80%
interest in this project including the Company's pro-rata share of the
development loan. The total cost of the project including the joint venture
partner's share is approximately $90 million of which up to $60 million
will be funded by a development loan. The Company's share of the
development loan outstanding at March 31, 1999 is approximately $.3
million.
In addition to the properties described above, the Company owns various
land parcels available for development. However, no significant development
activity is taking place on these sites at this time.
YEAR 2000
OVERVIEW OF Y2K PROBLEM
The Year 2000 or "Y2K" problem refers to the inability of many existing
computer programs to properly recognize a year that begins with "20" instead of
the familiar "19". If left uncorrected, many computer programs having
time-sensitive software may recognize a date using "00" as the year 1900 rather
than the year 2000. The failure to accurately recognize the year 2000 and other
key dates could result in a variety of problems from data miscalculations to the
failure of entire systems. Among the assumptions the Company has made in the
course of this discussion are the following:
- The Company's ability to accurately determine its Y2K readiness on a cost
effective basis.
- The availability of personnel and systems as required to correct any Y2K
problems known to the Company.
- The continued availability of such personnel and systems on a
commercially reasonable basis throughout 1999.
THE YEAR 2000 PROGRAM
In the early months of 1998, the Company formed a Year 2000 committee for
the purpose of creating a program (the "Program") to identify, understand and
address the myriad of issues associated with the Y2K problem. Such committee is
comprised of representatives from senior management and various departments at
the home and regional offices, including the legal, engineering,
telecommunications, information systems and office services departments. Due to
the wide ranging implications of the Y2K problem, management decided to carry
out the Program in multiple phases during 1998 and 1999. What follows is a
description of the activities that have been or are expected to be conducted in
each phase of the Program, including a summary of the results obtained to date
and a time table for completion. Although many of the phases of the Program are
being carried out simultaneously, the various phases will be discussed
separately.
24
<PAGE> 25
PHASE ONE -- ASSESSING THE COMPANY'S Y2K READINESS
The initial step in assessing the Company's Y2K readiness consists of
conducting a study to identify any systems and applications (collectively
referred to as "systems") that are date sensitive and, accordingly, could have
potential Y2K problems. The study includes an examination of information
technology and non-information technology systems at the Company's home and
regional offices and at the Company's Properties. For the most part, the initial
step of identifying potentially problematic systems has been completed by the
Company's Information Services department, building engineers and third party
consultants through a combination of physical inspections and informational
interviews with Company employees.
After identifying systems that could have a potential Y2K problem, the
second step of Phase 1 was to attempt to determine which of the systems actually
have a Y2K problem. Much of the required information is within the exclusive
control of the Company's vendors and manufacturers, who have been contacted
through standard form letters and telephone calls requesting information. In
many cases, information was also available on vendor and manufacturer web sites.
Even if a particular system has been represented to be Y2K ready or compliant,
the Company, in many cases, will not consider the system to be Y2K ready until
after the Company has confirmed the system's readiness by independent testing.
The Company currently plans to test all systems whose failure could have a
significant adverse effect on the daily operation of any of the Company's
departments. In addition to examining the Company's systems for Y2K readiness,
the Company continues to assess the progress of the Building Owners and Managers
Association ("BOMA"), the General Services Administration ("GSA") and other
industry leaders that are monitoring the compliance efforts of the major utility
and telecommunications companies. The following is a summary of the Phase One
results obtained to date.
BUILDING MANAGEMENT SYSTEMS
The Company has identified six categories of building management systems in
which it has the most exposure to potential Y2K problems. These categories
include:
- Building automation (e.g. energy management, HVAC)
- Security card access
- Fire and life safety
- Elevator
- Garage revenue control
- Telephone
Prior to January 1999, the Company completed a preliminary Y2K readiness
study of the building management systems outlined above at each of the Company's
Properties. Based upon this study, the Company will upgrade or replace specific
building management systems that were represented not to be Y2K ready or
compliant. The estimated cost of such upgrades and replacements is described in
the Phase Two summary that follows. It is possible that the independent testing
of the building management systems may reveal the need for additional upgrades
and replacements.
INFORMATION SYSTEMS
The Company's information systems falls into four general categories:
accounting and property management, network operating systems, desktop software
and secondary systems.
25
<PAGE> 26
ACCOUNTING AND PROPERTY MANAGEMENT
Management believes that it has determined the Company's exposure with
respect to the Company's accounting and property management software.
Specifically, although the general ledger system is believed to be Y2K ready,
the accounts payable and property management systems are not. The Company's
current expected schedule for Y2K readiness is as follows:
- Test software upgrades -- In Progress
- Begin installation of upgrades -- In Progress
- Full Y2K readiness -- Second to Third Quarter 1999
If the planned upgrades to the Company's accounting and property management
software do not perform in a manner that satisfies the Company's performance
criteria, the Company may elect to accelerate the implementation of an
accounting and property management software package that is currently scheduled
for usage beginning in the year 2000.
NETWORK OPERATING SYSTEMS
Management believes that the network operating servers are currently
approximately 50% Y2K ready. The servers that are not currently Y2K ready
require a software patch that is being acquired from the software manufacturer.
Upgrades of the Company's network operating systems are expected to be installed
in the first and second quarters of 1999, bringing the network operating servers
into full Y2K readiness. Management believes that testing of this new software
may not be necessary, as it has already been proven in the industry to be Y2K
compliant.
DESKTOP SOFTWARE
Management believes that all of the Company's desktop systems and software
applications have been reviewed. Management has identified those that are not in
compliance and compiled a list of necessary upgrades. The efforts to ready the
Company's desktop systems for Y2K are being directed towards a broader Company
initiative referred to as EO 2000. As part of the EO 2000 program, the Company
currently intends to install Windows NT and Microsoft Office 97 in all field and
home office desktop systems.
The Company's time frame for EO 2000 is expected to be as follows:
- Systems (hardware and software) testing for Y2K readiness -- Complete
- Install updated software that will also provide Y2K readiness -- In
Progress
- Complete installation/full Y2K readiness -- October 1999
SECONDARY INFORMATION SYSTEMS
The Company's "secondary" information systems include, but are not limited
to: payroll, human resources, fixed-asset system, forecasting modeling software,
and all types of internally developed software, such as the Company's budget
program and tenant-services system. The Company has retained a third party
consultant to assist in identifying and assessing the readiness of its
information systems, including the secondary systems. The initial step of
identifying any non-compliant systems was completed during the first quarter
1999 at a cost of approximately $.3 million. Such cost represents the cost of
work performed by third party consultants and does not attribute a dollar value
to any time spent by Company employees. As mentioned above, the Company
currently plans to test a number of the systems, including secondary systems,
that were represented by the vendors or manufacturers to be Y2K ready or
compliant. The Company is currently working with its third party consultant to
determine an appropriate scope and budget for the testing. The initial budget
for third party costs in connection with testing the Company's selected
information systems is approximately $.5 million.
26
<PAGE> 27
TELECOMMUNICATION SYSTEMS
Management generally believes that the Company's internal telephone systems
are not date sensitive and should not be materially affected by Y2K problems.
Although there could be some convenience issues such as inaccurate voice-mail
message date stamps, such problems are not expected to be material and, in large
part, should be corrected prior to the year 2000.
PHASE TWO -- DETERMINING THE COST OF ACHIEVING Y2K READINESS AND IMPLEMENTING
THE Y2K ACTION PLAN
Based upon the preliminary studies that were completed in January 1999, the
Company has budgeted approximately $7.4 million for the upgrade and replacement
of building management systems having potential Y2K related problems. This
amount equates to an average of approximately $.10 per rentable square foot at
each of the Company's Properties. It is management's belief that a large part of
the cost of bringing the building management systems into compliance will be
considered to be reimbursable to the Company under most tenant leases or is
being incurred as part of a broader initiative to improve building operating
systems. The estimated cost of the EO 2000 initiative is $1.7 million. Most of
the work related to EO 2000 is not Y2K related. The Company is still in the
process of completing Phases One and Two of the Program with respect to
Information Systems. As discussed above, approximately $.3 million was spent in
Phase I to identify information systems that could have potential Y2K problems
and to obtain information from the vendors and manufacturers of such systems as
to Y2K readiness. Based on the Company's initial budget, it is anticipated an
additional $.5 million will be spent to test selected information systems. Upon
completion of the testing, the Company will prepare a budget and action plan for
Y2K readiness.
PHASE THREE -- ASSESSING THE RISKS TO THE COMPANY OF NON-COMPLIANCE
Management does not currently believe that the impact of the Y2K problem
will have a material adverse effect on the Company's financial condition and
results of operations. Such belief is based on management's analysis of the
risks to the Company related to the Company's own potential Y2K problems
discussed above, as well as its assessment of the Y2K problems of the Company's
vendors, suppliers and customers.
Failure of Building Management Systems
Management believes that the Y2K risks to the Company's financial condition
and operation associated with a failure of building management systems is
immaterial due to the fact that most building management systems can be operated
in a manual or by-pass mode, thereby negating the Y2K problem until it can be
corrected. In addition, each of the Company's Properties has, for the most part,
separate building management systems. Accordingly, a Y2K problem that is
experienced at one Property should have no effect on other Properties. In
addition, based upon the study results received to date, management believes
that the Company will have sufficient time to correct those system problems
within its control before the year 2000. The Company has currently performed
preliminary testing of building systems at over 50% of the Company's Properties.
Testing of essential building management systems will continue throughout 1999.
In the event the Company does experience a failure of essential building
management systems at one or more of the Company's buildings, whether due to a
failure of one of its systems or an interruption of utilities, management
believes that the individual tenant leases will protect the Company from claims
of constructive eviction or other remedies that could result in a termination of
lease rights. It is also management's belief that most of its leases eliminate,
limit or quantify the rights of a tenant to receive an abatement under such
circumstances. Although there is always a risk of claims being brought on a
non-contractual basis (e.g. in tort), it is the Company's belief that its
efforts to identify and solve Y2K problems will minimize such risk. The Company
has also attempted to allocate the risk of non-compliance to the vendors and
manufacturers of the building management and information systems by establishing
standard riders and addenda to be attached to new contracts for systems using
time sensitive data.
27
<PAGE> 28
Failure of Information Systems
Since the Company's major source of income is rental payments under long
term leases, the failure of key information systems is not expected to have a
material adverse effect on the Company's financial condition and results of
operations. Even if the Company were to experience problems with its information
systems, the payment of rent under the leases would not be excused. In addition,
the Company expects to correct those information system problems within its
control before the year 2000, thereby minimizing or avoiding the increased cost
of correcting problems after the fact.
The Y2K Problems of the Company's Vendors
The success of the Company's business is not closely tied to the operations
of any one manufacturer, vendor or supplier. Accordingly, if any of the
Company's manufacturers, vendors or suppliers ceases to conduct business due to
Y2K related problems, the Company expects to be able to contract with alternate
providers without experiencing any material adverse effect on the Company's
financial condition and results of operations.
The Y2K Problems of the Company's Customers
Due to our broad customer/tenant base, the success of the Company's
business is not closely tied to the success of any particular tenant.
Accordingly, management believes that there should not be a material adverse
effect on the Company's financial condition and results of operations if any one
of its tenants ceased to conduct business (and pay rent) due to Y2K related
problems. This would not necessarily be the case, however, were Y2K problems
sufficiently pervasive as to affect the financial conditions of a material
number of the Company's tenants. As part of its efforts to keep its tenants
advised as to the steps the Company is taking to address potential Y2K problems,
the Company has also requested that its tenants provide it with periodic updates
as to their Y2K readiness.
Doomsday Scenario
The Company is aware that it is generally believed that the world's Y2K
problem, if uncorrected, may result in an economic crisis of global proportions.
The Company is unable to determine whether such predictions are true or false.
As mentioned above, the Company expects that the nature of its income (rent from
good credit tenants under long term leases) should serve as a hedge against any
short term disruptions of business. However, if the doomsday scenarios prove
true, all companies (including Equity Office Properties Trust) will experience
the effects.
Phase Four -- Developing Contingency Plans
The Company is beginning to take the initial steps in the development of
contingency plans for the operation of the Company's individual corporate
departments. In addition, the Company expects to develop a contingency plan for
the operation of the company's Properties during the third Quarter of 1999.
INFLATION
Substantially all of the office leases require the tenant to pay, as
additional rent, a portion of any increases in real estate taxes (except, in the
case of certain California leases, which limit the ability of the landlord to
pass through to the tenants the effect of increased real estate taxes
attributable to a sale of real property interests) 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.
28
<PAGE> 29
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 months ended March 31, 1999 and 1998 on a historical
basis:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
---------------------
(DOLLARS IN THOUSANDS) 1999 1998
- ------------------------------------------------------------ --------- ---------
<S> <C> <C>
Income before allocation to minority interests, income from
investment in unconsolidated joint ventures and
extraordinary items:...................................... $ 100,284 $ 84,331
Add back (deduct):
(Income) allocated to minority interests for partially
owned properties....................................... (545) (538)
Income from investment in unconsolidated joint ventures... 1,835 3,634
Depreciation and amortization (real estate related)....... 89,088 69,406
Net amortization of net premium on mortgage debt.......... (453) 274
Preferred distributions................................... (10,881) (6,271)
--------- ---------
Funds from Operations before effect of adjusting
straight-line rental revenue and expense included in Funds
from Operations to a cash basis(1)........................ 179,328 150,836
Deferred rental revenue................................... (16,540) (17,119)
Deferred rental expense................................... 653 555
--------- ---------
Funds from Operations excluding straight-line rental revenue
and expense adjustments................................... $ 163,441 $ 134,272
========= =========
Cash Flow Provided By (Used For):
Operating Activities...................................... $ 102,912 $ 110,765
Investing Activities...................................... $(153,933) $(270,947)
Financing Activities...................................... $ 25,907 $ (56,990)
Ratio of earnings to combined fixed charges and preferred
share distributions....................................... 1.7 1.9
</TABLE>
- ---------------
(1) The White Paper on Funds from Operations approved by the Board of Governors
of the National Association of Real Estate Investment Trusts ("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, nor does it represent cash available to pay distributions 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.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's future earnings, cash flows and fair values relevant to
financial instruments are dependent upon prevalent market rates. Market risk is
the risk of loss from adverse changes in market prices and interest rates. The
Company manages its market risk by matching projected cash inflows from
operating activities, financing activities and investing activities with
projected cash outflows to fund debt payments, acquisitions, capital
expenditures, distributions and other cash requirements. The majority of the
Company's outstanding debt (maturing at various times through 2029) has a fixed
interest rate, which minimizes the interest rate risk. The Company also utilizes
certain derivative financial instruments at times to limit market risk. Interest
rate protection agreements are sometimes used to convert floating rate debt to a
fixed rate basis or to hedge anticipated financing transactions. Derivatives are
used for hedging purposes rather than speculation. The Company does not enter
into financial instruments for trading purposes.
The Company has total outstanding debt of approximately $6.1 billion at
March 31, 1999, of which approximately $0.6 billion, or 9.9 %, is variable rate
debt. If market rates of interest on the Company's variable rate debt increase
by ten percent (or approximately 57 basis points), the increase in interest
expense on the Company's variable rate debt would decrease future earnings and
cash flows by approximately $.9 million for a three month period. If market
rates of interest increase by ten percent, the fair value of the Company's total
outstanding debt would decrease by approximately $131 million. If market rates
of interest on the Company's variable rate debt decrease by ten percent (or
approximately 57 basis points), the decrease in interest expense on the
Company's variable rate debt would increase future earnings and cash flows by
approximately $.9 million for a three month period. If market rates of interest
decrease by ten percent, the fair value of the Company's total outstanding debt
would increase by approximately $146 million.
At March 31, 1999, the Company has put option agreements outstanding in
connection with the acquisition of the Wright Runstad Properties and Columbus
America Properties. On August 13, 1999, the holders of Wright Runstad options
(the "WR Holders"), can require the Company to purchase all or a portion of the
3,435,668 Common Shares issued at acquisition at a price equal to $31.50 per
Common Share. Prior to August 13, 1999, if the WR Holders sell all or a portion
of their Common Shares to a third party for a price less than $29.10625, then
the Company is obligated to pay to the WR Holders an amount equal to the
difference between such sale price and $29.10625 multiplied by the number of
Common Shares sold, not to exceed $3.00 per Common Share. Any amounts paid by
the Company as a result of such sales, calculated as the difference between the
sale price and $29.10625 not exceeding $3.00 per Common Share, shall be recorded
as a reduction of shareholders' equity. For options exercised on August 13,
1999, any amounts paid up to $29.10625 per Common Share would be reflected as a
reduction to shareholders' equity; the portion of any amounts paid in excess of
$29.10625 per Common Share (not to exceed $2.39375 per Common Share up to an
aggregate of approximately $8.2 million) would be expensed by the Company. The
Company will not incur any loss on this transaction if the put option is not
exercised.
The Company's cash flows could decrease by up to $10.3 million if, prior to
August 13, 1999, the WR Holders sell all their Common Shares to third parties.
Cash flows of the Company may decrease by up to approximately $108 million if
the WR Holders exercise their rights under the put option agreement on August
13, 1999. There will be no impact on cash flows from this transaction if the put
option is not exercised. As of March 31, 1999, the WR Holders have not exercised
their option under the put option agreement.
The Company has a put option agreement outstanding with the seller of the
Columbus America Properties (the "CA Holder") related to 1,692,546 Units issued
at acquisition. The CA Holder has the option at any time after January 1, 1999
until the earlier of September 3, 2000 or the date the CA Holder has converted
all of its Units to Common Shares, to require the Company to purchase the Units
at a price equal to $29.00 per Unit. Under the terms of the agreement, prior to
September 3, 1999, the option shall be limited to an aggregate of 846,273 Units.
In the event of any option exercise the Company will recognize any cash paid as
a reduction in minority interest. The Company's cash flows could decrease by up
to $24.5 million if, prior to September 3, 1999, the CA Holder exercises its
option on 846,273 Units. Cash flows of the Company may decrease by up to $49.1
million if the CA Holder exercises its option on or after September 3, 1999.
There will
30
<PAGE> 31
be no impact on cash flows from this transaction if the put option is not
exercised. As of March 31, 1999, the CA Holder has not exercised its option to
require the Company to purchase the Units.
These amounts were determined by considering the impact of hypothetical
interest rates and equity prices on the Company's financial instruments. These
analyses do not consider the effects of the reduced level of overall economic
activity that could exist in such an environment. Further, in the event of a
change of such magnitude, management would likely take actions to further
mitigate its exposure to the change. However, due to the uncertainty of the
specific actions that would be taken and their possible effects, these analyses
assumes no changes in the Company's financial structure.
PART II
OTHER INFORMATION
ITEM 5. OTHER INFORMATION
On January 6, 1999, the Company received a Private Letter Ruling from the
Internal Revenue Service to the effect that revenue received by the Company with
respect to telecommunication services provided to tenants of the Company will
qualify as "rents from real property" for purposes of the REIT qualifying income
requirements and that the provision of telecommunication services will not cause
otherwise qualifying income to fail to qualify as "rents from real property".
"Telecommunication services" were defined in the Ruling as "telephone and other
communications, e-mail, video communications, electronic research, internet
access, communications networking, safety and security systems, and
environmental control systems."
As a result of this Ruling, the Company is proceeding with various
telecommunication service arrangements, the most significant of which are the
following:
(a) The Company has entered into agreements with Allied Riser Communications,
Inc. ("ARC") for the provision of telecommunication services currently
consisting of high-speed internet access and private networking to tenants of 57
of the Company's Office Properties. Each of these agreements obligates ARC to
install a fiber optic telecommunications riser within the subject building for
the purpose of delivering such telecommunication services to subscribing tenants
and to pay the Company a fee generally equal to an agreed percentage of the
gross receipts generated from such delivery. Each of these agreements is for a
term of five years, subject to a right of ARC to extend for an additional
five-year term.
At the suggestion of its chairman, Mr. Samuel Zell, the Company previously
considered the feasibility of an investment in ARC. Its independent trustees,
however, ultimately determined not to proceed with this investment (due
primarily to its uncertain tax treatment at the time the investment was offered
to the Company) and, in so doing, acknowledged Mr. Zell's right to invest for
his own account. Subsequent to that determination, Mr. Zell purchase $15 million
of the $66 million of ARC's issued and outstanding preferred stock and
approximately 21.5% of ARC's issued and outstanding common stock (all of which
common stock was issued for nominal consideration). Although representatives of
Mr. Zell sit on the Board of ARC, he is not active in the day-to-day business
activities of ARC.
The Company believes its agreements with ARC are on competitive market
terms. The Company further believes that the undertaking of ARC (unlike that of
other providers) to install fiber optic telecommunication riser facilities
within an Office Property prior to having first signed up customers within the
Property is a competitive benefit to the Company in attracting and maintaining
tenants. During the first quarter of 1999, the Company received nominal amounts
of revenue as a result of its license agreement with ARC and an additional $.2
million as rent for ARC's use of office space. ARC has advised the Company that,
as of March 31, 1999, ARC's investment in the subject buildings exceeded $9.4
million and was expected to increase with further installations.
(b) The Company has also entered into telecommunication service agreements with
WinStar Wireless, Inc. ("WinStar") granting it a non-exclusive license to locate
equipment and sell telecommunication services to tenants in 88 of the Company's
Office Properties (some of which are also subject to agreements with ARC as
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<PAGE> 32
described above). Under the terms of these agreements, WinStar has agreed to pay
the Company an initial administration fee per building as well as a fixed
monthly access fee. The Company does not otherwise share in the gross receipts
of WinStar. The agreements with WinStar are for a five-year term and, in the
case of "hub" buildings, allow WinStar the option of extending for an additional
five-year period.
The licenses granted under the terms of the agreements with both ARC and
WinStar are non-exclusive in order to preserve the benefits of competition in
terms of pricing and quality of service for telecommunication services provided
to the Company's tenants.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits: (27) Financial Data Schedule
(b) Reports on Form 8-K:
(1) A report on Form 8-K, dated January 7, 1999 containing Item 2,
Item 5, Item 7 and the following financial statements:
- Pro Forma Condensed Combined Financial Statements as of and for the
nine months ended September 30, 1998 and for the year ended December
31, 1997;
- Statements of Revenue and Certain Expenses for Park Avenue Tower for
the year ended December 31, 1997 and the period from January 1, 1998
through May 31, 1998;
- Combined Statements of Revenue and Certain Expenses for Worldwide
Plaza for the year ended December 31, 1997 and the period from January
1, 1998 through August 31, 1998.
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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.
<TABLE>
<S> <C>
EQUITY OFFICE PROPERTIES TRUST
Date: May 7, 1999 By: /s/ STANLEY M. STEVENS
--------------------------------------------
Stanley M. Stevens
Executive Vice President,
Chief Legal Counsel and Secretary
Date: May 7, 1999 By: /s/ RICHARD D. KINCAID
--------------------------------------------
Richard D. Kincaid
Executive Vice President,
Chief Financial Officer
</TABLE>
33
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<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> MAR-31-1999
<CASH> 41,966
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0
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