<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-Q/A
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1998
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission File Number: 1-13589
PRIME GROUP REALTY TRUST
(Exact name of registrant as specified in its charter)
MARYLAND 36-4173047
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
77 WEST WACKER DRIVE, SUITE 3900, CHICAGO, ILLINOIS 60601
(Address of principal executive offices) (Zip Code)
(312) 917-1300
(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 __
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date:
At August 14, 1998, 15,572,494 of the Registrant's Common Shares of Beneficial
Interest were outstanding.
<PAGE>
PRIME GROUP REALTY TRUST
FORM 10-Q/A
INDEX
PART I: FINANCIAL INFORMATION
<TABLE>
<CAPTION>
Item 1: Financial Statements (Unaudited) PAGE
----
<S> <C>
Consolidated Balance Sheets of Prime Group Realty Trust
as of June 30, 1998 and December 31, 1997.......................................... 3
Consolidated Statement of Income of Prime Group Realty
Trust for the Three Months Ended June 30, 1998 and the
Combined Statement of Operations of the Predecessor
Properties (predecessor to Prime Group Realty Trust) for
the Three Months Ended June 30, 1997............................................... 4
Consolidated Statement of Income of Prime Group Realty
Trust for the Six Months Ended June 30, 1998 and the
Combined Statement of Operations of the Predecessor
Properties (predecessor to Prime Group Realty Trust) for
the Six Months Ended June 30, 1997................................................. 5
Consolidated Statement of Cash Flows of Prime Group Realty Trust for
the Six Months Ended June 30, 1998 and the Combined Statement of Cash
Flows of the Predecessor Properties (predecessor to Prime Group
Realty Trust) for
the Six Months Ended June 30, 1997................................................. 6 - 7
Notes to Consolidated and Combined Financial Statements
of Prime Group Realty Trust and of the Predecessor
Properties (predecessor to Prime Group Realty Trust)............................... 8 - 13
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations................................................ 14 - 20
Item 3. Quantitative and Qualitative Disclosures About Market Risk......................... 20
PART II: OTHER INFORMATION
Item 1. Legal Proceedings.................................................................. 21
Item 2. Changes in Securities and Use of Proceeds.......................................... 21
Item 3. Defaults Upon Senior Securities.................................................... 21
Item 4. Submission of Matters to a Vote of Security Holders................................ 21
Item 5. Other Information.................................................................. 21
Item 6. Exhibits and Reports on Form 8-K................................................... 22
Signatures ................................................................................... 23
</TABLE>
2
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1: FINANCIAL STATEMENTS
PRIME GROUP REALTY TRUST
CONSOLIDATED BALANCE SHEETS
(000'S OMITTED, EXCEPT SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1998 1997
----------- -------------
ASSETS (RESTATED)
<S> <C> <C>
Real estate and equipment, at cost:
Land........................................................................ $157,913 $ 92,440
Building and improvements .................................................. 688,485 496,839
----------- -----------
846,398 589,279
Accumulated depreciation ................................................... (12,424) (2,338)
----------- -----------
833,974 586,941
Mortgage note receivable ....................................................... 56,988 56,263
Cash and cash equivalents ...................................................... 13,167 11,969
Tenant receivables ............................................................. 6,185 3,897
Restricted cash escrows ........................................................ 10,484 3,175
Deferred rent receivable ....................................................... 38,492 37,751
Deferred costs, net ............................................................ 32,033 28,472
Due from affiliates ............................................................ 6,352 5,258
Other .......................................................................... 25,053 7,742
----------- -----------
Total assets ................................................................... $ 1,022,728 $ 741,468
----------- -----------
----------- -----------
LIABILITIES AND SHAREHOLDERS' EQUITY
Mortgage notes payable ......................................................... $ 378,501 $ 249,610
Mortgage note payable - Affiliate .............................................. -- 3,984
Bonds payable .................................................................. 74,450 74,450
Accrued interest payable ....................................................... 1,703 1,245
Accrued real estate taxes ...................................................... 25,420 17,915
Accounts payable and accrued expenses .......................................... 17,720 13,903
Liabilities for leases assumed ................................................. 5,083 5,758
Dividends payable .............................................................. 6,597 2,505
Other .......................................................................... 5,712 822
----------- -----------
Total liabilities .............................................................. 515,186 370,192
Minority interests:
Operating Partnership ...................................................... 147,271 147,207
Other ...................................................................... 1,000 --
Shareholders' equity:
Preferred shares:
Series B Cumulative Redeemable Preferred Shares, $.01 par value; 4,600,000
shares authorized, 4,000,000
issued and outstanding ................................................. 40 --
Series A Cumulative Convertible Preferred Shares,
$.01 par value; 30,000,000 shares authorized, 2,000,000
issued and outstanding ................................................. 20 20
Common shares, $.01 par value; 100,000,000 shares
authorized; 15,572,494 and 12,980,000 shares issued and
outstanding at June 30, 1998 and December 31, 1997,
respectively ............................................................. 156 130
Additional paid-in capital ................................................. 365,756 225,632
Distributions in excess of earnings ........................................ (6,701) (1,713)
----------- -----------
Total shareholders' equity ..................................................... 359,271 224,069
----------- -----------
Total liabilities and shareholders' equity ..................................... $ 1,022,728 $ 741,468
----------- -----------
----------- -----------
</TABLE>
See notes to consolidated and combined financial statements.
3
<PAGE>
PRIME GROUP REALTY TRUST (THE COMPANY)
AND PREDECESSOR PROPERTIES (THE PREDECESSOR TO THE COMPANY)
CONSOLIDATED STATEMENT OF INCOME OF THE COMPANY AND
COMBINED STATEMENT OF OPERATIONS OF THE PREDECESSOR
(000'S OMITTED, EXCEPT PER SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
JUNE 30
--------------------------
1998 1997
------------- -----------
PRIME GROUP PREDECESSOR
REALTY TRUST PROPERTIES
------------- -----------
(RESTATED)
<S> <C> <C>
REVENUE
Rental .............................................................. $ 23,391 $ 8,145
Tenant reimbursements ............................................... 10,026 3,563
Mortgage note interest .............................................. 1,507 --
Other ............................................................... 1,999 263
-------- --------
Total revenue ....................................................... 36,923 11,971
EXPENSES
Property operations ................................................. 6,885 1,961
Real estate taxes ................................................... 6,874 2,767
Depreciation and amortization ....................................... 6,240 3,413
Interest ............................................................ 8,061 7,019
Interest - Affiliates ............................................... -- 2,719
Financing fees ...................................................... -- 272
Property and asset management fees - Affiliates ..................... -- 412
General and administrative .......................................... 1,648 907
Provision for environmental remediation costs ....................... -- 3,205
-------- --------
Total expenses ...................................................... 29,708 22,675
-------- --------
Income (loss) before minority interest and extraordinary item ....... 7,215 (10,704)
Minority interest ................................................... (2,352) 109
-------- --------
Income (loss) before extraordinary item ............................. 4,863 (10,595)
Extraordinary loss on extinguishment of debt, net of minority
interest of $375 .................................................. (525) --
-------- --------
Net income (loss) ................................................... 4,338 $(10,595)
--------
--------
Net income allocated to preferred shareholders ...................... (1,341)
--------
Net income available to common shareholders ......................... $ 2,997
--------
--------
Net income available per weighted-average
common share of beneficial interest - Basic and diluted ......... $ 0.19
--------
--------
</TABLE>
See notes to consolidated and combined financial statements.
4
<PAGE>
PRIME GROUP REALTY TRUST (THE COMPANY)
AND PREDECESSOR PROPERTIES (THE PREDECESSOR TO THE COMPANY)
CONSOLIDATED STATEMENT OF INCOME OF THE COMPANY AND
COMBINED STATEMENT OF OPERATIONS OF THE PREDECESSOR
(000'S OMITTED, EXCEPT PER SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30
-------------------------
1998 1997
------------ -----------
PRIME GROUP PREDECESSOR
REALTY TRUST PROPERTIES
------------ -----------
(RESTATED)
<S> <C> <C>
REVENUE
Rental .............................................................. $ 41,476 $ 16,131
Tenant reimbursements ............................................... 18,401 7,769
Mortgage note interest .............................................. 3,014 --
Other ............................................................... 2,783 689
-------- --------
Total revenue ....................................................... 65,674 24,589
EXPENSES
Property operations ................................................. 11,941 4,318
Real estate taxes ................................................... 12,232 5,590
Depreciation and amortization ....................................... 11,575 6,492
Interest ............................................................ 14,476 13,587
Interest - Affiliates ............................................... -- 5,649
Financing fees ...................................................... -- 640
Property and asset management fees - Affiliates ..................... -- 801
General and administrative .......................................... 3,044 1,886
Provision for environmental remediation costs ....................... -- 3,205
-------- --------
Total expenses ...................................................... 53,268 42,168
-------- --------
Income (loss) before minority interest and extraordinary item ....... 12,406 (17,579)
Minority interest ................................................... (4,317) 368
-------- --------
Income (loss) before extraordinary item ............................. 8,089 (17,211)
Extraordinary loss on extinguishment of debt, net of minority
interest of $375 .................................................. (525) --
-------- --------
Net income (loss) ................................................... 7,564 $(17,211)
--------
--------
Net income allocated to preferred shareholders ...................... (2,041)
--------
Net income available to common shareholders ......................... $ 5,523
--------
--------
Net income available per weighted-average
common share of beneficial interest - Basic and diluted ......... $ 0.39
--------
--------
</TABLE>
See notes to consolidated and combined financial statements.
5
<PAGE>
PRIME GROUP REALTY TRUST (THE COMPANY)
AND PREDECESSOR PROPERTIES (THE PREDECESSOR TO THE COMPANY)
CONSOLIDATED STATEMENT OF CASH FLOWS OF THE COMPANY AND
COMBINED STATEMENT OF CASH FLOWS OF THE PREDECESSOR
(000'S OMITTED)
(UNAUDITED)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30
----------------------------
1998 1997
------------- ------------
PRIME GROUP PREDECESSOR
REALTY TRUST PROPERTIES
------------- -----------
(RESTATED)
<S> <C> <C>
OPERATING ACTIVITIES
Net income (loss) ............................................ $ 7,564 $(17,211)
Adjustments to reconcile net income (loss) to
net cash provided by (used in) operating activities:
Amortization of costs for leases assumed
(included in rental revenue) ........................... 591 622
Depreciation and amortization ............................ 11,575 6,492
Interest added to principal on mortgage note
payable - Affiliate .................................... -- 5,642
Standby loan fee-affiliate added to principal on mortgage
note payable - Affiliate ............................... -- 262
Minority interest ........................................ 4,317 (368)
Extraordinary item, net .................................. 525 --
Changes in operating assets and liabilities:
Increase in tenant receivables ......................... (2,288) (154)
(Increase) decrease in deferred rent receivable ........ (741) 149
Increase in deferred costs ............................. -- (921)
(Increase) decrease in other assets .................... (18,046) 458
Increase (decrease) in accrued interest payable ........ 458 (53)
Increase in accrued real estate taxes .................. 7,505 977
Increase (decrease) in accounts payable and accrued
expenses ............................................. 1,246 (1,797)
Decrease in liabilities for leases assumed ............. (380) (542)
Increase in other liabilities .......................... 4,890 3,717
-------- --------
Net cash provided by (used in) operating activities .......... 17,216 (2,727)
</TABLE>
See notes to consolidated and combined financial statements.
6
<PAGE>
PRIME GROUP REALTY TRUST (THE COMPANY)
AND PREDECESSOR PROPERTIES (THE PREDECESSOR TO THE COMPANY)
CONSOLIDATED STATEMENT OF CASH FLOWS OF THE COMPANY AND
COMBINED STATEMENT OF CASH FLOWS OF THE PREDECESSOR (CONTINUED)
(000'S OMITTED)
(UNAUDITED)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30
---------------------------
1998 1997
------------ ------------
PRIME GROUP PREDECESSOR
REALTY TRUST PROPERTIES
------------ ------------
(RESTATED)
<S> <C> <C>
INVESTING ACTIVITIES
Expenditures for real estate and equipment .............. $(257,119) $(3,612)
Leasing costs ........................................... (1,789) --
Additions to mortgage note receivable ................... (25) --
Increase in escrow deposits for property acquisitions ... (7,309) --
(Increase) decrease in due from affiliates .............. (1,094) 2,803
--------- ---------
Net cash used in investing activities ................... (267,336) (809)
FINANCING ACTIVITIES
Proceeds from the sale of Series B Cumulative Redeemable
Preferred Shares ...................................... 95,318 --
Proceeds from the private placement of common shares .... 47,194 --
Proceeds from mortgage notes payable .................... 341,856 480
Proceeds from mortgage notes payable- Affiliate ......... -- 1,980
Repayment of mortgage notes payable ..................... (212,268) (62)
Repayment of mortgage note payable- Affiliate ........... (3,984) --
Financing costs ......................................... (4,161) --
Increase in due to affiliates ........................... -- 26
Contributions from minority interest - other ............ 1,000 --
Distribution to minority interest - Operating Partnership (5,176) --
Distributions to partners ............................... -- (3)
Dividends paid to preferred shareholders ................ (1,045) --
Dividends paid to common shareholders ................... (7,416) --
---------- ---------
Net cash provided by financing activities ............... 251,318 2,421
---------- ---------
Net (decrease) increase in cash and cash equivalents .... 1,198 (1,115)
Cash and cash equivalents at beginning of period ........ 11,969 5,573
---------- ---------
Cash and cash equivalents at end of period .............. $13,167 $4,458
========== =========
</TABLE>
See notes to consolidated and combined financial statements.
7
<PAGE>
PRIME GROUP REALTY TRUST (THE COMPANY)
AND PREDECESSOR PROPERTIES (THE PREDECESSOR TO THE COMPANY)
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying unaudited consolidated and combined financial statements have
been prepared in accordance with generally accepted accounting principles for
interim financial information and with the instructions to Form 10-Q and Article
10 of Regulation S-X. Accordingly, they do not include all of the information
and footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring accruals) considered necessary for a fair presentation have
been included. Operating results for the six month period ended June 30, 1998
are not necessarily indicative of the results that may be expected for the year
ended December 31, 1998. For further information, refer to the consolidated
financial statements and footnotes thereto included in the Prime Group Realty
Trust's annual report on Form 10-K for the fiscal year ended December 31, 1997
as filed with the Securities and Exchange Commission on March 31, 1998 ("Form
10-K").
Certain prior period amounts have been reclassified to conform with the current
financial statement presentation.
2. FORMATION OF THE COMPANY
Prime Group Realty Trust (the "Company") was formed in Maryland on July 21, 1997
to succeed to and expand the office and industrial real estate business of The
Prime Group, Inc. ("PGI"), which consisted of a portfolio of five office and
seventeen industrial properties, as well as a parking garage facility and the
office and industrial real estate ownership, acquisition, development, leasing
and management businesses historically conducted by PGI (the "PGI Properties").
On November 17, 1997, the Company completed its initial public offering (the
"IPO" or "Offering") of 12.98 million common shares of beneficial interest
("Common Shares") and the private placement of 2.0 million Series A Cumulative
Convertible Preferred Shares ("Convertible Preferred Shares") of beneficial
interest (the "Convertible Preferred Share Private Placement"). The Company's
assets are owned and controlled by, and all of its operations are conducted
through, Prime Group Realty, L.P. (the "Operating Partnership") and other
subsidiaries. The Operating Partnership also sold 4,569,893 common units in the
Operating Partnership for $85.0 million to Primestone Investment Partners, L.P.
("Primestone Joint Venture"), a joint venture between PGI and certain affiliates
of Blackstone Real Estate Advisors, L.P., BRE/Primestone Investment L.L.C. and
BRE/Primestone Joint Venture in exchange for the contribution of 3,375,000 of
its common units in the Operating Partnership received from the contribution of
its interest in the PGI Properties to the Operating Partnership.
Pursuant to financing arrangements for the properties, the partnerships or
limited liability companies which are subsidiaries of the Operating Partnership
and own the properties often have, as a partner or member, a separate corporate
subsidiary of the Company whose board of directors includes an independent
director that, as required by such financing arrangements, must approve the
commencement of any voluntary dissolution or insolvency proceeding with respect
to such subsidiary.
3. INCOME TAXES
Commencing with the period ended December 31, 1997, it is the intent of the
Company to qualify as a real estate investment trust ("REIT") under the Internal
Revenue Code of 1986, as amended. As a REIT, the Company generally will not be
subject to federal income tax to the extent that it distributes at least 95% of
its REIT taxable income to its shareholders. REITs are subject to a number of
organizational and operational requirements. If the Company fails to qualify as
a REIT in any taxable year, the Company will be subject to federal income tax
(including any applicable alternative minimum tax) on its taxable income at
regular corporate tax rates.
8
<PAGE>
PRIME GROUP REALTY TRUST (THE COMPANY)
AND PREDECESSOR PROPERTIES (THE PREDECESSOR TO THE COMPANY)
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS - CONTINUED
(UNAUDITED)
4. USE OF ESTIMATES
The preparation of the financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenue and expenses during the reporting
period. Actual results could differ from these estimates.
5. RECENT DEVELOPMENTS
During the period from January 1, 1998 through June 30, 1998 the Company
acquired the following eight office properties:
<TABLE>
<CAPTION>
NET ACQUISITION MORTGAGE
RENTABLE COST DEBT (*) MONTH
PROPERTY LOCATION SQUARE FEET (IN MILLIONS) (IN MILLIONS) ACQUIRED
-------- -------- ----------- ------------- ------------- --------
<S> <C> <C> <C> <C>
33 North Dearborn Chicago, IL 302,818 $34.4 $18.0 1/98
Commerce Point Arlington Hts., IL 236,642 29.4 20.0 2/98
208 South LaSalle Street Chicago, IL 827,494 61.2 45.8 3/98
122 South Michigan Chicago, IL 512,369 29.6 --- 4/98
2100 Swift Drive Oak Brook, IL 58,000 6.2 5.2 4/98
6400 Shafer Court Rosemont, IL 161,730 21.4 14.4 5/98
Two Century Centre Schaumburg, IL 217,960 35.7 --- 6/98
Oak Brook Business Center Oak Brook, IL 199,245 16.2 --- 6/98
--------- ------- -------
2,516,258 $ 234.1 $ 103.4
--------- ------- -------
--------- ------- -------
</TABLE>
(*) See Management's Discussion and Analysis of Financial Condition and Results
of Operations -"Liquidity and Capital Resources" for a description of the debt
terms.
In June 1998, the Company acquired the following parcels of land under two
purchase contracts:
<TABLE>
<CAPTION>
ACQUISITION
COST
PROPERTY LOCATION ACRES (IN MILLIONS)
-------- -------- ----- -------------
<S> <C> <C>
Aurora Land - I Aurora, IL 37.3 $ 3.1
Aurora Land - II Aurora, IL 17.4 1.4
---- ------
54.7 $ 4.5
---- ------
---- ------
</TABLE>
The contracts require purchase of an additional 132.7 acres over a three to five
year period for additional consideration of $10,394,210. Certain minimum
installment payments are required; however, the timing of purchases is at the
Company's discretion.
Concurrently with the closing of the IPO, the Company obtained a secured
revolving credit facility (the "Credit Facility") from a group of financial
institutions. In March 1998, the Credit Facility was amended to provide that the
commitments under the Credit Facility be reduced from $235.0 million to $200.0
million. In April 1998, the Credit Facility was further amended to provide that
the commitments under the Credit Facility be reduced to $190.0 million.
9
<PAGE>
PRIME GROUP REALTY TRUST (THE COMPANY)
AND PREDECESSOR PROPERTIES (THE PREDECESSOR TO THE COMPANY)
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS - CONTINUED
(UNAUDITED)
5. RECENT DEVELOPMENTS (CONTINUED)
In January 1998, the Company obtained a $15.0 million revolving line of credit
with LaSalle National Bank (the "Line of Credit"). The Line of Credit, which
matures in January 1999 and is subject to a one-year extension at the Company's
option, is collateralized by an industrial property known as 475 Superior
Avenue. Outstanding balances under the Line of Credit bear interest at a rate
equal to LIBOR plus 195 basis points. Generally, the covenants contained in the
Line of Credit are identical to the covenants contained in the Credit Facility.
Concurrently with the closing of the IPO, the Company borrowed $83.5 million in
financing on a short-term basis evidenced by two separate notes (the "New
Mortgage Notes") which were collateralized by first mortgages on certain office
and industrial properties. On April 1, 1998, the Company refinanced one of the
New Mortgage Notes (which had an original principal balance of $27.5 million)
with a loan of $29.4 million which will mature on March 23, 2008. Interest on
this loan is fixed for 10 years at a rate of 6.85% and is payable monthly. The
remaining New Mortgage Note (which had an original principal balance of $56.0
million) was refinanced on May 1, 1998 with two loans, the first of which is a
$47.0 million loan which has principal and interest payable monthly, using a
30-year amortization period, with interest fixed at 7.17% and a maturity of May
1, 2008. The second loan is a $14.6 million loan which has interest only payable
monthly at 150 basis points over LIBOR or .50% plus the greater of (a) the
lender's U.S. prime rate or (b) the Federal Funds Rate plus 1.0% and matures on
May 1, 2000, not including a six-month extension option. The refinanced notes
are collateralized by first mortgages on certain office and industrial
properties. As a result of the above refinancing, the Company recognized an
extraordinary item of $525,000, net of minority interest of $375,000,
representing the write-off of previously unamortized deferred financing fees.
In February 1998, the Company refinanced $48.8 million of letters of credit that
provided credit enhancements on certain of the Company's bonds payable from the
Credit Facility to a separate financing facility provided by a financial
institution (the "New LOC's"). The New LOC's have a quarterly fee of 1.4% of the
face amount and are collateralized by mortgages on certain industrial and office
properties and a $5.0 million cash collateral account.
On March 31, 1998, the Company issued 10,000 and 2,500 Common Shares granted to
an officer and a board member of the Company, respectively, pursuant to an
employment agreement and a consulting agreement.
On March 25, 1998, the Company completed a private placement of 2.58 million
Common Shares to institutional investors (the "Private Placement"). The Company
received proceeds, net of underwriter discount, of approximately $49.2 million
from the Private Placement, which were used to fund the acquisition of the
office properties located at 208 South LaSalle Street and 122 South Michigan
Avenue.
On March 30, 1998, the Company entered into a joint venture that acquired an
approximately 67,000 square foot vacant parcel of land located in the Chicago,
Illinois central business district ("Chicago CBD"). The parcel was acquired for
the potential development of a Class A multi-purpose facility, with up to
900,000 square feet of office space, 125,000 square feet of retail space and a
parking garage with a capacity for approximately 250 cars. The Company has
economic control of the joint venture and, therefore, has consolidated the
operations of the joint venture from the date of inception. The joint venture
entered into a bank loan in the amount of $13.5 million to acquire the land.
Interest is payable monthly at a rate of LIBOR plus 200 basis points or at the
lender's prime rate. The note matures April 1, 1999, not including a six-month
extension option. The other joint venturer's interest has been reflected as
Minority Interest - Other at June 30, 1998.
10
<PAGE>
PRIME GROUP REALTY TRUST (THE COMPANY)
AND PREDECESSOR PROPERTIES (THE PREDECESSOR TO THE COMPANY)
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS - CONTINUED
(UNAUDITED)
5. RECENT DEVELOPMENTS (CONTINUED)
On May 15, 1998, the Company obtained a 7.22% note payable with a principal
balance of $75.0 million, collateralized by a mortgage on the suburban office
building known as Continental Towers. The note matures in 2013, with a
prepayment option in 2005, and has monthly payments of principal and interest,
using a 25-year principal amortization payment schedule. The Company used $70.0
million of the proceeds to repay a portion of the Credit Facility. The remaining
proceeds were utilized to pay related costs and to fund escrow reserve required
by the terms of the note.
On June 5, 1998, the Company completed the sale of 4.0 million shares of its
Series B Cumulative Redeemable Preferred Stock (the "Redeemable Preferred Share
Offering"). The Company received net proceeds, net of underwriters' discounts,
of approximately $96.85 million which were used to fund the acquisition of Two
Century Centre and Oak Brook Business Center and repay borrowings under the
Credit Facility and the Line of Credit. Distributions on the Series B Redeemable
Preferred Shares are payable quarterly on or about the last day of January,
April, July and October of each year, at the rate of 9% (equivalent to $2.25 per
annum per Series B Cumulative Redeemable Preferred Share). The Series B
Cumulative Redeemable Preferred Shares rank senior to the Common Shares and the
Convertible Preferred Shares as to the payment of dividends and as to the
distribution of assets.
On and after June 5, 2003, the Series B Cumulative Redeemable Preferred Shares
may be redeemed at the option of the Company at a redemption price of $25.00 per
share plus accrued and unpaid distributions. The redemption price is payable
solely out of the sale of proceeds of other capital shares of beneficial
interest of the Company.
6. RECENTLY ISSUED ACCOUNTING PRINCIPLES
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, Accounting for Derivative Instruments
and Hedging Activities ("Statement 133"), which is effective for all fiscal
quarters and fiscal years beginning after June 15, 1999. The Company intends to
adopt Statement 133 in 1999. Management believes that the adoption of Statement
133 will not have a material affect on the Company's results of operations or
financial position.
7. EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted net income
available per weighted-average common share of beneficial interest ("Common
Share") for the three months and six months ended June 30, 1998:
<TABLE>
<CAPTION>
THREE MONTHS SIX MONTHS
ENDED ENDED
JUNE 30, 1998 JUNE 30, 1998
------------- -------------
<S> <C> <C>
NUMERATOR:
Net income available to Common Shares before
extraordinary item ........................ $3,522 $6,048
Extraordinary item ........................ (525) (525)
------ ------
Numerator for basic earnings per share-income
available to Common Shares ................ $2,997 $5,523
------ ------
------ ------
</TABLE>
11
<PAGE>
PRIME GROUP REALTY TRUST (THE COMPANY)
AND PREDECESSOR PROPERTIES (THE PREDECESSOR TO THE COMPANY)
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS - CONTINUED
(UNAUDITED)
7. EARNINGS PER SHARE (CONTINUED)
<TABLE>
<CAPTION>
THREE MONTHS SIX MONTHS
ENDED ENDED
JUNE 30, 1998 JUNE 30, 1998
------------- -------------
<S> <C> <C>
DENOMINATOR:
Denominator for basic earnings per share - weighted
average common shares .................................................. 15,572,494 14,383,258
----------- -------------
Effect of dilutive securities:
Employee stock options ............................................... -- 16,545
----------- -------------
Denominator for diluted earnings per share -
adjusted weighted-average common shares and assumed
conversions ............................................................ 15,572,494 14,399,803
----------- -------------
----------- -------------
Basic and diluted earnings available to common shares per weighted average
common share:
Net income before extraordinary item ................................... $ 0.22 $ 0.42
Extraordinary item ..................................................... (0.03) (0.03)
----------- -------------
Net income per common share ............................................ $ 0.19 $ 0.39
----------- -------------
----------- -------------
</TABLE>
Options to purchase 1,167,500 Common Shares at a weighted average exercise price
of $20.05 per share outstanding during the three months ended June 30, 1998 and
options to purchase 82,500 Common Shares at a weighted average price of $20.64
per share outstanding during the six months ended June 30, 1998 were not
included in the computation of diluted earnings per share because the conversion
would be antidilutive.
The Company had 10,280,882 Common Units outstanding at June 30, 1998, of which
9,353,782 ("Convertible Common Units") may be converted into Common Shares after
one year from the completion of the Offering at the option of the Company. The
Convertible Common Units were not included in the computation of diluted
earnings per share because the conversion would be antidilutive.
The Company had 2,000,000 Convertible Preferred Shares outstanding during the
six months ended June 30, 1998 which were not included in the computations of
diluted earnings per share because the conversion would be antidilutive.
8. PRO FORMA CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
The accompanying unaudited Pro Forma Condensed Consolidated Statements of
Operations of the Company are presented as if, at January 1, 1997, (i) the
Company had completed the Offering, the Convertible Preferred Share Private
Placement, the Redeemable Preferred Share Offering and the Private Placement and
used the net proceeds to acquire Preferred Units and Common Units of the
Operating Partnership, (ii) PGI and other individuals had contributed certain of
their respective properties and operations (the "Contribution Properties") to
the Operating Partnership, (iii) the Operating Partnership had completed the
sale of Common Units to Primestone Joint Venture, (iv) the Operating Partnership
acquired various office and industrial properties with cash and debt proceeds
(the "Acquisition Properties") and a property management company from various
third parties, and (v) the Operating Partnership repaid debt on
12
<PAGE>
PRIME GROUP REALTY TRUST (THE COMPANY)
AND PREDECESSOR PROPERTIES (THE PREDECESSOR TO THE COMPANY)
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS - CONTINUED
(UNAUDITED)
8. PRO FORMA CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (CONTINUED)
certain of the Contribution Properties. The unaudited pro forma Condensed
Consolidated Statements of Operations should be read in conjunction with
unaudited Pro Forma Condensed Consolidated financial statements and all of the
historical financial statements contained in Form 10-K. In management's opinion,
all adjustments necessary to reflect the transactions described above have been
made.
The unaudited Pro Forma Condensed Consolidated Statements of Operations of the
Company are not necessarily indicative of what the actual results of operations
would have been assuming the Offering, the Convertible Preferred Share Private
Placement, the Redeemable Preferred Share Offering the Private Placement and
other transactions described above had occurred at the dates indicated above,
nor do they purport to present the future results of operations of the Company.
<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE 30,
1998 1997
------------- --------------
<S> <C> <C>
Total revenue (in 000's) $ 75,499 $ 70,553
-------- --------
-------- --------
Net income (in 000's) $ 10,667 $ 6,761
-------- --------
-------- --------
Net income (loss) available to common shareholders (in 000's) $ 4,767 $ (861)
-------- --------
-------- --------
Earnings (loss) per common share $ 0.31 $ (0.06)
-------- --------
-------- --------
</TABLE>
Pro forma earnings per common share increased by $0.25 from the six months ended
June 30, 1997 to the six months ended June 30, 1998 primarily due to improved
operations at the properties in 1998.
9. SUBSEQUENT EVENTS
In July and August 1998, the Company entered into contracts to acquire three
office properties, one industrial property and two land parcels for total
contract prices of approximately $422.5 million. The Company has made escrow and
other deposits of $30.2 million related to these contracts.
The Company expects to complete the above acquisitions by the end of the first
quarter of 1999; however, there can be no assurance that any or all of the
acquisitions will be completed.
13
<PAGE>
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
OVERVIEW
The Company is a fully-integrated real estate company providing property
management, leasing, marketing, acquisition, development, redevelopment,
construction, finance and other related services. As of June 30, 1998, the
Company expects to qualify as a REIT for federal income tax purposes. The
Company (through the Operating Partnership) owns 24 office properties ("Office
Properties") containing an aggregate of approximately 5.8 million net rentable
square feet, 46 industrial properties ("Industrial Properties") containing an
aggregate of approximately 5.8 million net rentable square feet, one retail
center and one parking facility. The properties are located primarily in the
Chicago, Illinois metropolitan area. In addition, the Company owns a mortgage on
an office property containing 728,406 net rentable square feet. The Company also
owns approximately 139.7 acres (including a development site containing
approximately 67,000 square feet located in the Chicago CBD held by a joint
venture with a third party) and has rights to acquire approximately 437.8 acres
of developable land (including rights to acquire a development site located in
the Chicago CBD containing approximately 58,000 square feet), which management
believes could be developed with approximately 3.0 million square feet of
additional office space and over 9.4 million square feet of additional
industrial space primarily in the Chicago metropolitan area.
In terms of net rentable square feet, approximately 90.1% of the Office
Properties and 87.5% of the Industrial Properties are located in the Chicago
metropolitan area in prime business locations within established business
communities. The properties located in the Chicago metropolitan area account for
approximately 93.1% of the Company's rental revenue and tenant reimbursement
revenue for the six months ended June 30, 1998. The remaining Office Properties
are located in Nashville, Tennessee; Knoxville, Tennessee; and the Milwaukee,
Wisconsin metropolitan areas, and the remaining Industrial Properties are
located in the Columbus, Ohio metropolitan area. The Company intends to continue
to invest in the acquisition, development and redevelopment of office and
industrial properties primarily located in the Chicago metropolitan area.
The Company intends to access multiple sources of capital to fund future
acquisition and development activities. These capital sources may include
undistributed cash flow, borrowings under certain acquisition facilities,
proceeds from the issuance of long-term, tax-exempt bonds, joint venture
arrangements and other debt or equity securities and other bank and/or
institutional borrowings. There can be no assurance that any such financing will
be obtained.
CAUTIONARY STATEMENTS
The following discussion in "Management's Discussion and Analysis of Financial
Condition and Results of Operations" contains certain forward-looking statements
within the meaning of the Private Securities Litigation Reform Act of 1995 which
reflect management's current view with respect to future events and financial
performance. Such forward-looking statements are subject to certain risks and
uncertainties, including, but not limited to, the effects of future events on
the Company's financial performance; the risk that the Company may be unable to
finance its planned acquisition and development activities; risks related to the
industrial and office industry in which the Company's properties compete,
including the potential adverse impact of external factors such as inflation,
consumer confidence, unemployment rates and consumer tastes and preferences;
risks associated with the Company's development activities, such as the
potential for cost overruns, delays and lack of predictability with respect to
the financial returns associated with these development activities; the risk of
potential increase in market interest rates from current rates; and risks
associated with real estate ownership, such as the potential adverse impact of
changes in the local economic climate on the revenues and the value of the
Company's properties.
14
<PAGE>
RESULTS OF OPERATIONS
COMPARISON OF THE THREE MONTHS ENDED JUNE 30, 1998 OF THE COMPANY TO THE THREE
MONTHS ENDED JUNE 30, 1997 OF THE PREDECESSOR PROPERTIES
In analyzing the operating results for the quarter ended June 30, 1998, the
changes in rental and reimbursable income, property operating expenses, real
estate taxes and depreciation and amortization from 1997 are due principally to
the addition of operating results from properties contributed and acquired as
part of the Company's IPO as well as properties acquired after the IPO through
June 30, 1998.
The Predecessor Properties consisted of five office properties, 17 industrial
properties, as well as a parking facility. At the time of the IPO, 11 additional
office properties, 28 additional industrial properties and one retail center
were contributed or acquired. After the date of the IPO and through June 30,
1998, the Company acquired ten additional office properties and the first
mortgage note encumbering one office property as described in the footnotes to
the Company's Form 10-K.
For the three months ended June 30, 1998, rental revenue increased $15.2
million, or 187.2%, to $23.4 million, tenant reimbursement income increased $6.5
million, or 181.4%, to $10.0 million, other revenue increased $1.7 million to
$2.0 million, or 566.7%, property operating expenses increased $4.9 million, or
251.1%, to $6.9 million, real estate tax expense increased $4.1 million, or
148.4%, to $6.9 million and depreciation and amortization increased $2.8
million, or 82.8%, to $6.2 million as compared to the three months ended June
30, 1997. The additional office and industrial properties resulted in total
rental revenue of $15.9 million, tenant reimbursements income of $5.9 million,
property operating expenses of $5.0 million, real estate tax expense of $4.0
million and depreciation and amortization of $3.2 million for the three months
ended June 30, 1998. Rental revenue and tenant reimbursement income for the
Predecessor Properties (decreased) increased $(0.6) million and $0.6 million,
respectively, for the three months ended June 30, 1998 compared to the same
period in 1997, due to a major tenant of the 77 West Wacker Drive building
defaulting on its lease in the second quarter of 1997. Property operating
expenses, real estate tax expense and depreciation and amortization for the
Predecessor Properties for the three months ended June 30, 1998 remained
consistent with the same period in 1997.
Mortgage note interest income increased by $1.5 million to $1.5 million on due
to the acquisition of the first mortgage note encumbering the property known as
180 North LaSalle in December 1997.
Interest expense had a net decrease of $1.7 million, or 17.2%, to $8.1 million
during the three months ended June 30, 1998. The decrease was due to an $9.1
million decrease as a result of the repayment of debt with proceeds from the
Company's IPO, offset by an increase of $7.4 million due to mortgages obtained
on certain of the properties which were contributed or acquired after the IPO,
as well as Credit Facility and Line of Credit borrowings used to fund property
acquisitions.
General and administrative expense increased $0.7 million during the three
months ended June 30, 1998, reflecting costs related to the Company's new public
status and its increased size.
The decrease in financing fees and property and asset management fees is due to
these fees being incurred by the Predecessor Properties under their previous
ownership and the costs are no longer incurred by the Company.
In 1997, the Predecessor Properties recorded a provision for environmental
remediation costs of $3.2 million as an estimate of costs to be incurred for
environmental clean-up of certain properties. In management's opinion, no
additional provision is necessary.
Income allocated to minority interest increased $2.5 million to $2.4 million for
the three months ended June 30, 1998 compared to the same period in 1997 due to
an increase in income before minority interest of $17.9 million to $7.2 million
and a change in the ownership structure. The increase in income before minority
interest is due to additional properties either being contributed or acquired
and the effects they had on revenue and expenses described above. The change in
ownership structure is due to certain ownership percentages changing during the
IPO.
15
<PAGE>
Net income increased $14.9 million to $4.3 million for the three months ended
June 30, 1998 compared to the same period in 1997 due to the changes in revenue,
expenses and minority interest described above.
COMPARISON OF THE SIX MONTHS ENDED JUNE 30, 1998 OF THE COMPANY TO THE SIX
MONTHS ENDED JUNE 30, 1997 OF THE PREDECESSOR PROPERTIES
In analyzing the operating results for the six months ended June 30, 1998, the
changes in rental and reimbursable income, property operating expenses, real
estate taxes and depreciation and amortization from 1997 are due principally to
the addition of operating results from properties contributed and acquired as
part of the Company's IPO as well as properties acquired after the IPO through
June 30, 1998.
For the six months ended June 30, 1998, rental revenue increased $25.3 million,
or 157.1%, to $41.5 million, tenant reimbursement income increased $10.6
million, or 136.8%, to $18.4 million, property operating expenses increased $7.6
million, or 176.5%, to $11.9 million, real estate tax expense increased $6.6
million, or 118.8%, to $12.2 million and depreciation and amortization increased
$5.1 million, or 78%, to $11.6 million as compared to the six months ended June
30, 1997. The additional office and industrial properties resulted in total
rental revenue of $24.8 million, tenant reimbursements income of $9.3 million,
property operating expenses of $8.3 million, real estate tax expense of $7.0
million and depreciation and amortization of $4.9 million for the six months
ended June 30, 1998. Rental revenue and tenant reimbursement income for the
Predecessor Properties increased (decreased) $(0.8) million and $(0.8) million,
respectively, for the six months ended June 30, 1998 compared to the same period
in 1997, due to a major tenant of the 77 West Wacker Drive building defaulting
on its lease in the second quarter of 1997. Property operating expenses, real
estate tax expense and depreciation and amortization for the Predecessor
Properties for the six months ended June 30, 1998 remained consistent with the
same period in 1997.
Mortgage note interest income increased by $3.0 million to $3.0 million due to
the acquisition of the first mortgage note encumbering the property known as 180
North LaSalle in December 1997.
Interest expense had a net decrease of $4.8 million, or 24.7%, to $14.5 million
during the six months ended June 30, 1998. The decrease was due to an $17.9
million decrease as a result of the repayment of debt with proceeds from the
Company's IPO, offset by an increase of $13.1 million due to mortgages obtained
on certain of the properties which were contributed or acquired after the IPO,
as well as Credit Facility and Line of Credit borrowings used to fund property
acquisitions.
General and administrative expense increased $1.2 million during the six months
ended June 30, 1998, reflecting costs related to the Company's new public status
and its increased size.
The decrease in financing fees and property and asset management fees is due to
these fees being incurred by the Predecessor Properties under their previous
ownership and the costs are no longer incurred by the Company.
In 1997, the Predecessor Properties recorded a provision for environmental
remediation costs of $3.2 million as an estimate of costs to be incurred for
environmental clean-up of certain properties. In management's opinion, no
additional provision is necessary.
Income allocated to minority interest increased $4.7 million to $4.3 million for
the six months ended June 30, 1998 compared to the same period in 1997 due to an
increase in income before minority interest of $30.0 million to $12.4 million
and a change in the ownership structure. The increase in income before minority
interest is due to additional properties being either contributed or acquired
and the effects they had on revenue and expenses described above. The change in
ownership structure is due to the certain ownership percentages changing during
the IPO.
Net income increased $24.8 million to $7.6 million for the six months ended June
30, 1998 compared to the same period in 1997 due to the changes in revenue,
expenses and minority interest described above.
16
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
THE CREDIT FACILITY. As of June 30, 1998, the Company has a Credit
Facility of $190.0 million from a group of banks led by BankBoston, N.A. and
Prudential Securities Credit Corporation ("PSCC"), an affiliate of Prudential
Securities Incorporated. Borrowings under the Credit Facility are available to
fund acquisitions and development activities and to provide letters of credit
for $26.0 million of tax-exempt bonds. The Credit Facility, which matures on
November 17, 2000, is collateralized by the 77 West Wacker Building and all of
the Company's properties located in Tennessee and was secured by a pledge of the
Company's mortgage note receivable on Continental Towers until May 15, 1998 when
the Company repaid $70.0 million of the Credit Facility in connection with
obtaining the $75.0 million loan collateralized by Continental Towers described
below under "1998 Mortgage Notes". Concurrently with the loan transaction, the
Credit Facility was reduced from $200.0 million to $190.0 million.
The Credit Facility, at the Company's election, bears interest on Eurodollar
loans at a floating rate based on a spread over the Eurodollar rate equal to 120
to 150 basis points, depending upon the Company's applicable leverage ratio, or
the higher of BankBoston's prime rate or the federal funds rate plus 50 basis
points. Notwithstanding the foregoing, the Credit Facility was amended to
provide that for the period from December 15, 1997 through February 14, 1998,
the spread over the Eurodollar rate applicable to Eurodollar loans was equal to
175 basis points and for the period from February 15, 1998 through May 15, 1998,
such spread was equal to 200 basis points. Borrowings under the Credit Facility
may be repaid at any time, without penalty, except for the costs related to the
breakage of the Eurodollar rate loan, if any. The Credit Facility requires
monthly payments of interest only on prime rate and Eurodollar rate loans.
Eurodollar rate loans may be for periods of between 30 and 180 days. At June 30,
1998 borrowings under the Credit Facility bore interest at a weighted-average
rate equal to 7.13%.
The Company's ability to borrow under the Credit Facility is subject to the
Company's ongoing compliance with a number of financial and other covenants. The
Credit Facility, except under certain circumstances, limits the Company's
ability to make distributions in excess of 90% of its annual Funds from
Operations.
Since the IPO, the Credit Facility has been amended from time to time to, among
other things, modify the loan commitments and the interest rate payable
thereunder, and the Company has obtained several limited waivers from the
lenders under the Credit Facility in connection with certain acquisitions.
NEW MORTGAGE NOTES. The Company borrowed $83.5 million in aggregate
principal amount under the New Mortgage Notes. PSCC provided the original New
Mortgage Notes financing on a short-term basis. The New Mortgage Notes consist
of two separate notes secured, respectively, by first mortgages on certain
office and industrial properties. Prior to their refinancing, interest on the
New Mortgage Notes was fixed to 7.19% (a rate equal to seven-year U.S. Treasury
Notes, plus 1.27%). On March 23, 1998, the Company refinanced one of the New
Mortgage Notes (which had an original principal balance of $27.5 million) with a
loan of $29.4 million, which will mature on April 1, 2008. Interest on this loan
accrues at a rate of 6.85% and is payable monthly. The remaining New Mortgage
Note (which had an original principal balance of $56.0 million) was refinanced
on May 1, 1998 with two loans, the first of which is a $47.0 million loan which
has principal and interest payable monthly, using a 30-year amortization period,
with interest fixed at 7.17% and will mature on May 1, 2008. The second loan is
a $14.6 million loan which has interest only payable monthly at 150 basis points
over LIBOR or 0.50% plus the greater of (a) the lender's U.S. prime rate or (b)
the Federal Funds rate plus 1.0% and will mature on May 1, 2001, not including a
six-month extension option. The refinanced notes are collateralized by first
mortgages on certain office and industrial properties. As a result of the above
refinancing, the Company recognized an extraordinary item of $525,000, net of
minority interest of $375,000, representing the write-off of previously
unamortized deferred financing fees.
17
<PAGE>
1998 MORTGAGE NOTES. During 1998, the Company has acquired five of its
eight new Office Properties with proceeds from property mortgage loans. The
following is a summary of those loans:
<TABLE>
<CAPTION>
INITIAL
PRINCIPAL INTEREST
PROPERTY (IN MILLIONS) RATE (%) MATURITY
- -------------------- ---------------------- ---------------------- ----------
<S> <C> <C> <C>
33 North Dearborn $ 18.0 LIBOR plus 165 basis points 1/2000
Commerce Point 20.0 7.07 2/2008
208 South LaSalle 45.8 7.785 4/2008
2100 Swift Drive 5.2 7.19 5/2028
6400 Shafer Court 14.4 7.09 5/2028
------
$ 103.2
======
</TABLE>
Except for the loan relating to 33 North Dearborn, all of the loans require
monthly payments of principal and interest. The 33 North Dearborn loan requires
monthly payments of interest only.
On May 15, 1998, the Company obtained a 7.22% note payable, collateralized by
the Company's note receivable encumbering a suburban office building known as
Continental Towers, with a principal balance of $75.0 million. The note matures
in 2013, with a prepayment option in 2005, and has monthly payments of principal
and interest, using a 25-year principal amortization payment schedule. The
Company used $70.0 million of the proceeds to repay a portion of the Credit
Facility.
In January 1998, the Company obtained a $15.0 million revolving line of credit
with LaSalle National Bank (the "Line of Credit"). The Line of Credit, which
matures in January 1999 and is subject to a one-year extension at the Company's
option, is collateralized by an industrial property known as 475 Superior
Avenue. Outstanding balances under the Line of Credit bear interest at a rate
equal to LIBOR plus 195 basis points. Generally, the covenants contained in the
Line of Credit are identical to the covenants contained in the Credit Facility.
LETTERS OF CREDIT. The Company has refinanced $48.8 million of letters of
credit that provided credit enhancements on certain of the Company's bonds
payable from the Credit Facility to the New LOC's. The New LOC's have a
quarterly fee of 1.4% of the face amount and are collateralized by mortgages on
certain industrial and office properties and a $5.0 million cash collateral
account.
ANALYSIS OF LIQUIDITY AND CAPITAL RESOURCES. The Company expects to meet
its short-term liquidity requirements generally through its working capital and
net cash provided by operations. The properties require periodic investments of
capital for tenant-related capital expenditures and for general capital
improvements. Over the past three years, the Company's recurring tenant
improvements and leasing commissions for the Predecessor Properties averaged
$4.47 per square foot of leased space and $0.40 per square foot of leased
industrial space per year. The Company expects that the average annual cost of
recurring tenant improvements and leasing commissions will be approximately $3.6
million based on an average annual square feet for which leases expire during
the next three years. The Company expects the cost of general capital
improvements to the properties to average approximately $0.9 million annually
based upon an estimate of $0.08 per square foot.
The Company expects to meet its long-term liquidity requirements for the funding
of property development, property acquisitions and other non-recurring capital
improvements through long-term secured and unsecured indebtedness (including the
Credit Facility), joint venture agreements and the issuance of additional equity
securities from the Company. The terms of the Credit Facility and the
Convertible Preferred Shares impose restrictions on the Company's ability to
incur indebtedness and issue additional preferred shares.
HISTORICAL CASH FLOWS
In analyzing cash flows for the quarter ended June 30, 1998, the changes in 1997
are due principally to the addition of cash flows from properties contributed
and acquired as part of the Company's IPO as well as properties acquired after
the IPO through June 30, 1998.
18
<PAGE>
The Company had net cash provided by (used in) operating activities of $17.2
million and $(2.7) million for the six months ended June 30, 1998 and 1997,
respectively. The $19.9 million increase is primarily due to a $24.8 million
increase in net income, a 5.1 million increase in depreciation and amortization
expense, a $4.7 million increase in income allocated to minority interest, a
$0.5 million increase in accrued interest, a $3.0 million increase in accounts
payable and accrued expenses, a $6.5 million increase in accrued real estate
taxes, and a $1.2 million increase in other liabilities, offset by a $5.9
million decrease in interest expense and fees added to principal on mortgage
note payable affiliate, a $2.1 million increase in tenant receivables, and a
$18.5 million increase in other assets.
The Company had net cash used in investing activities of $267.3 million and $0.8
million for the six months ended June 30, 1998 and 1997, respectively. The
$266.5 million increase in net cash used in investing activities from the period
ended June 30, 1997 as compared to the period ended June 30, 1998 was primarily
due to an $253.5 million increase in expenditures for real estate and equipment,
principally related to the acquisition of five properties, $7.3 million in
escrow deposits for future acquisitions, a $3.9 million net increase in advances
to affiliates and a $1.8 million increase in leasing costs.
The Company had net cash provided by financing activities of $251.3 million and
$2.4 million for the six months ended June 30, 1998 and 1997, respectively. The
$248.9 million increase in net cash provided by financing activities from the
period ended June 30, 1997 as compared to the period ended June 30, 1998 was due
to net proceeds of $95.3 from the Redeemable Preferred Share Offering, net
proceed of $47.2 million from the Private Placement, net proceeds from mortgage
notes payable of $125.6 million and additional minority interest contributions
of $1.0 million, offset by financing costs of $4.1 million and distributions to
preferred shareholders, common shareholders and minority interest of $13.6
million.
FUNDS FROM OPERATIONS
Industry analysts generally consider Funds from Operations, as defined by the
National Association of Real Estate Investment Trusts, Inc. ("NAREIT"), an
alternative measure of performance of an equity REIT. Funds from Operations is
defined by NAREIT to mean net income (loss) determined in accordance with GAAP,
excluding gains (or losses) from debt restructuring and sales of property, plus
depreciation and amortization (other than amortization of deferred financing
costs and depreciation of non-real estate assets) and after adjustment for
unconsolidated partnerships and joint ventures. The Company believes that in
order to facilitate a clear understanding of the combined historical operating
results of the Company, Funds from Operations should be examined in conjunction
with net income (loss) as presented in the unaudited financial statements
included elsewhere in this Form 10-Q. The following table represents the
unaudited calculation of the Company's Funds from Operations for the six months
ended June 30, 1998 (in thousands):
<TABLE>
<CAPTION>
PROFORMA(1) ACTUAL
----------- ------
<S> <C> <C>
Net income allocated to common shareholders................. $ 4,767 $ 5,523
Real estate depreciation and amortization............ 12,055 10,849
Amortization of costs for leases assumed............. 566 566
Straight-line rental revenue adjustments............. (522) (522)
Minority interest.................................... 3,402 4,317
Extraordinary loss................................... -- 525
------ ------
Funds from Operations (2)................................... $20,268 $21,258
------ ------
------ ------
</TABLE>
(1) The pro forma calculation of Funds from Operations of the Company is
presented as if, at January 1, 1998, (i) the Company had completed the
Redeemable Preferred Share Offering and the Private Placement and used the
net proceeds to acquire Preferred Units and Common Units of the Operating
Partnership, (ii) the Operating Partnership had acquired the various office
and industrial properties acquired during the six months ended June 30,
1998 and (iii) the Operating Partnership repaid certain
19
<PAGE>
indebtedness. The unaudited pro forma calculation of Funds from Operations
should be read in conjunction with unaudited Pro Forma Condensed
Consolidated financial statements contained in the Company's Form 10-K. In
management's opinion, all adjustments necessary to reflect the effects of
the above described transactions have been made.
(2) The Company computes Funds from Operations in accordance with standards
established by the Board of Governors of NAREIT in its March 1995 White
Paper (with the exception that the company reports rental revenues on a
cash basis (based on contractual lease terms), rather than a straight-line
GAAP basis, which the Company believes results in a more accurate
presentation of its actual operating activities), which may differ from the
methodology for calculating Funds from Operations used by certain other
office and/or industrial REITs and, accordingly, may not be comparable to
such other REITs. As a result of the Company's reporting rental revenues on
a contractual basis, contractual rent increases will cause reported Funds
from Operations to increase. Further, Funds from Operations does not
represent amounts available for management's discretionary use because of
needed capital replacement or expansion, debt repayment obligations, or
other commitments and uncertainties. Funds from Operations should not be
considered as an alternative to net income (loss), as an indication of the
Company's performance or to cash flows as a measure of liquidity or the
ability to pay dividends or make distributions.
READINESS FOR YEAR 2000
The Company is currently evaluating the nature and extent of the work required
to make its systems and infrastructure Year 2000 compliant. Based on a recent
assessment, the Company will have to modify or replace significant portions of
its hardware and software so that its systems will function properly with
respect to the Year 2000 and beyond. Certain of these systems are currently in
the process of being modified and/or replaced. The Company believes that with
modifications to certain existing software and conversions to new software
applications, in addition to hardware upgrades on certain mechanical systems,
the Year 2000 issue will not pose significant operational problems. However, if
such modifications and conversions are not made, or are not completed in a
timely manner, the Year 2000 issue could have a material impact on the
operations of the Company.
The Company continues to evaluate the Year 2000 issue and will utilize both
internal and external resources in order to reprogram, or replace, systems that
are not in compliance with the Year 2000. The Company anticipates completing the
project in mid-1999. The cost to complete the project has not yet been
determined.
The project completion date is based on management's best estimates, which were
derived utilizing numerous assumptions of future events, including the ability
of third parties to modify the Company's systems on a timely basis. There can be
no guarantee that the project will be completed in a timely manner. Specific
factors that might delay completion of the project include, but are not limited
to, the availability of qualified personnel, the ability to locate and correct
relevant computer codes, and similar uncertainties.
INFLATION
The Company's leases with the majority of its tenants require the tenants to pay
most operating expenses, including real estate taxes and insurance, and
increases in common area maintenance expenses, which reduce the Company's
exposure to increases in costs and operating expenses resulting from inflation.
As of June 30, 1998, approximately $201.3 million in principal amount of the
Company's indebtedness bore interest at floating rates and future indebtedness
may bear floating rate interest. Inflation, and its impact on floating interest
rates, could affect the amount of interest payments due on such indebtedness.
ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
20
<PAGE>
PART II: OTHER INFORMATION
ITEM 1. Legal Proceedings.
No material developments with respect to legal proceedings occurred during the
period covered by this quarterly report.
ITEM 2. Changes in Securities and Use of Proceeds
On June 5, 1998, the Company issued and sold 4,000,000 9% Series B Cumulative
Redeemable Preferred Shares for $25 per share, or an aggregate consideration of
approximately $100 million. So long as any Series B Cumulative Redeemable
Preferred Shares ("Series B Shares") are outstanding, no dividends may be
declared or paid or set apart for payment on Common Shares or Convertible
Preferred Shares unless full cumulative dividends on the Series B Shares have
been or contemporaneously are declared and a sum sufficient for the payment
thereof set apart for such payment. In addition, the Series B Shares rank senior
to the Common Shares and the Convertible Preferred Shares as to the payment of
dividends and as to the distribution of assets upon liquidation, dissolution or
winding up. In the event of any liquidation, dissolution or winding up of the
Company, before any payment or distribution of the assets of the Company shall
be made to or set apart for the holders of Common Shares or Convertible
Preferred Shares, the holders of Series B Shares shall be entitled to receive
$25.00 per Series B Share, plus an amount equal to all dividends (whether or not
earned or declared) accrued and unpaid thereon to the date of final distribution
to such holders. Further, if and whenever six consecutive quarterly dividends
payable on the Series B Shares shall be in arrears, the number of trustees then
constituting the Board of Trustees shall be increased by two and the holders of
Series B Shares, together with the holders of shares of every other series of
shares on parity with the Series B Shares (which does not include the Common
Shares or the Convertible Preferred Shares), shall be entitled to elect the two
additional trustees to serve on the Board of Trustees.
ITEM 3. Defaults Upon Senior Securities.
None.
ITEM 4. Submission of Matters to a Vote of Security Holders.
The Company's annual Meeting of Shareholders was held on May 22, 1998. At the
meeting, shareholders voted on (i) the election of two trustees; and (ii)
ratification of the appointment of Ernst & Young LLP as the Company's
independent auditors for 1998. Voting on each such matter was as follows:
<TABLE>
<CAPTION>
VOTES VOTES WITHHELD/ BROKER
FOR AGAINST ABSTENTIONS NON-VOTES
----- ------- ----------- ---------
<S> <C> <C> <C> <C>
1. Election of Trustees:
Michael W. Reschke 13,096,353 --- 6,640 0
Jacque M. Ducharme 13,095,053 --- 7,940 0
2. Ratification of Auditors: 13,092,902 3,750 6,341 0
</TABLE>
ITEM 5. Other Information.
None
21
<PAGE>
ITEM 6. Exhibits and Reports on Form 8-K.
(a) Exhibits:
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------ -----------
<C> <S>
3.1* Amendment No. 7 to the Amended and Restated Agreement of Limited Partnership dated as of April 15, 1998 as
filed as an exhibit to Amendment No. 1 to the Company's Registration Statement on Form S-11 (No.
333-51599) as filed with the Commission on May 14, 1998 and incorporated herein by reference
3.2* Amendment No. 8 to the Amended and Restated Agreement of Limited Partnership dated as of May 15, 1998
3.3* Amendment No. 9 to the Amended and Restated Agreement of Limited Partnership dated as of June 5, 1998
3.4* Amendment No. 10 to the Amended and Restated Agreement of Limited Partnership dated as of June 15, 1998
4.1* Articles Supplementary Classifying and Designating a Series of
Preferred Shares of Beneficial Interest as 9% Series B
Cumulative Redeemable Preferred Shares of Beneficial Interest
and Fixing Distribution and Other Preferences and Rights of Such
Series dated June 1, 1998
10.1* Amendment No. 4 to the Credit Facility dated as of April 24, 1998 as filed as an exhibit to Amendment No.
1 to the Company's Registration Statement on Form S-11 (No. 333-51599) as filed with the Commission on May
14, 1998 and incorporated herein by reference
10.2* Subordination and Intercreditor Agreement made as of May 14, 1998 among Connecticut General Life Insurance
Company and Prime Group Realty, L.P.
10.3* Employment Agreement dated as of May 6, 1998 by and between the Company and Louis Conforti
10.4* Promissory Note dated May 14, 1998 in the principal amount of
$75,000,000.00 made by American National Bank and Trust Company
of Chicago, a national banking association, not personally but
solely as trustee under trust agreement dated July 26, 1977 and
known as Trust No. 40935 and American National Bank and Trust
Company of Chicago, a national banking association, as successor
trustee to First Bank, N.A., as successor trustee to National
Boulevard Bank of Chicago, not personally, but solely as trustee
under trust agreement dated September 27, 1976 and known as
Trust No. 5602, payable to the order of Connecticut General Life
Insurance Company
27.1 Financial Data Schedule
</TABLE>
---------------
* Previously Filed
(b) Reports on Form 8-K:
The Company filed the following reports on Form 8-K and Form 8-K/A relating to
the acquisition of certain real estate properties and the required financial
information: Form 8-K on January 14, 1998; Form 8-K on January 30, 1998; Form
8-K/A on February 27, 1998; Form 8-K on March 6, 1998; Form 8-K/A on March 31,
1998; Form 8-K on April 14, 1998; Form 8-K on April 15, 1998; Form 8-K/A on May
5, 1998; Form 8-K on June 15, 1998 and Form 8-K/A on June 15, 1998.
22
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
PRIME GROUP REALTY TRUST
------------------------
Registrant
Date: MAY 14, 1999 /S/ RICHARD S. CURTO
------------------------- ---------------------
Richard S. Curto
President and Chief Executive Officer
Date: MAY 14, 1999 /S/ WILLIAM M. KARNES
------------------------- ----------------------
William M. Karnes
Executive Vice President and
Chief Financial Officer
23
<PAGE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> MAR-31-1998
<PERIOD-END> JUN-30-1998
<CASH> 13,167
<SECURITIES> 0
<RECEIVABLES> 101,665
<ALLOWANCES> 0
<INVENTORY> 73,922<F1>
<CURRENT-ASSETS> 0
<PP&E> 846,398
<DEPRECIATION> 12,424
<TOTAL-ASSETS> 1,022,728
<CURRENT-LIABILITIES> 210,506<F2>
<BONDS> 452,951
0
60
<COMMON> 156
<OTHER-SE> 359,055
<TOTAL-LIABILITY-AND-EQUITY> 1,022,728
<SALES> 0
<TOTAL-REVENUES> 36,923
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 23,999<F3>
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 8,061
<INCOME-PRETAX> 4,863
<INCOME-TAX> 0
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> (525)
<CHANGES> 0
<NET-INCOME> 4,338
<EPS-PRIMARY> 0.19
<EPS-DILUTED> 0.19
<FN>
<F1>Amount includes restricted cash escrows ($10,484), net deferred costs
($32,033), loans receivable from Services Company ($8,352) and other assets
($25,053)
<F2>Amount includes accrued interest payable ($1,703) accrued real estate taxes
($25,420), accounts payable and accrued expenses ($17,720), liabilities for
leases assumed ($5,083), dividends payable ($6,597), other liabilities ($5,712)
and minority interests of ($148,271).
<F3>Amount includes property operations ($6,885), real estate taxes ($6,874),
depreciation and amortization ($6,240), general and administrative expenses
($1,648) and minority interests allocation ($2,352).
</FN>
</TABLE>
