<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 SEPTEMBER 30, 1998 or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission File Number: 1-13625
EOP OPERATING LIMITED PARTNERSHIP
(Exact name of registrant as specified in its charter)
DELAWARE 36-4156801
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
TWO NORTH RIVERSIDE PLAZA
SUITE 2200, CHICAGO ILLINOIS 60606
(Address of principal executive offices) (Zip Code)
(312)466-3300
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
----- -----
APPLICABLE ONLY TO CORPORATE ISSUERS
On November 4, 1998, 288,657,159 of the Registrant's Units were outstanding.
<PAGE> 2
PART I - FINANCIAL INFORMATION
ITEM 1. Financial Statements
EOP OPERATING LIMITED PARTNERSHIP
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
September 30,
1998 December 31,
(Unaudited) 1997
---------------- ---------------
(Dollars in thousands,
except per Unit data)
<S> <C> <C>
Assets:
Investment in real estate....................................................... $ 12,710,343 $ 10,746,424
Developments in process......................................................... 276,312 259,718
Land available for development.................................................. 63,154 34,872
Accumulated depreciation........................................................ (272,680) (64,695)
------------- -------------
12,777,129 10,976,319
Cash and cash equivalents....................................................... 140,356 228,853
Tenant and other receivables (net of allowance for doubtful
accounts of $504 and $675, respectively)...................................... 42,818 32,531
Deferred rent receivable........................................................ 70,338 20,050
Escrow deposits and restricted cash............................................. 36,775 25,772
Investment in unconsolidated joint ventures..................................... 370,552 387,332
Deferred financing costs (net of accumulated amortization of
$1,815 and $1,855, respectively).............................................. 54,884 5,090
Deferred leasing costs (net of accumulated amortization
of $6,420 and $1,473, respectively) .......................................... 51,257 26,994
Prepaid expenses and other assets............................................... 87,725 48,731
------------- -------------
Total Assets................................................................ $ 13,631,834 $ 11,751,672
============= =============
Liabilities and Partners' Capital:
Mortgage debt (including a net premium of $1,974 and
$1,157, respectively)......................................................... $ 2,097,405 $ 2,063,017
Unsecured notes (including a net premium of $4,398 and
$0, respectively)............................................................. 2,459,398 180,000
Lines of credit................................................................. 1,115,312 2,041,300
Accounts payable and accrued expenses........................................... 269,982 260,401
Due to affiliates............................................................... 952 733
Dividend/distribution payable................................................... 107,154 1,191
Other liabilities............................................................... 94,991 45,055
------------- -------------
Total Liabilities........................................................... 6,145,194 4,591,697
------------- -------------
Commitments and contingencies (Note 13).........................................
Minority Interests - partially owned properties................................. 30,122 29,612
------------- -------------
Preferred Units, 100,000,000 authorized:
8.98% Series A Cumulative Redeemable Preferred Units, liquidation
preference $25.00 per unit, 8,000,000 issued and outstanding................ 200,000 200,000
5.25% Series B Convertible, Cumulative Redeemable Preferred Units,
liquidation preference $50.00 per unit, 6,000,000 issued and outstanding.... 300,000 --
Partners' Capital:
General Partners............................................................. 115,503 115,230
Limited Partners............................................................. 6,841,015 6,815,133
------------- -------------
Total Partners' Capital.................................................... 7,456,518 7,130,363
------------- -------------
Total Liabilities and Partners' Capital.................................... $ 13,631,834 $ 11,751,672
============= =============
</TABLE>
See accompanying notes.
2
<PAGE> 3
EOP OPERATING LIMITED PARTNERSHIP CONSOLIDATED STATEMENTS OF OPERATIONS
AND EQUITY OFFICE PREDECESSORS COMBINED STATEMENT OF OPERATIONS
(Unaudited)
<TABLE>
<CAPTION>
EOP Operating Limited Partnership Equity Office
----------------------------------------- Predecessors For
For the Three For the Period the Period from
Months Ended from July 11, 1997 July 1, 1997 to
September 30, 1998 to September 30, 1997 July 10, 1997
------------------ --------------------- ----------------
(Dollars in thousands, except per Unit data)
<S> <C> <C> <C>
Revenues:
Rental............................................. $ 339,169 $ 124,962 $ 14,410
Tenant reimbursements.............................. 61,729 23,614 2,985
Parking............................................ 24,659 12,653 1,141
Other.............................................. 4,246 1,061 269
Fees from noncombined affiliates................... 5,102 1,331 70
Interest / dividends............................... 2,028 947 443
------------- ------------ ---------
Total revenues................................... 436,933 164,568 19,318
------------- ------------ ---------
Expenses:
Interest:
Expense incurred.................................. 91,240 25,793 4,180
Amortization of deferred financing costs.......... 1,073 1,374 410
Depreciation........................................ 74,557 22,787 4,718
Amortization........................................ 2,200 - 497
Real estate taxes................................... 51,197 18,317 2,326
Insurance........................................... 1,832 1,255 245
Repairs and maintenance............................. 48,033 19,651 2,412
Property operating.................................. 52,115 22,539 2,123
Ground rent......................................... 1,813 1,123 70
General and administrative.......................... 16,697 5,855 2,475
------------- ------------ ---------
Total expenses.................................... 340,757 118,694 19,456
------------- ------------ ---------
Income before allocation to minority interests, income
from investment in unconsolidated joint ventures and
extraordinary items................................. 96,176 45,874 (138)
Minority Interests - partially owned properties..... (572) (279) (33)
Income from investment in unconsolidated joint
ventures............................................. 3,129 1,426 (43)
------------- ------------ ---------
Income before extraordinary items................... 98,733 47,021 (214)
Extraordinary items.................................... - (12,930) -
------------- ------------ ---------
Net income............................................. 98,733 34,091 (214)
Preferred distributions................................ (8,427) - -
------------- ------------ ---------
Net income available for Units......................... $ 90,306 $ 34,091 $ (214)
============= ============ =========
Net income available per weighted average
Unit outstanding - Basic............................... $ .32 $ .21
============= ============
Weighted average Units outstanding - Basic......... 281,223,315 164,146,711
============= ============
Net income available per weighted average
Unit outstanding - Diluted.......................... $ .32 $ .21
============= ============
Weighted average Units outstanding - Diluted...... 281,929,910 165,384,651
============= ============
</TABLE>
See accompanying notes.
3
<PAGE> 4
EOP OPERATING LIMITED PARTNERSHIP CONSOLIDATED STATEMENTS OF OPERATIONS
AND EQUITY OFFICE PREDECESSORS COMBINED STATEMENT OF OPERATIONS
(Unaudited)
<TABLE>
<CAPTION>
EOP Operating Limited Partnership Equity Office
---------------------------------------- Predecessors for
For the Nine For the Period the Period from
Months Ended from July 11, 1997 January 1, 1997
September 30, 1998 to September 30, 1997 to July 10, 1997
------------------ --------------------- -----------------
(Dollars in thousands, except per Unit data)
<S> <C> <C> <C>
Revenues:
Rental........................................ $ 937,070 $ 124,962 $ 256,146
Tenant reimbursements...................... 170,472 23,614 43,241
Parking........................................ 69,266 12,653 21,091
Other........................................... 17,886 1,061 6,539
Fees from noncombined affiliates.......... 7,766 1,331 2,510
Interest / dividends.......................... 8,237 947 9,577
----------- ----------- ----------
Total revenues............................... 1,210,697 164,568 339,104
----------- ----------- ----------
Expenses:
Interest:
Expense incurred............................ 237,194 25,793 80,481
Amortization of deferred financing
costs........................................ 5,149 1,374 2,771
Depreciation................................. 207,987 22,787 57,379
Amortization................................. 4,947 - 5,884
Real estate taxes.............................. 148,769 18,317 34,000
Insurance.................................... 5,703 1,255 3,060
Repairs and maintenance.................. 134,710 19,651 45,540
Property operating............................ 137,330 22,539 42,309
Ground rent................................. 5,385 1,123 2,376
General and administrative................ 45,137 5,855 17,201
----------- ----------- ----------
Total expenses............................ 932,311 118,694 291,001
----------- ----------- ----------
Income before allocation to minority
interests, income from investment in
unconsolidated joint ventures, gain on
sale of real estate and extraordinary items 278,386 45,874 48,103
Minority Interests - partially owned
properties....................................... (1,608) (279) (912)
Income from investment in unconsolidated
joint ventures.................................. 8,155 1,426 1,982
Gain on sale of real estate...................... - - 12,510
----------- ----------- ----------
Income before extraordinary items.......... 284,933 47,021 61,683
Extraordinary items........................... (7,506) (12,930) (274)
----------- ----------- ----------
Net income......................................... 277,427 34,091 61,409
Preferred distributions........................... (23,130) - -
----------- ----------- ----------
Net income available for Units................ $ 254,297 $ 34,091 $ 61,409
=========== =========== ==========
Net income available per weighted average
Unit outstanding - Basic...................... $ .91 $ .21
=========== ===========
Weighted average Units outstanding -
Basic............................................ 280,077,070 164,146,711
=========== ===========
Net income available per weighted average
Units outstanding - Diluted.................. $ .90 $ .21
=========== ===========
Weighted average Units outstanding -
Diluted......................................... 281,207,972 165,384,651
=========== ===========
</TABLE>
See accompanying notes.
4
<PAGE> 5
EOP OPERATING LIMITED PARTNERSHIP CONSOLIDATED STATEMENTS OF CASH FLOWS
AND EQUITY OFFICE PREDECESSORS COMBINED STATEMENT OF CASH FLOWS
(Unaudited)
<TABLE>
<CAPTION>
EOP Operating Limited Partnership Equity Office
---------------------------------------------- Predecessors for
For the Nine For the Period the Period from
Months Ended from July 11, 1997 to January 1, 1997 to
September 30, 1998 September 30, 1997 July 10, 1997
------------------ --------------------- -------------------
<S> <C> <C> <C>
OPERATING ACTIVITIES: (Dollars in thousands)
Net income before preferred distributions....................... $ 277,427 $ 34,091 $ 61,409
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization................................. 218,083 24,161 66,034
Amortization of premiums/discounts on
unsecured notes and terminated interest rate
protection agreements........................................ 2,083 - -
Compensation related to restricted shares issued
to employees................................................. 2,167 - -
(Income) from unconsolidated joint ventures..................... (8,155) (1,426) (1,982)
(Gain) on sale of real estate................................... - - (12,510)
Extraordinary items............................................. 7,506 12,930 274
Provision for doubtful accounts................................. 185 1,556 1,175
Allocation to minority interests................................ 1,608 279 912
Changes in assets and liabilities:
(Increase) decrease in rents receivable...................... (10,472) 5,297 2,664
(Increase) in deferred rent receivables...................... (50,288) (10,213) (8,061)
Decrease (increase) in prepaid expenses and
other assets............................................... 5,961 (27,742) (8,839)
Increase in accounts payable and accrued
expenses................................................... 9,581 12,504 2,916
Increase (decrease) in due to affiliates..................... 219 (1,678) (722)
Increase (decrease) in other liabilities..................... 50,235 9,906 (7,310)
---------- ----------- -----------
Net cash provided by operating activities.................... 506,140 59,665 95,960
---------- ----------- -----------
INVESTING ACTIVITIES:
Property acquisitions........................................... (1,730,507) (26,025) (531,968)
Payments for capital and tenant improvements.................... (116,122) (42,587) (59,511)
Proceeds from sales of real estate.............................. - - 72,078
Distributions from (investments in) unconsolidated
joint ventures................................................. 8,973 1,535 (44,260)
Payments of lease acquisition costs............................. (29,210) (6,331) (9,260)
Investment in preferred securities.............................. (48,500) - -
(Increase) decrease in escrow deposits and restricted
cash........................................................... (11,003) (12,226) 1,853
---------- ----------- -----------
Net cash (used for) investing activities.................... (1,926,369) (85,634) (571,068)
---------- ----------- -----------
</TABLE>
See accompanying notes.
5
<PAGE> 6
EOP OPERATING LIMITED PARTNERSHIP CONSOLIDATED STATEMENTS OF CASH FLOWS
AND EQUITY OFFICE PREDECESSORS COMBINED STATEMENT OF CASH FLOWS - (CONTINUED)
(Unaudited)
<TABLE>
<CAPTION>
EOP Operating Limited Partnership Equity Office
------------------------------------------ Predecessors for
For the Nine For the Period the Period from
Months Ended from July 11, 1997 to January 1, 1997 to
September 30, 1998 September 30, 1997 July 10, 1997
------------------ --------------------- ------------------
<S> <C> <C> <C>
FINANCING ACTIVITIES:
Proceeds from Trust related to sale of Common
Shares, net of offering costs............................ 43,985 564,506 -
Proceeds from exercise of options.......................... 15,024 - -
Redemption of Units........................................ (33) - -
Distributions to unit holders.............................. (179,737) - -
Payment of preferred distributions......................... (21,124) - -
Proceeds from sale of preferred units, net of
offering costs........................................... 289,329 - -
Payment of offering costs.................................. (117) - -
Capital contributions...................................... - - 287,949
Capital distributions...................................... - - (288,652)
(Distributions to) minority interest in partially
owned properties........................................ (1,098) (1,355) (3,401)
Cash contributed from net assets at the IPO................ - 181,163 -
Proceeds from mortgage debt................................ 9,029 1,697 154,090
Proceeds from unsecured notes.............................. 2,279,572 180,000 -
Proceeds from lines of credit.............................. 3,915,500 425,125 218,000
Principal payments on mortgage debt........................ (23,567) (691,714) (47,472)
Principal payments on lines of credit...................... (4,934,885) (486,625) (72,500)
Payments of loan costs..................................... (21,869) (1,327) (1,889)
Termination of interest rate protection agreements......... (38,277) - -
Prepayment penalties on early extinguishments of
debt..................................................... - (12,877) (274)
----------- ---------- ----------
Net cash provided by financing activities.................. 1,331,732 158,593 245,851
----------- ---------- ----------
Net (decrease) increase in cash and cash equivalents....... (88,497) 132,624 (229,257)
Cash and cash equivalents at the beginning of the
period................................................... 228,853 25 410,420
----------- ---------- ----------
Cash and cash equivalents at the end of the period......... $ 140,356 $ 132,649 $ 181,163
=========== ========== ==========
SUPPLEMENTAL INFORMATION:
Interest paid during the period, including capitalized
interest of $10,357, $1,711 and $3,669,
respectively............................................... $ 215,205 $ 30,273 $ 82,969
=========== ========== ==========
</TABLE>
See accompanying notes.
6
<PAGE> 7
EOP OPERATING LIMITED PARTNERSHIP AND EQUITY OFFICE PREDECESSORS
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS
(Unaudited)
Definitions of Terms: Capitalized terms used but not defined herein are as
defined in the Company's Annual Report on Form 10-K, as amended by Form 10-K/A,
for the year ended December 31, 1997 (the "Form 10-K").
The consolidated financial statements of the Company and the combined
financial statements of Equity Office Predecessors 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,
1997 audited consolidated and combined financial statements of EOP Operating
Limited Partnership 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
As used herein, "Company" means EOP Operating Limited Partnership, a
Delaware limited partnership and the predecessors thereof ("Equity Office
Predecessors"). The Company is a subsidiary of Equity Office Properties Trust
(the "Trust"), which 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 Trust, and to complete the consolidation of the Equity
Office Predecessors (the "Consolidation") and its initial public offering (the
"IPO") on July 11, 1997. The Company is a fully integrated, self-administered
and self-managed real estate company engaged in acquiring, owning, managing,
leasing and renovating office properties and parking facilities. The Trust's
assets, which include investments in joint ventures, are owned by, and
substantially all of its operations are conducted through the Company. The
Trust is the managing general partner of the Company. The Trust elected to be
taxed as a real estate investment trust ("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 September 30, 1998, the Company owned or had an
interest in 285 office properties (the "Office Properties") containing
approximately 74.1 million rentable square feet of office space and owned 17
stand-alone parking facilities (the "Parking Facilities" and, together with the
Office Properties, the "Properties") containing approximately 16,749 parking
spaces. The weighted average occupancy for the Office Properties at September
30, 1998 was approximately 94.6%. The Office Properties are located in 82
submarkets in 39 markets in 24 states and the District of Columbia. The Office
Properties, by rentable square feet, are located approximately 52% in central
business districts ("CBDs") and 48% in suburban markets.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation. The Consolidation and the Beacon Merger were
accounted for as purchases in accordance with Accounting Principles Board
Opinion No. 16. Accordingly, the fair value of the consideration given by the
Company was used as the valuation basis for the transactions. The assets
acquired and liabilities assumed by the Company were recorded at their fair
value as of the closing dates of the Consolidation and the Beacon Merger,
respectively, and the excess of the purchase price over the related historical
basis of the net assets acquired was allocated primarily to investment in real
estate.
The combined financial statements of Equity Office Predecessors prior to
the Consolidation included interests in the Properties of the ZML Opportunity
Partnerships together with their limited and general partners and the Management
Business.
Use of Estimates. The preparation of the consolidated financial statements
of the Company and the combined financial statements of Equity Office
Predecessors 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 and nine months ended September 30, 1998, the
period from July 11, 1997 to September 30, 1997, and the combined financial
statements of Equity Office Predecessors for the period from July 1, 1997 to
July 10, 1997 and January 1, 1997 to July 10, 1997 and related footnote
disclosures are unaudited. In the opinion of management, such financial
7
<PAGE> 8
EOP OPERATING LIMITED PARTNERSHIP AND EQUITY OFFICE PREDECESSORS
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS
(Unaudited)
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.
Reclassifications. Certain reclassifications have been made to the
previously reported 1997 statements in order to provide comparability with the
1998 statements reported herein. These reclassifications have not changed the
1997 results or partners' capital.
NOTE 3 - INVESTMENT IN REAL ESTATE
During the nine months ended September 30, 1998, the Company acquired the
Properties listed below. Each Property was purchased from an unaffiliated party
and was funded from the Company's Credit Facilities, working capital, assumption
of mortgage debt, issuance of promissory notes and/or issuance of Units.
<TABLE>
<CAPTION>
Total
Date Rentable Acquisition Cost
Acquired Property Location Square Feet (in thousands)
- -------- ------------------------------------------ -------------- ----------- ----------------
<S> <C> <C> <C> <C>
1/29/98 BP Tower Garage Cleveland, OH - $ 10,224
3/18/98 100 Summer Street Boston, MA 1,037,801 222,695
3/31/98 The Tower at New England Executive Park (a) Burlington, MA 195,228 27,931
4/2/98 Westbrook Corporate Center Vacant Land Westchester, IL - 3,973
4/21/98 Denver Post Tower Denver, CO 579,999 52,836
4/29/98 301 Howard Street and 215 Fremont Street (b) San Francisco, CA 570,891 89,928
4/30/98 410 17th Street Denver, CO 388,953 44,637
4/30/98 One Tabor Center (c) Denver, CO 674,278 144,260
4/30/98 Trinity Place Denver, CO 189,163 18,991
5/14/98 Dominion Plaza Denver, CO 571,468 59,764
5/19/98 Millenium Plaza Englewood, CO 330,033 46,061
5/22/98 James K. Polk Building and the Zachary Arlington, VA 902,371 153,452
Taylor Building (d)
6/1/98 Walker Building Washington, D.C. 75,456 8,624
6/26/98 Columbia Seafirst Center Seattle, WA 1,537,932 401,738
7/2/98 Northland Plaza Bloomington, MN 296,965 47,051
7/15/98 4949 Syracuse Denver, CO 62,633 8,255
7/15/98 Metropoint I and Metropoint III vacant land Denver, CO 263,719 45,697
7/15/98 One Park Square Albuquerque, NM 262,020 36,311
7/15/98 Park Avenue Tower (e) New York, NY 550,894 244,880
7/15/98 Terrace Building Englewood, CO 115,408 15,430
7/15/98 The Solarium Englewood, CO 162,817 19,467
7/29/98 Second and Spring Seattle, WA 134,871 19,684
9/30/98 Colonnade I, II and III (f) Dallas, TX 984,254 151,601
----------- -----------
9,887,154 $ 1,873,490
=========== ===========
</TABLE>
(a) The Tower at New England Executive Park Property was approximately 36.5%
leased at acquisition and is currently undergoing a significant renovation
in an effort to re-tenant the Property.
(b) The 215 Fremont Street Property is currently vacant and is expected to
undergo a significant renovation and extensive seismic retrofitting prior
to re-tenanting.
(c) The total acquisition cost of the One Tabor Center Property of
approximately $144.3 million includes vacant land of approximately $15.0
million and a 1,694 space parking facility.
(d) Total acquisition cost of approximately $153.5 million represents the cost
to acquire the remaining 90% limited partnership interest in the James K.
Polk Building and the Zachary Taylor Building.
(e) The Company acquired a $290 million first mortgage note secured by the Park
Avenue Tower Property for approximately $244.9 million. In accordance with
certain agreements concerning the first mortgage note, the Company controls
the financial and operational decisions for the Property and is entitled to
substantially all
8
<PAGE> 9
EOP OPERATING LIMITED PARTNERSHIP AND EQUITY OFFICE PREDECESSORS
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS
(Unaudited)
cash flow and residual profit. Accordingly, the Company consolidated the
financial position and results of operations of the Property.
(f) The Colonnade III Property was acquired by the Company from an unaffiliated
party and is approximately 68% leased as of September 30, 1998. The seller
of the Property may be entitled to receive an earnout payment for leases
executed in accordance with terms outlined in the purchase agreement. The
maximum earnout payment is approximately $2.5 million.
NOTE 4 - INVESTMENT IN UNCONSOLIDATED JOINT VENTURES
The following is a summary of the Company's ownership in the unconsolidated
joint ventures:
<TABLE>
<CAPTION>
Company's Ownership
as of September 30,
Entity Property 1998
- --------------------------- ------------------------ --------------------
<S> <C> <C>
EOP - Orange, L.L.C. and EOP - Ramlessview
Investors, L.L.C. (a) 500 Orange Tower 100%
Civic Parking, L.L.C. (b) St.Louis Parking Garages 50%
Wright Runstad Associates Limited Partnership (c) N/A 28.5%
One Post Office Square Associates (d) One Post Office 50%
BeaMetFed, Inc. (e) 75-101 Federal Street 52%
Rowes Wharf Associates (f) Rowes Wharf 50%
Lehndorff Four Oaks Place Associates (g) Four Oaks Place 2.55%
Metropoint II Associates (h) Metropoint II 70%
WRC Sunset North, L.L.C. (i) Sunset North Corporate Campus 80%
</TABLE>
(a) The Company owns a mortgage note receivable secured by the Property and
land underlying and adjacent to the Property.
(b) The Company owns a 50% membership interest.
(c) The Company owns a 28.5% non-controlling interest in a property management
and development company (see Note 13).
(d) The Company is a 50% general partner in the joint venture.
(e) The Company is a shareholder in the corporation (a private REIT) which owns
the Property.
(f) The Company owns a 50% equity interest in the Property and, subject to a
subparticipation which the Company expects to redeem for approximately
$500,000, 50% of a first mortgage.
(g) The Company owns a 3% general partner interest in this general partnership
which owns an 85% general partnership interest in the Property.
(h) In July, 1998, the Company entered into a joint venture agreement with an
unaffiliated party to develop Metropoint II, a $22.5 million, 150,000
square foot office building, which is currently under construction in the
Denver Tech Center. The Company acquired a 70% interest in the joint
venture, while the unaffiliated party retained a 30% interest and will
continue as the developer of the project. The Company has invested
approximately $3.0 million in this project as of September 30, 1998. A
buy / sell option may be exercised to acquire the other venturer's interest
by either the Company or its joint venture partner if certain conditions
are met as defined in the joint venture agreement.
(i) In July, 1998, the Company entered into a joint venture agreement with
Wright Runstad Associates Limited Partnership, an affiliated party, to
develop Sunset North Corporate Campus, a three building, 462,000
square-foot office complex in Bellevue, Washington. Development of the
campus is estimated to cost approximately $98.0 million. The Company will
own 80% of the project during its development and will have the option to
acquire the remaining 20% interest once stabilized occupancy has been
achieved. The Company has invested approximately $21.4 million in this
project as of September 30, 1998. A buy / sell option may be exercised to
acquire the other venturer's interest by either the Company or its joint
venture partner if certain conditions are met as defined in the joint
venture agreement.
These investments are accounted for utilizing the equity method of
accounting except for the Company's investment in Lehndorff Four Oaks Place
Associates, which is accounted for utilizing the cost method of
9
<PAGE> 10
EOP OPERATING LIMITED PARTNERSHIP AND EQUITY OFFICE PREDECESSORS
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS
(Unaudited)
accounting. Under the equity method of accounting, the net equity investment of
the Company is reflected on the consolidated balance sheets, and the
consolidated and combined statements of operations include the Company's share
of net income or loss from the unconsolidated joint ventures. As a result of
purchase method accounting for the Beacon Merger and the Consolidation, any
difference between the carrying amount of these investments on the balance sheet
of the Company and the underlying equity in net assets is amortized as an
adjustment to income from unconsolidated joint ventures over 40 years.
Combined summarized financial information of the unconsolidated joint
ventures is as follows:
<TABLE>
<CAPTION>
September 30, 1998 December 31, 1997
- --------------------------------------------------------- ------------------ ------------------
(Dollars in thousands)
Balance Sheets:
<S> <C> <C>
Real estate, net........................................ $467,878 $523,670
Other assets............................................ 75,629 73,450
------------ ------------
Total Assets........................................... $543,507 $597,120
============ ============
Mortgage debt........................................... $239,635 $344,427
Other liabilities....................................... 13,244 15,271
Partners' and shareholders' equity...................... 290,628 237,422
------------ ------------
Total Liabilities and Partners' and Shareholders' Equity $543,507 $597,120
============ ============
Company's share of equity................................ $149,550 $155,522
Excess of cost of investments over the net book value
of underlying net assets, net of accumulated
depreciation of $4,294 and $99, respectively............ 221,002 231,810
------------ ------------
Carrying value of investments in unconsolidated joint
ventures................................................ $370,552 $387,332
============ ============
Company's share of unconsolidated mortgage debt.......... $121,268 $ 92,400
============ ============
<CAPTION>
For the three months ended For the nine months ended
------------------------------------------- -------------------------------------------
September 30, September 30, September 30, September 30,
1998 1997 1998 1997
---------------- ------------------ ---------------- ------------------
(Dollars in thousands)
Statement of Operations:
<S> <C> <C> <C> <C>
Revenues........................... $26,297 $ 3,798 $82,319 $ 8,442
---------------- ------------------ ---------------- ------------------
Expenses:
Operating expenses................ 9,999 759 28,923 1,564
Interest expense.................. 4,462 - 12,640 -
Depreciation and amortization..... 4,463 765 14,296 1,793
---------------- ------------------ ---------------- ------------------
Total expenses................... 18,924 1,524 55,859 3,357
---------------- ------------------ ---------------- ------------------
Net income......................... $ 7,373 $ 2,274 $26,460 $ 5,085
================ ================== ================ ==================
Company's share of net income...... $ 3,129 $ 1,383 $ 8,155 $ 3,408
================ ================== ================ ==================
Company's share of interest expense $ 2,259 $ - $ 6,385 $ -
================ ================== ================ ==================
Company's share of depreciation and
amortization (real estate related) $ 3,513 $ 517 $10,729 $ 1,330
================ ================== ================ ==================
</TABLE>
10
<PAGE> 11
EOP OPERATING LIMITED PARTNERSHIP AND EQUITY OFFICE PREDECESSORS
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS
(Unaudited)
NOTE 5 - INVESTMENT IN PREFERRED SECURITIES
On July 28, 1998, the Company completed the purchase of 50,000 shares of
Capital Trust 8.25% Step Up Convertible Trust Preferred Securities, $1,000
liquidation preference per share, for $48.5 million, in a private placement. Mr.
Zell, Chairman of the Board of Trustees of the Trust, is also Chairman of the
Board of Capital Trust. The preferred shares are convertible at any time by the
holders into common shares of Capital Trust at a conversion price of $11.70,
reflecting a 30% conversion premium over Capital Trust's common share price at
the close of business on July 24, 1998. The preferred shares are non-callable
for five years, and have a 20-year maturity. The quarterly dividend was paid on
September 30, 1998, and is payable each calendar quarter thereafter; commencing
in year seven, the dividend will increase by 75 basis points per annum. In
connection with the investment, Capital Trust has granted the Company and other
investors the right to participate in certain strategic lending opportunities.
The Company classified this investment with other assets on the balance sheet.
NOTE 6 - MORTGAGE DEBT
On July 1, 1998, the Company repaid the mortgage note on the 175 Federal
Street Property in the amount of approximately $12.5 million.
NOTE 7 - UNSECURED NOTES
The Company filed a registration statement, which was declared effective on
June 18, 1998, relating to an offer to exchange the $180 Million Notes, the
$1.25 billion of unsecured notes (the "$1.25 Billion Notes") and the $250
million of 6.376% Mandatory Par Put Remarketed Securities (the "$250 Million
MOPPRS") for registered securities of the Company with terms identical in all
material respects to the terms of the existing notes. This exchange offer
expired on July 30, 1998.
The Company filed a registration statement, which was declared effective on
July 22, 1998, relating to the 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 in amounts, at prices and on terms described in one or more supplements
to the prospectus.
The Company filed a registration statement, which was declared effective on
September 4, 1998, relating to an offer to exchange (a) $775 million of
unsecured notes issued in June 1998 (the "$775 Million Notes"); (b) 300,000
warrants to purchase an additional $300 million in unsecured notes at a later
date; and (c) portions of the $1.25 Billion Notes and $250 Million MOPPRS for
registered securities of the Company with terms identical in all material
respects to the terms of the existing notes. This exchange offer expired on
October 27, 1998.
NOTE 8 - LINES OF CREDIT
In connection with the acquisition of 4949 Syracuse, Metropoint I, One Park
Square, The Solarium and the Terrace Building on July 15, 1998, the Company
issued approximately $54.0 million in promissory notes secured by letters of
credit. The promissory notes are due 120 days after the acquisition of the
Properties and are payable in cash or Common Shares of the Trust at the
Company's option. The promissory notes bear interest at approximately 4.7% per
annum. On August 21, 1998, the Company repaid approximately $25.6 million of
the promissory notes.
On August 14, 1998, the Company closed a new $328 million unsecured term
loan facility (the "$328 Million Credit Facility") with J.P. Morgan. The $328
Million Credit Facility is priced at 90-day LIBOR plus 80 basis points and is
prepayable on any interest payment date. The $328 Million Credit Facility
matures on August 15, 2000. The proceeds from the $328 Million Credit Facility
were used to pay down the $1.0 Billion Credit Facility.
On September 22, 1998, the Company closed a new $200 million unsecured term
loan facility (the "$200 Million Credit Facility") with The Chase Manhattan
Bank. Interest accrues under the $200 Million Credit Facility at an initial
rate of LIBOR plus 50 basis points with a facility fee equal to 20 basis points
per annum. Pricing for the
11
<PAGE> 12
EOP OPERATING PARTNERSHIP AND EQUITY OFFICE PREDECESSORS
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS
(Unaudited)
first twelve months is based on a matrix tied to the Company's credit rating and
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. The proceeds of the $200 Million Credit Facility were used to pay down the
$1.0 Billion Credit Facility.
NOTE 9 - PARTNERS' CAPITAL
On July 15, 1998, the Board of Trustees of the Trust declared a third
quarter distribution for the 6,000,000 units of 5.25% Series B Convertible,
Cumulative Redeemable Preferred Units, $50 liquidation preference per unit (the
"Series B Preferred Units") of $.65625 per unit, based on a full quarterly
distribution and an annual distribution of $2.625 per unit. The distribution
was paid on August 17, 1998, to holders of record as of August 3, 1998.
On August 17, 1998, the Board of Trustees of the Trust declared a third
quarter distribution for the Series A Preferred Units of $.56125 per unit. The
distribution was paid on September 15, 1998 to holders of record as of September
1, 1998.
On September 18, 1998, the Board of Trustees of the Trust declared a third
quarter distribution in the amount of $0.37 per Common Share/Unit, based on a
full quarterly distribution and an annual distribution rate of $1.48 per Common
Share/Unit. The distribution was paid on October 9, 1998, to common
shareholders / unit holders of record as of September 30, 1998.
In connection with the acquisition of the Second and Spring Property on
July 29, 1998, the Company issued 178,976 Units.
The Trust filed a registration statement, which was declared effective on
July 22, 1998, relating to the registration of $1.5 billion of Common Shares,
preferred shares of beneficial interest and warrants to be issued at prices and
on terms to be determined at the time of offering. The Trust may issue the
securities separately or together, in separate series, in amounts, at prices and
on terms described in one or more supplements to the prospectus.
The Trust filed a registration statement, which was declared effective on
July 22, 1998, relating to the resale by a selling shareholder of the 1,628,009
Common Shares issued in a private placement in April 1998.
The Trust filed a registration statement, which was declared effective on
September 4, 1998, relating to the resale by certain selling shareholders of
20,210,129 Common Shares previously issued in various property acquisitions or
for cash or which may be issuable upon redemption of Units previously issued in
various Property acquisitions.
The Trust filed a registration statement, which was declared effective on
September 4, 1998, relating to the resale of the Series B Preferred Shares. The
shares were required to be registered under the terms of a registration rights
agreement entered into at the time of the original private placement. The Trust
will receive no proceeds of any sales of the Series B Preferred Shares.
The following table presents the changes in the issued and outstanding
Units for the nine months ended September 30, 1998:
Units
------------
Balance at January 1, 1998...................................... 278,687,351
Units issued to the Trust through issuance of Common Shares..... 1,628,009
Units issued to the Trust through exercise of options........... 787,883
Redemption of Units............................................. (1,167)
Units issued in exchange for property acquisitions.............. 182,344
-------------
Balance at September 30, 1998................................... 281,284,420
=============
12
<PAGE> 13
EOP OPERATING PARTNERSHIP AND EQUITY OFFICE PREDECESSORS
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS
(Unaudited)
NOTE 10 - EARNINGS PER UNIT
The following table sets forth the computation of basic and diluted
earnings per Unit:
<TABLE>
<CAPTION>
For the Period
For the Three Months For the Nine Months from
Ended Ended July 11, 1997 to
(Dollars in thousands, except per Unit data) September 30, 1998 September 30, 1998 September 30, 1997
- -------------------------------------------- -------------------- ------------------ ------------------
<S> <C> <C> <C>
NUMERATOR:
Net income available to Units before extraordinary
items......................................... $ 90,306 $ 261,803 $ 47,021
Extraordinary items............................ - (7,506) (12,930)
----------- ----------- -----------
Numerator for basic and diluted earnings per Unit -
income available to Units..................... $90,306 $ 254,297 $ 34,091
=========== =========== ===========
DENOMINATOR:
Denominator for basic earnings per Unit -
weighted average Units........................ 281,223,315 280,077,070 164,146,711
Effect of dilutive securities:
Units issuable upon exercise of Trust stock
options....................................... 706,595 1,130,902 1,237,940
----------- ----------- -----------
Denominator for diluted earnings per Unit -
adjusted weighted average Units and assumed
conversions................................... 281,929,910 281,207,972 165,384,651
=========== =========== ===========
Basic Earnings Available to Units per Weighted
Average Unit:
Net income before extraordinary items.......... $ .32 $ .94 $ .29
Extraordinary items............................ - (.03) (.08)
----------- ----------- -----------
Net income per Unit............................ $ .32 $ .91 $ .21
=========== =========== ===========
Diluted Earnings Available to Units Per Weighted
Average Units:
Net income before extraordinary items.......... $ .32 $ .93 $ .28
Extraordinary items............................ - (.03) (.07)
----------- ----------- -----------
Net income per Unit............................ $ .32 $ .90 $ .21
=========== =========== ===========
</TABLE>
Options to purchase 2,970,468 Common Shares at a weighted average exercise
price of $30.26 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 September 30, 1998, and were not included in the
computation of diluted earnings per share for the three months ended September
30, 1998 since they would have an antidilutive effect. In addition, options to
purchase 2,929,825 Common Shares at a weighted average exercise price of $30.31
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 nine
months ended September 30, 1998, and were not included in the computation of
diluted earnings per share for the nine months ended September 30, 1998, since
they would have an antidilutive effect. In addition, options to purchase
726,500 Common Shares at a weighted average exercise price of $32.93 per Common
Share were outstanding during the period from July 11, 1997 to September 30,
1997, and were not included in the computation of diluted earnings per share for
the period from July 11, 1997 to September 30, 1997, since they would have an
antidilutive effect.
13
<PAGE> 14
EOP OPERATING LIMITED PARTNERSHIP AND EQUITY OFFICE PREDECESSOR
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS
(Unaudited)
NOTE 11 - PRO FORMA STATEMENT OF OPERATIONS
The accompanying unaudited Pro Forma Condensed Combined Statement of
Operations for the nine months ended September 30, 1998 reflects the following
transactions as if they had occurred on January 1, 1998: (a) the acquisition of
27 Office Properties, and one parking facility, acquired during the nine months
ended September 30, 1998; (b) the purchase of the remaining partnership
interests in one of the Company's unconsolidated joint ventures; (c) the
February 1998 $1.5 Billion Notes Offering; (d) the Series B Preferred Offering;
(e) the increase in the $600 Million Credit Facility to $1.0 billion; (f) the
UIT Offering in April 1998, (g) the June 1998 $775 Million Notes Offering and
(h) the $48.5 million investment in preferred shares of Capital Trust.
The accompanying unaudited Pro Forma Condensed Combined Statement of
Operations for the nine months ended September 30, 1997 reflects the following
transactions as if they had occurred on January 1, 1997: (a) the acquisition of
66 Office Properties, including 20 Office Properties acquired by Beacon prior to
the Beacon Merger, and seven Parking Facilities, including an interest in four
Parking Facilities, acquired during the year ended December 31, 1997; (b) the
disposition of three office properties; (c) the $180 Million Notes Offering
which closed on September 3, 1997; (d) the transactions that occurred in
connection with the Consolidation of Equity Office Predecessors and the IPO
which closed on July 11, 1997, and the decrease in interest expense resulting
from the use of the net proceeds for the repayment of mortgage debt; (e) the net
change in interest expense from draws on the $1.5 Billion Credit Facility used
to refinance existing mortgage debt; (f) the Beacon Merger; (g) the acquisition
of 27 Office Properties and one parking facility acquired between January 1,
1998 and September 30, 1998: (h) the purchase of the remaining partnership
interest in one of the Company's unconsolidated joint ventures; (i) the February
1998 $1.5 Billion Notes Offering (j) the Series B Preferred Offering; (k) the
increase in the $600 Million Credit Facility to $1.0 billion; (l) the UIT
Offering; (m) the June 1998 $775 Million Notes Offering and (n) the $48.5
million investment in preferred shares of Capital Trust.
The accompanying unaudited pro forma condensed combined financial
statements have been prepared by management of the Company and do not purport to
be indicative of the results which would actually have been obtained had the
transactions described above been completed on the dates indicated or which may
be obtained in the future.
For the nine months ended September 30,
-------------------------------------------
1998 1997
------------- -------------
(Dollars in thousands except per Unit data)
Total Revenues...................... $ 1,302,226 $ 1,239,989
============= =============
Income before extraordinary items... $ 275,341 $ 219,244
============= =============
Net income available for Units...... $ 242,517 $ 178,769
============= =============
Net income per Unit - Basic......... $ .86 $ .63
============= =============
Units Outstanding - Basic........... 281,666,000 281,657,000
============= =============
Net income per Unit - Diluted....... $ .86 $ .63
============= =============
Units Outstanding - Diluted........... 282,373,000 282,257,000
============= =============
14
<PAGE> 15
EOP OPERATING LIMITED PARTNERSHIP AND EQUITY OFFICE PREDECESSORS
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS
(Unaudited)
NOTE 12 - NON-CASH INVESTING AND FINANCING ACTIVITIES
Additional supplemental disclosures of non-cash investing and financing
activities are as follows:
For the Nine For the Period
Months Ended from July 11, 1997 to
September 30, 1998 September 30, 1997
-------------------------------------------
Mortgage loans assumed / promissory
notes issued through property
acquisitions......................... $ 141,506 $ 90,000
==================================
Units issued through property
acquisitions......................... $ 4,698 $ 49,100
==================================
Mortgage loans and line of credit
assumed in the
Consolidation........................ -- $ 2,196,708
==================================
Net liabilities assumed in the
Consolidation........................ -- $ 62,706
==================================
Units issued in the Consolidation.... -- $ 2,830,918
==================================
NOTE 13 - 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 periodically 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 extent of non-performance by the swap
counterparties since each counterparty is a major U.S. financial institution,
and management does not anticipate their 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.
Litigation. The Company has become a party to various legal actions
resulting from the operational activities transferred to the Company 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.
The Company is involved in continuing discussions with its joint venture
partner in One Post Office Square and Rowes Wharf, which were acquired in
connection with the Beacon Merger, with respect to the Company's control over
property management of such Properties. The joint venture partner did not
consent to the transfer to the Company of Beacon's joint venture interest in
these Properties. Although the Company believes that such consent was not
required, unless the Company is able to reach an agreement with respect to
day-to-day management of such Properties, it is possible that the joint venture
partner could challenge the transfer of such Properties in the Beacon Merger, or
seek to trigger the buy-sell remedy found in the joint venture documents.
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
15
<PAGE> 16
EOP OPERATING LIMITED PARTNERSHIP AND EQUITY OFFICE PREDECESSORS
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS
(Unaudited)
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 1970's
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 Rand Tower Garage in Minneapolis, Minnesota upon completion of the
parking structure. The purchase price for this 589 space parking facility will
be approximately $19.2 million and is scheduled for completion in March 1999.
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 March 1998, the Board of Trustees of the Trust approved the purchase of
Prominence in Buckhead, an office building development in Atlanta, Georgia. The
property, which will consist of a 430,000 square foot office building and 1,350
parking spaces, is expected to be acquired upon its anticipated completion in
August 1999. The purchase will also include an 11.88-acre site that may be used
to develop Phase II of Prominence. The purchase price for the described assets
and amounts to be incurred for tenanting the property will be approximately
$88.2 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 World Trade
Center East Project in Seattle, Washington. The property will consist of a
187,000 square foot office building and is scheduled for shell completion in
March 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 $38.6 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 the
Wright Runstad Associates Limited Partnership ("WRALP") (see Note 4), the
Company agreed to make available to WRALP up to $20.0 million in additional
financing or credit support for future development. As of September 30, 1998,
no amounts have been funded pursuant to this agreement.
Contingencies. Effective as of August 13, 1998, the Trust 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 Trust 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 all or a portion of their
Common Shares to a third party for a price less than $29.10625 per Common Share,
then the Trust shall 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 Trust 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 $31.50 per Common Share) would be expensed by the
Trust. The portion expensed would not exceed $2.39375 per Common Share.
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
16
<PAGE> 17
EOP OPERATING LIMITED PARTNERSHIP AND EQUITY OFFICE PREDECESSORS
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS
(Unaudited)
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 partners' capital.
NOTE 14 - SUBSEQUENT EVENTS
The following significant transactions relating to the Company occurred
during the period from October 1, 1998 to November 5, 1998:
1) On October 1, 1998, the Company acquired Worldwide Plaza from an
unaffiliated party. The Property consists of approximately 1.7 million
total square feet and is located in New York City. The 47-story building
includes 1,575,445 square feet of office space, as well as 20,788 square
feet of retail space in the office tower's arcade and was more than 98%
leased as of September 30, 1998. The acquisition also includes a
controlling financial interest in an entertainment component that features
108,000 square feet of retail, a health club and movie theaters, as well as
a 473-space parking garage. The complex also includes a residential
condominium tower that was not acquired by the Company. The $578.0 million
purchase price specified in the purchase contract was adjusted to $624.6
million for the following: (a) the assumption of a $268.6 million mortgage
with an estimated mark to market adjustment of $11.2 million; (b) the
assumption of a deferred real estate tax liability with a present value of
approximately $31.2 million; (c) the issuance of 6,861,166 Units with an
estimated fair value of $171.9 million based on a fair value of $25.05 per
Unit; (d) a cash payment of approximately $110.1 million; (e) closing and
transaction costs of approximately $4.2 million; and (f) the issuance of a
transferable put option on the Units exercisable only on the third
anniversary of closing with an estimated fair value of $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.
2) On October 15, 1998, the Board of Trustees of the Trust declared a fourth
quarter distribution for the Series B Preferred Units of $.65625 per unit,
based on a full quarterly distribution and an annual distribution of $2.625
per unit. The distribution will be paid on November 16, 1998 to holders of
record as of November 2, 1998.
3) On November 5, 1998, the Company sold First Union Center, One Clearlake
Centre, Tampa Commons and the Westshore Center for approximately $124.0
million to various unaffiliated parties. The Properties are located in
Florida and consist of approximately .9 million square feet. In addition,
the Company repaid the mortgage note encumbering Westshore Center of
approximately $7.2 million and approximately $1.8 million of additional
debt on Properties that were cross-collateralized with the Westshore Center
mortgage note at closing. The Company classified these properties as held
for disposition as of September 30, 1998. As of September 30, 1998, the
net book value of these Properties was approximately $110.8 million. Net
income of these properties for the nine months ended September 30, 1998 was
approximately $7.2 million.
4) The Company is in negotiations with the lender of the mortgage note secured
by the 150 Federal Street Property that matured on November 1, 1998, to
extend the term. This transaction is contingent upon negotiations with the
lender. There can be no assurance that this transaction will be
consummated as described above.
17
<PAGE> 18
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 consolidated and combined results of operations should be read in
conjunction with the Consolidated Financial Statements of the Company and the
Combined Financial Statements of Equity Office Predecessors, and Notes thereto
contained herein. All references to the historical activities of the Company
prior to July 11, 1997, the date of the Trust's initial public offering (the
"IPO") contained in this "Management's Discussion and Analysis of Financial
Condition and Results of Operations" refer to the activities of the Equity
Office Predecessors. Terms employed herein as defined terms, but without
definition, shall have the meaning set forth in the Company's Annual Report on
Form 10-K, as amended by Form 10-K/A, for the year ended December 31, 1997.
Statements contained in this "Management's Discussion and Analysis of Financial
Condition and Results of Operations" including without limitation, the "Year
2000" disclosure, which are not historical facts may be forward-looking
statements within the meaning of Section 21E of 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 and are included for purposes of complying therewith. Such
statements are subject to certain risks and uncertainties which could cause
actual results to differ materially from those projected. Readers are cautioned
not to place undue reliance on these forward-looking statements which speak only
as of September 30, 1998.
During the period from January 1, 1998 to September 30, 1998, the Company
acquired an additional 27 Office Properties containing approximately 8.7 million
square feet and one parking facility. The aggregate purchase price for these
acquisitions was approximately $1.7 billion. Excluded in these figures is the
James K. Polk Building and the Zachary Taylor Building containing approximately
902,371 square feet which the Company owned a 10% interest and acquired the
remaining 90% interest for approximately $153.5 million on May 22, 1998. Also
excluded in these figures is the 215 Fremont Street Property acquired on April
29, 1998, which contains approximately 265,000 square feet and is expected to
undergo a major redevelopment prior to re-tenanting. In addition, the Company
was active in the capital markets. Below is a schedule of significant capital
events that have taken place:
* In February 1998, the Company completed the $1.25 Billion Notes Offering
and the $250 Million MOPPRS Offering.
* In February 1998, the Trust completed the $300 Million Series B Preferred
Shares Offering, and the Trust contributed the net proceeds to the Company
in exchange for $300 million Series B Preferred Units.
* In April 1998, the Trust completed a private placement of 1,628,009 Common
Shares at $28.5625 per share for net proceeds of approximately $44.1
million, which was contributed to the Company in exchange for a
corresponding number of Units.
* In June 1998, the Company completed the private placement of the $775
Million Notes and 300,000 warrants (the "$775 Million Notes Offering") for
a potential additional $300 million in unsecured notes.
* In July 1998, the Company completed the purchase of $48.5 million of
Capital Trust 8.25% Step Up Convertible Trust Preferred Securities.
* In August 1998, the Company closed on the $328 Million Credit Facility.
* In September 1998, the Company closed on the $200 Million Credit Facility.
* In September 1998, the Board of Trustees of the Trust increased the annual
dividend / distribution amount for Common Shares / Units to $1.48 per
Common Share / Unit from $1.28 per Common Share / Unit.
RESULTS OF OPERATIONS
GENERAL
The following discussion is based primarily on the Consolidated Financial
Statements of the Company and the Combined Financial Statements of Equity Office
Predecessors, as applicable, as of September 30, 1998 and December 31, 1997 and
for the three and nine month periods ended September 30, 1998 and 1997,
respectively.
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 stand-alone Parking
Facilities.
As of September 30, 1998, the Company owned or had an interest in 285
Office Properties totaling approximately 74.1 million square feet, and 17
stand-alone Parking Facilities with approximately 16,749 spaces (the "Total
Portfolio"). Of the Total Portfolio, 82 of these Office Properties totaling
approximately 28.7 million square feet and ten Parking Facilities were acquired
prior to January 1, 1997; 176 Office Properties totaling approximately 36.6
million square feet and seven Parking Facilities were acquired in 1997; and 27
Office Properties totaling approximately 8.7 million square feet were acquired
during the nine months ended September 30, 1998. As a result of this rapid
growth in the size of the Total Portfolio, the financial data presented shows
large increases in revenues and expenses from 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. The
Core Portfolio for the comparison between the nine months ended September 30,
1998 and 1997 consists of 81 Office Properties totaling approximately 28.2
million square feet and ten Parking Facilities acquired prior to
18
<PAGE> 19
January 1, 1997. The Core Portfolio for the comparison between the three months
ended September 30, 1998 and 1997 consists of 91 Office Properties totaling
approximately 32.2 million square feet and 14 Parking Facilities acquired prior
to July 1, 1997. The Core Portfolio for these comparisons excludes Barton Oaks
Plaza II, a 118,529 square foot office property which was sold in January 1997,
and 8383 Wilshire, a 417,463 square foot office property, which was sold in May
1997. The 28 State Street Property, a 570,040 square foot Office Property
acquired by the Company on January 23, 1995, was undergoing major redevelopment
until May 1997 and is excluded from the Core Portfolio in the comparison for the
nine months ended September 30, 1998 and 1997, and included in the Core
Portfolio in the comparison for the three months ended September 30, 1998 and
1997.
COMPARISON OF THREE MONTHS ENDED SEPTEMBER 30, 1998 TO THE THREE MONTHS ENDED
SEPTEMBER 30, 1997.
The table below represents selected operating information for the Total
Portfolio and for the Core Portfolio which consists of 91 Office Properties and
14 Parking Facilities acquired or placed in service prior to July 1, 1997.
<TABLE>
<CAPTION>
TOTAL PORTFOLIO CORE PORTFOLIO
-------------------------------------------- --------------------------------------------
INCREASE/ % INCREASE/ %
1998 1997 (DECREASE) CHANGE 1998 1997 (DECREASE) CHANGE
--------- -------- ------------ --------- --------- -------- ------------ --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Property revenues $429,803 $181,095 $248,708 137.3% $185,505 $179,789 $5,716 3.2%
Fees from noncombined affiliates 5,102 1,401 3,701 264.2 - - - -
Interest/dividend income 2,028 1,390 638 45.9 298 280 18 6.4
--------- -------- ---------- --------- --------- -------- --------- ---------
Total revenues 436,933 183,886 253,047 137.6 185,803 180,069 5,734 3.2
--------- -------- ---------- --------- --------- -------- --------- ---------
Interest expense 91,240 29,973 61,267 204.4 20,975 24,901 (3,926) (15.8)
Depreciation and amortization 77,830 29,786 48,044 161.3 33,808 28,736 5,072 17.7
Property operating expenses 153,177 68,868 84,309 122.4 66,554 68,256 (1,702) (2.5)
Ground rent 1,813 1,193 620 52.0 1,109 1,192 (83) (7.0)
General and administrative 16,697 8,330 8,367 100.4 -- 102 (102) (100.0)
--------- -------- ---------- --------- --------- -------- --------- ---------
Total expenses 340,757 138,150 202,607 146.7 122,446 123,187 (741) (0.6)
--------- -------- ---------- --------- --------- -------- --------- ---------
Income before allocation to
minority interests, income from
investment in unconsolidated
joint ventures and extraordinary
items 96,176 45,736 50,440 110.3 63,357 56,882 6,475 11.4
Minority interests (572) (312) (260) 83.3 (559) (312) (247) 79.2
Income from unconsolidated
joint ventures 3,129 1,383 1,746 126.2 815 557 258 46.3
Extraordinary items - (12,930) 12,930 (100.0) - (12,930) 12,930 (100.0)
--------- -------- ---------- --------- --------- -------- --------- ---------
Net income $ 98,733 $ 33,877 $ 64,856 191.4% $ 63,613 $ 44,197 $ 19,416 43.9%
========= ======== ========== ========= ========= ======== ========= =========
Property revenues less property
operating expenses before
depreciation and amortization,
general and administrative,
ground rent and interest expense $276,626 $112,227 $164,399 146.5% $118,951 $111,533 $ 7,418 6.7%
========= ======== ========== ========= ========= ======== ========= =========
</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
92.3% at July 1, 1997 to 95.3% as of September 30, 1998. This increase
represents approximately 1.0 million square feet of additional occupancy in the
Core Portfolio between July 1, 1997 and September 30, 1998. Property Revenues
for the Total Portfolio include lease termination fees of approximately $2.3
million and $.9 million for the three months ended September 30, 1998 and 1997,
respectively, and Property Revenues for the Core Portfolio include lease
termination fees of approximately $.5 million and $.9 million for the three
months ended September 30, 1998 and 1997, respectively, (which are included in
the "other revenue" category on the consolidated and combined 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 the
lease. Although the Company has historically experienced similar levels of such
termination fees, there is no way of predicting the timing or amounts of future
lease termination fees. The straight-line rent adjustment included in rental
revenues for the Total Portfolio for the three months ended September 30, 1998
and 1997 was approximately $17.7 million and $8.7 million, respectively. The
straight-line rent adjustment included in rental revenues for the Core Portfolio
for the three months ended September 30, 1998 and 1997 was approximately $8.2
million and $9.7 million, respectively.
Interest/Dividend Income: Interest/dividend income for the Total Portfolio
increased by approximately $.6 million to $2.0 million for the three months
ended September 30, 1998, compared to $1.4 million for the three months ended
September 30, 1997, mainly as a result of dividend income earned during the
three months ended September 30, 1998 of approximately $.7 million on the
Company's $48.5 million investment in 50,000 shares of Capital Trust's 8.25%
Step-Up Convertible Trust Preferred Securities. The $.7 million represents a
pro rata distribution for the three months ended September 30, 1998 since the
Company made its investment on July 28, 1998.
19
<PAGE> 20
Interest Expense: Interest expense increased approximately $61.3 million for the
Total Portfolio to $91.2 million for the three months ended September 30, 1998
compared to $30.0 million for the three months ended September 30, 1997. This
increase resulted from having higher debt outstanding in the third quarter of
1998 than during the comparable period of 1997. The increase in total debt and
the related increase in interest expense was directly attributable to Property
acquisitions and as a result, the Company's total debt as a percentage of total
assets increased from approximately 32.0% of total assets at September 30, 1997
to 41.6% of total assets at September 30, 1998, and the Company's interest
coverage ratio decreased from approximately 3.6 times in 1997 to 2.9 times in
1998. Although the Company's total debt has increased, the weighted average
interest rate on the Company's debt decreased from approximately 7.4% at
September 30, 1997 to approximately 7.0% at September 30, 1998. The decrease in
interest expense in the Core Portfolio of approximately $3.9 million is
primarily due to the pay down of outstanding indebtedness with the IPO proceeds
and the replacement of secured debt with unsecured debt.
Depreciation and Amortization: Depreciation and amortization expense for the
Total Portfolio increased by approximately $48.0 million to $77.8 million for
the three months ended September 30, 1998, compared to $29.8 million for the
three months ended September 30, 1997, as a result of Properties acquired and
capital and tenant improvements made at Properties during 1998 and 1997.
Depreciation and amortization expense for the Core Portfolio increased by
approximately $5.1 million to $33.8 million for the three months ended September
30, 1998, compared to $28.7 million for the three months ended September 30,
1997, as a result of capital and tenant improvements made at the Properties.
Property Operating Expenses: Real estate taxes and insurance, repairs and
maintenance, and property operating expenses ("Property Operating Expenses")
decreased approximately $1.7 million for the Core Portfolio to $66.6 million for
the three months ended September 30, 1998 compared to $68.3 million for the
three months ended September 30, 1997 mainly as a result of real estate taxes.
Real estate taxes decreased approximately $1.6 million from the prior period of
which approximately $2.7 million related to a reduction in real estate tax
expense recognized during the three months ended September 30, 1998, as a result
of successful tax appeals and lower property tax assessments on certain
properties partially offset by an increase in real estate tax expense as a
result of higher property tax assessments and tax rates in certain markets.
Insurance expense decreased approximately $.5 million from the prior period as a
result of lower premiums incurred during the current period as a result of the
Company's ability to achieve economies of scale on its insurance coverage.
General and Administrative Expenses: General and administrative expenses
increased by approximately $8.4 million to $16.7 million for the three months
ended September 30, 1998, compared to $8.3 million for the three months ended
September 30, 1997. General and administrative expenses as a percentage of
total revenues was approximately 3.8% and 4.5% for the three months ended
September 30, 1998 and 1997, respectively. The primary reasons for the increase
in general and administrative expenses are the significant increase in the size
of the Company's portfolio and increased expenses associated with becoming a
public company. While general and administrative expenses will continue to
increase as the size of the Company's portfolio increases, it is anticipated
that the Company will realize increased economies of scale with future growth.
20
<PAGE> 21
COMPARISON OF NINE MONTHS ENDED SEPTEMBER 30, 1998 TO THE NINE MONTHS ENDED
SEPTEMBER 30, 1997.
The table below represents selected operating information for the Total
Portfolio and for the Core Portfolio which consists of 81 Office Properties and
ten Parking Facilities acquired or placed in service prior to January 1, 1997.
<TABLE>
<CAPTION>
TOTAL PORTFOLIO CORE PORTFOLIO
-------------------------------------------- --------------------------------------------
INCREASE/ % INCREASE/ %
1998 1997 (DECREASE) CHANGE 1998 1997 (DECREASE) CHANGE
--------- -------- ------------ --------- --------- -------- ------------ --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Property revenues $1,194,694 489,307 $705,387 144.2% $481,696 $447,625 $ 34,071 7.6%
Fees from noncombined affiliates 7,766 3,841 3,925 102.2 - - - -
Interest/dividend income 8,237 10,524 (2,287) (21.7) 775 1,359 (584) (43.0)
---------- -------- ---------- --------- --------- --------- --------- --------
Total revenues 1,210,697 503,672 707,025 140.4 482,471 448,984 33,487 7.5
---------- -------- ---------- --------- --------- --------- --------- --------
Interest expense 237,194 106,274 130,920 123.2 62,765 98,971 (36,206) (36.6)
Depreciation and amortization 218,083 90,195 127,888 141.8 85,222 81,045 4,177 5.2
Property operating expenses 426,512 186,671 239,841 128.5 170,349 168,570 1,779 1.1
Ground rent 5,385 3,499 1,886 53.9 3,335 3,449 (114) (3.3)
General and administrative 45,137 23,056 22,081 95.8 210 180 30 16.7
---------- -------- ---------- --------- --------- --------- --------- --------
Total expenses 932,311 409,695 522,616 127.6 321,881 352,215 ( 30,334) (8.6)
---------- -------- ---------- --------- --------- --------- --------- --------
Income before allocation to
minority interests, income from
investment in unconsolidated
joint ventures, gain on sale of
real estate and extraordinary
items 278,386 93,977 184,409 196.2 160,590 96,769 63,821 66.0
Minority interests (1,608) (1,191) (417) 35.0 (1,539) (1,191) (348) 29.2
Income from unconsolidated
joint ventures 8,155 3,408 4,747 139.3 1,816 1,796 20 1.1
Gain on sale of real estate and
extraordinary items (7,506) (694) (6,812) 981.6 - (12,885) 12,885 (100.0)
---------- -------- ---------- --------- --------- --------- --------- --------
Net income $277,427 $ 95,500 $ 181,927 190.5% $160,867 $ 84,489 $ 76,378 90.4%
========== ======== ========== ========= ========= ========= ======== ========
Property revenues less property
operating expenses before
depreciation and amortization,
general and administrative,
ground rent and interest expense $768,182 $302,636 $465,546 153.8% $311,347 $279,055 $ 32,292 11.6%
========== ======== ========== ========= ========= ========= ======== ========
</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
92.1% at January 1, 1997 to 95.9% as of September 30, 1998. This increase
represents approximately 1.1 million square feet of additional occupancy in the
Core Portfolio between January 1, 1997 and September 30, 1998. Property
Revenues for the Total Portfolio include lease termination fees of approximately
$10.4 million and $3.6 million for the nine months ended September 30, 1998 and
1997, respectively, and Property Revenues for the Core Portfolio include lease
termination fees of $2.3 million and $3.6 million for the nine months ended
September 30, 1998 and 1997, respectively (which are included in the other
revenue category on the consolidated and combined 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 the lease.
Although the Company has historically experienced similar levels of such
termination fees, there is no way of predicting the timing or amounts of future
lease termination fees. The straight-line rent adjustment included in rental
revenues for the Total Portfolio for the nine months ended September 30, 1998
and 1997 was approximately $50.4 million and $16.4 million, respectively. The
straight-line rent adjustment included in rental revenues for the Core Portfolio
for the nine months ended September 30, 1998 and 1997 was approximately $20.8
million and $16.2 million, respectively.
Interest/Dividend Income: Interest/dividend income for the Total Portfolio
decreased by approximately $2.3 million to $8.2 million for the nine months
ended September 30, 1998, compared to $10.5 million for the nine months ended
September 30, 1997. Prior to the Consolidation, each of the entities involved in
the Consolidation needed to maintain separate cash reserves which in the
aggregate were higher than the cash reserves the Company maintains going
forward. Due to the availability of borrowings under the Credit Facilities, the
Company currently maintains lower cash reserves which are targeted to be between
$25 to $50 million (although the cash balance may at times be more or less in
anticipation of pending acquisitions or other transactions). Although the lower
cash balance will result in lower interest income in future periods, this loss
in income is expected to be offset by savings on interest expense on the Credit
Facilities. The decrease in interest income was partially offset by dividend
income earned during the three months ended September 30, 1998 of approximately
$.7 million on the Company's $48.5 million investment in 50,000 shares of
Capital Trust's 8.25% Step-Up Convertible Trust Preferred Securities. The $.7
million represents a pro rata distribution for the three months ended September
30, 1998 since the Company made its investment on July 28, 1998.
21
<PAGE> 22
Interest Expense: Interest expense increased by approximately $130.9 million
for the Total Portfolio to $237.2 million for the nine months ended September
30, 1998 compared to $106.3 million for the nine months ended September 30,
1997. This increase resulted from having higher debt outstanding in the nine
months ended September 30, 1998 than during the comparable period of 1997. The
increase in total debt and the related increase in interest expense was directly
attributable to Property acquisitions and as a result, the Company's total debt
as a percentage of total assets increased from approximately 32.0% of total
assets at September 30, 1997 to 41.6% of total assets at September 30, 1998, and
the Company's interest coverage ratio increased from approximately 2.8 times in
1997 to 3.1 times in 1998. Although the Company's total debt increased, the
weighted average interest rate on the Company's debt decreased from
approximately 7.4% at September 30, 1997 to approximately 7.0% at September 30,
1998. The decrease in interest expense in the Core Portfolio of approximately
$36.2 million is primarily due to the paydown of outstanding indebtedness with
the IPO proceeds and the replacement of secured debt with unsecured debt.
Depreciation and Amortization: Depreciation and amortization expense increased
for the Total Portfolio by approximately $127.9 million to $218.1 million for
the nine months ended September 30, 1998, compared to $90.2 million for the nine
months ended September 30, 1997 as a result of Properties acquired and capital
and tenant improvements made at the Properties during 1998 and 1997 and the
recording of substantially all the Company's assets and liabilities at their
fair market value in connection with the Consolidation and the IPO.
Depreciation and amortization expense increased for the Core Portfolio by
approximately $4.2 million to $85.2 million for the nine months ended September
30, 1998, compared to $81.0 million for the nine months ended September 30,
1997, as a result of capital and tenant improvements made at the Properties.
Property Operating Expenses: Real estate taxes and insurance, repairs and
maintenance, and property operating expenses ("Property Operating Expenses")
increased approximately $1.8 million for the Core Portfolio to $170.3 million
for the nine months ended September 30, 1998 compared to $168.6 million for the
nine months ended September 30, 1997 as a result of the following: Real estate
taxes increased approximately $5.4 million from the prior period of which
approximately $5.9 million related to a reduction in real estate tax expense
recognized during the nine months ended September 30, 1997, as a result of
successful tax appeals and lower property tax assessments on certain Properties.
This was partially offset by tax reductions and increases in real estate taxes
as a result of higher property tax assessments and tax rates in certain markets
in 1998. Repairs and maintenance decreased approximately $2.2 million from the
prior period of which approximately $1.0 million related to a nonrecurring
expenditure at a single building incurred during the nine months ended September
30, 1997. Insurance expense decreased approximately $1.1 million from the prior
period as a result of lower premiums incurred during the current period as a
result of the Company's ability to achieve economies of scale on its insurance
coverage.
General and Administrative Expenses: General and administrative expenses
increased by approximately $22.1 million to $45.1 million for the nine months
ended September 30, 1998, compared to $23.1 million for the nine months ended
September 30, 1997. General and administrative expenses as a percentage of
total revenues was approximately 3.7% and 4.6% for the nine months ended
September 30, 1998 and 1997, respectively. The primary reasons for the increase
in general and administrative expenses are the significant increase in the size
of the Company's portfolio and increased expenses associated with becoming a
public company. While general and administrative expenses will continue to
increase as the size of the Company's portfolio increases, it is anticipated
that the Company will realize increased economies of scale with future growth.
22
<PAGE> 23
PARKING OPERATIONS
The Total Portfolio and Core Portfolio selected operating information for the
three and nine months ended September 30, 1998 and 1997 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 SEPTEMBER 30, 1998 TO THE THREE MONTHS
ENDED SEPTEMBER 30, 1997.
<TABLE>
<CAPTION>
TOTAL PARKING PORTFOLIO CORE PARKING PORTFOLIO
---------------------------------------- -----------------------------------------
INCREASE/ % INCREASE/ %
1998 1997 (DECREASE) CHANGE 1998 1997 (DECREASE) CHANGE
------ ------- ---------- -------- ------ ------- ---------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Property revenues $7,350 $6,311 $ 1,039 16.5% $ 5,651 $ 5,652 $ (1) -
Interest income 2 35 (33) (94.3) 2 86 (84) (97.7)%
-------- -------- -------- -------- -------- -------- -------- --------
Total revenues 7,352 6,346 1,006 15.9 5,653 5,738 (85) (1.5)
-------- -------- -------- -------- -------- -------- -------- --------
Interest expense 1,424 475 949 200.0 1,424 475 949 200.0
Depreciation and amortization 1,475 1,068 407 38.1 1,164 986 178 18.1
Property operating expenses 1,901 1,071 830 77.5 1,445 904 541 59.8
-------- -------- -------- -------- -------- -------- -------- --------
Total expenses 4,800 2,614 2,186 83.6 4,033 2,365 1,668 70.5
-------- -------- -------- -------- -------- -------- -------- --------
Income before allocation to
minority interests and income
from investment in
unconsolidated joint ventures 2,552 3,732 (1,180) (31.6) 1,620 3,373 (1,753) (52.0)
Minority interests (84) (79) (5) 6.3 (84) (79) (5) 6.3
Income from unconsolidated
joint ventures 363 825 (462) (56.0) 363 825 (462) (56.0)
-------- -------- -------- -------- -------- -------- -------- --------
Net income $2,831 $4,478 $(1,647) (36.8)% $ 1,899 $ 4,119 $(2,220) (53.9)%
======== ======== ======== ======== ======== ======== ======== ========
Property revenues less property
operating expenses before
depreciation and amortization
and interest expense $5,449 $5,240 $ 209 4.0% $ 4,206 $ 4,748 $ (542) (11.4)%
======== ======== ======== ======== ======== ======== ======== ========
</TABLE>
COMPARISON OF THE NINE MONTHS ENDED SEPTEMBER 30, 1998 TO THE NINE MONTHS ENDED
SEPTEMBER 30, 1997.
<TABLE>
<CAPTION>
TOTAL PARKING PORTFOLIO CORE PARKING PORTFOLIO
---------------------------------------- -----------------------------------------
INCREASE/ % INCREASE/ %
1998 1997 (DECREASE) CHANGE 1998 1997 (DECREASE) CHANGE
------ ------- ---------- -------- ------ ------- ---------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Property revenues $ 21,793 $ 16,282 $ 5,511 33.8% $16,691 $ 15,623 $ 1,068 6.8%
Interest income 39 149 (110) (73.8) 39 310 (271) (87.4)
-------- -------- ------- ------- ------- -------- ------- -------
Total revenues 21,832 16,431 5,401 32.9 16,730 15,933 797 5.0
-------- -------- ------- ------- ------- -------- ------- -------
Interest expense 4,117 2,566 1,551 60.4 4,117 2,528 1,589 62.9
Depreciation and amortization 4,326 2,703 1,623 60.0 3,395 2,665 730 27.4
Property operating expenses 5,998 3,458 2,540 73.5 4,653 3,388 1,265 37.3
-------- -------- ------- ------- ------- -------- ------- -------
Total expenses 14,441 8,727 5,714 65.5 12,165 8,581 3,584 41.8
-------- -------- ------- ------- ------- -------- ------- -------
Income before allocation to
minority interests and income
from investment in
unconsolidated joint ventures 7,391 7,704 (313) (4.1) 4,565 7,352 (2,787) (37.9)
Minority interests (228) (200) (28) 14.0 (228) (200) (28) 14.0
Income from unconsolidated
joint ventures 1,474 1,611 (137) (8.5) - - - -
-------- -------- ------- ------- ------- -------- ------- -------
Net income $ 8,637 $ 9,115 $ (478) (5.2)% $ 4,337 $ 7,152 $ (2,815) (39.4)%
======== ======== ======= ======= ======= ======== ======== =======
Property revenues less property
operating expenses before
depreciation and amortization $ 15,795 $ 12,824 $ 2,971 23.2% $12,038 $ 12,235 $ (197) (1.6)%
and interest expense ======== ======== ======= ======= ======= ======== ======== =======
</TABLE>
23
<PAGE> 24
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. Prior to the Trust's IPO, the
Company made annual distributions equal to approximately 100% of taxable income.
Cash generated in excess of taxable income (resulting primarily from non-cash
items such as depreciation and amortization) was retained for working capital
and to fund capital improvements and non-revenue enhancing tenant improvements.
The Company currently intends to continue to make, but has not contractually
bound itself to make, regular quarterly distributions to holders of Series A
Preferred Units, Series B Preferred Units and Units. The Company established
annual distribution rates as follows: 8.98% per annum ($2.245 per unit) for each
Series A Preferred Unit, 5.25% per annum ($2.625 per unit) for each Series B
Preferred Unit, and $1.48 per annum per Unit. The Company increased its Unit
distribution from $1.28 per annum to $1.48 per annum effective for the quarter
ended September 30, 1998.
The Company intends to continue to fund 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,
unanticipated cash needs, and funding of acquisitions.
The anticipated size of the Company's distributions will not allow the
Company, using only cash from operations, to retire all of its debt as it comes
due and, therefore, the Company will be required to repay maturing debt with
funds from debt and/or equity financing.
DEBT FINANCING
The table below summarizes the mortgage debt, unsecured notes and Credit
Facility indebtedness outstanding at September 30, 1998 and December 31, 1997,
including a net premium on mortgage debt and unsecured notes (net of accumulated
amortization of approximately $2.8 million and $2.1 million) of approximately
$6.4 million and $1.2 million, respectively, recorded in connection with the
Company's Consolidation, debt assumed in connection with certain of the
Company's acquisitions, and unsecured notes.
<TABLE>
<CAPTION>
(Dollars in thousands) SEPTEMBER 30, 1998 DECEMBER 31, 1997
- ------------------------------------------------- --------------------- --------------------
DEBT SUMMARY:
<S> <C> <C>
Balance
Fixed rate...................................... $4,592,064 $2,219,496
Variable rate................................... 1,080,051 2,064,821
--------------------- --------------------
Total.......................................... $5,672,115 $4,284,317
===================== ====================
Percent of total debt:
Fixed rate...................................... 81% 51.8%
Variable rate................................... 19% 48.2%
--------------------- --------------------
Total.......................................... 100.0% 100.0%
===================== ====================
Weighted average interest
rate at end of period:
Fixed rate...................................... 7.2% 7.5%
Variable rate................................... 6.4% 6.9%
--------------------- --------------------
Weighted average............................... 7.0% 7.2%
===================== ====================
</TABLE>
The majority of the variable rate debt shown above bore interest at various
LIBOR-based floating interest rates. The weighted average spread of the
Company's interest rate over the average LIBOR rate of 5.6% at September 30,
1998 was approximately .8%.
<PAGE> 25
MORTGAGE FINANCING
As of September 30, 1998, the Company's total mortgage debt (excluding the
Company's share of unconsolidated debt of approximately $121.3 million)
consisted of approximately $2.1 billion of fixed rate debt with a weighted
average interest rate of approximately 7.5% and $32.6 million of variable rate
debt bearing interest at the 30-day LIBOR plus 1.0%. The Company's mortgage
debt at September 30, 1998 will mature as follows:
<TABLE>
<CAPTION>
Dollars in thousands
- --------------------
<S> <C>
1998................................... $108,161
1999................................... 52,908
2000................................... 146,026
2001................................... 433,179
2002................................... 69,779
Thereafter............................. 1,285,378
--------------
Subtotal.............................. 2,095,431
Net premium (net of accumulated
amortization of $2.9 million)......... 1,974
--------------
Total.................................. $2,097,405
==============
</TABLE>
The instruments encumbering the Properties restrict transfer of the
Properties, prohibit liens and require payment of taxes on the Properties,
maintenance of the Property in good condition, maintenance of insurance on the
Property and obtaining lender consent to leases with material tenants.
CREDIT FACILITIES
Lines of Credit. On May 29, 1998, the Company amended and restated the $600
Million Credit Facility to a $1.0 billion unsecured revolving credit facility
(the "$1.0 Billion Credit Facility"). The $1.0 Billion Credit Facility matures
on May 29, 2001. The Company incurred fees of approximately $2.5 million at the
closing of the $1.0 Billion Credit Facility which will be amortized over the
term along with approximately $1.0 million of unamortized deferred financing
costs on the $600 Million Credit Facility which will also be amortized over the
term. 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 and the
facility fee is equal to 20 basis points. 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. The
outstanding balance on the $1.0 Billion Credit Facility was approximately $519.5
million as of September 30, 1998. Subsequent to September 30, 1998, the Company
borrowed an additional $110.0 million on the $1.0 Billion Credit Facility.
On August 14, 1998, the Company closed on the $328 Million Credit Facility.
The facility is priced at 90-day LIBOR plus 80 basis points and is prepayable on
any interest payment date. The facility matures on August 15, 2000. The
proceeds from the facility were used to pay down the $1.0 Billion Credit
Facility.
On September 22, 1998, the Company closed on the $200 Million Credit
Facility. Interest accrues under the $200 Million Credit Facility at an initial
rate of LIBOR plus 50 basis points with a facility fee equal to 20 basis points
per annum. Pricing for the first twelve months is based on a matrix tied to the
Company's credit rating and 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. The proceeds from the facility were used to
pay down the $1.0 Billion Credit Facility.
UNSECURED NOTES
$180 Million Notes Offering. In September 1997, the Company completed the
$180 Million Notes Offering. The terms of the $180 Million Notes Offering
consist of four tranches with maturities from seven to ten years.
$1.25 Billion Notes Offering. In February 1998, the Company completed the
$1.25 Billion Notes Offering. The $1.25 Billion Notes consist of four tranches
with maturities of five to twenty years.
$250 MandatOry Par Put Remarketed Securities Offering. In February 1998,
the Company completed the $250 Million MOPPRS Offering. The $250 Million MOPPRS
are subject to mandatory tender on February 15, 2002.
$775 Million Unsecured Notes and 300,000 warrants offering. In June 1998,
the Company completed the $775 Million Notes Offering. The $775 Million Notes
consist of three tranches with maturities of six to thirty years.
25
<PAGE> 26
The table below summarizes the Company's unsecured notes as of September
30, 1998:
<TABLE>
<CAPTION>
Amount Stated Effective
Tranche (in thousands) Rate Rate (A)
- ---------------------- --------------- ------- ---------
<S> <C> <C> <C>
4 Year MOPPRS due 2002 $250,000 6.38% 6.30%
5 Year Notes due 2003 300,000 6.38% 6.73%
6 Year Notes due 2004 250,000 6.50% 6.68%
7 Year Notes due 2004 30,000 7.24% 7.26%
7 Year Notes due 2005 400,000 6.63% 7.02%
8 Year Notes due 2005 50,000 7.36% 7.69%
9 Year Notes due 2006 50,000 7.44% 7.74%
9 Year Notes due 2007 300,000 6.76% 6.76%
10 Year Notes due 2007 50,000 7.41% 7.70%
10 Year Notes due 2008 300,000 6.75% 7.01%
20 Year Notes due 2018 250,000 7.25% 7.54%
30 Year Notes due 2028 225,000 7.25% 7.31%
--------------- -------- ----------
Subtotal 2,455,000 6.76% 6.97%
======== ==========
Net premium (net of accumulated
amortization of $.2 million) 4,398
---------------
Total $2,459,398
===============
</TABLE>
(a) Includes the cost of the terminated interest rate protection agreements,
offering and transaction costs, the premium on the warrants and the
discount on unsecured notes.
The Company filed a registration statement, which was declared effective
on June 18, 1998, relating to an offer to exchange the $180 Million Notes, the
$1.25 Billion Notes and the $250 Million MOPPRS for registered securities of
the Company with terms identical in all material respects to the terms of the
existing notes. This exchange offer expired on July 30, 1998.
The Company filed a registration statement, which was declared effective
on July 22, 1998, related to the 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 in amounts, at prices and on terms described in one or more
supplements to the prospectus.
The Company filed a registration statement, which was declared effective
on September 4, 1998, relating to an offer to exchange (a) the $775 Million
Notes; (b) 300,000 warrants to purchase an additional $300 million in unsecured
notes at a later date; and (c) portions of the $1.25 Billion Notes and $250
Million MOPPRS for registered securities of the Company with terms identical in
all material respects to the terms of the existing notes. This exchange offer
expired on October 27, 1998.
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
Below is a summary of the equity securities issued in connection with various
transactions occurring since June 30, 1998:
- - During the three months ended September 30, 1998 there were 23,079 share
options exercised, as a result of which the Company issued a corresponding
number of Units to the Trust in reliance upon a private placement exemption
pursuant to Section 4(2) of the Securities Act. On July 29, 1998, the
Company issued a total of 178,976 Units to accredited investors in reliance
upon a private placement exemption pursuant to Section 4(2) of the
Securities Act and Rule 506 thereunder, in connection with the Second and
Spring Property acquisition. The 178,976 Units are redeemable for Common
Shares or, at the option of the Trust, the cash equivalent thereof.
26
<PAGE> 27
CASH FLOWS
NINE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED TO SEPTEMBER 30, 1997
Cash and cash equivalents decreased by approximately $88.5 million, to
$140.4 million at September 30, 1998, from $228.9 million at December 31, 1997.
This decrease was the result of approximately $506.1 million provided by
operating activities, $1,926.4 million used for investing activities and
$1,331.7 million provided by financing activities. Net cash provided by
operating activities increased by approximately $350.5 million to approximately
$506.1 million from $155.6 million primarily due to the additional cash flow
generated by the increase in the number of Properties owned. Net cash used for
investing activities increased by approximately $1,269.7 million from $656.7
million to $1,926.4 million mainly due to an increase in the amount of real
estate assets purchased during the nine months ended September 30, 1998
compared to the nine months ended September 30, 1997. Net cash provided by
financing activities increased by approximately $927.3 million from $404.4
million to $1,331.7 million due primarily to the proceeds from the unsecured
notes offerings reduced primarily by a net pay down in the Company's Credit
Facilities and distributions to common shareholders, unitholders and preferred
shareholders.
CAPITAL IMPROVEMENTS
The Company has a history of acquiring and repositioning undercapitalized
and poorly managed properties, many of which have required significant capital
improvements due to deferred maintenance and/or required substantial renovation
to enable them to compete effectively. A number of the Properties also have
had significant amounts of shell space requiring build out at the time of
acquisition. The Company takes these capital improvements and revenue
enhancing tenant improvements into consideration at the time of acquisition in
determining the amount of equity and debt financing required to purchase the
property and fund the improvements. Therefore, capital improvements made
during the first five years after acquisition of these Properties are treated
separately from typical recurring capital expenditures, non-revenue enhancing
tenant improvements and leasing commissions required once these Properties have
reached stabilized occupancy, and deferred maintenance and renovations planned
at the time of acquisition have been completed. Capital improvements
(including tenant improvements and leasing commissions for shell space) for the
nine months ended September 30, 1998 were approximately $21.5 million or .29
per square foot. These amounts exclude capital and tenant improvements of
approximately $42.0 million incurred for the nine months ended September 30,
1998 for developments in process.
The Company considers capital expenditures to be recurring expenditures
relating to the on-going maintenance of the Office Properties. The table below
summarizes capital expenditures for the nine months ended September 30, 1998.
The capital expenditures set forth below are not necessarily indicative of
future capital expenditures.
<TABLE>
<CAPTION>
For the Nine Months Ended
September 30, 1998
-------------------------
<S> <C>
Number of Office Properties 285
Rentable Square Feet (in millions) 74.1
Capital Expenditures per square foot .07
</TABLE>
27
<PAGE> 28
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 nine months ended September 30, 1998 excluding amounts attributable to
developments in process. The tenant improvement and leasing commission costs
set forth below are presented on an aggregate basis and do not reflect
significant regional variations and, in any event, are not necessarily
indicative of future tenant improvement and leasing commission costs:
<TABLE>
<CAPTION>
For the Nine Months Ended
September 30, 1998
-------------------------
<S> <C>
Number of Office Properties 285
Rentable square feet (in millions) 74.1
Revenue enhancing tenant improvements and leasing
commissions:
Amounts (in thousands) $27,524
Per square foot improved 16.23 (1)
Per total square foot 0.50 (2)
Non-revenue enhancing tenant improvements and leasing
commissions:
Renewal space
Amounts (in thousands) $20,346
Per square foot improved 8.09 (1)
Per total square foot .37 (2)
Retenanted space
Amounts (in thousands) $23,634
Per square foot improved 16.90 (1)
Per total square foot .43 (2)
------------
Total non-revenue enhancing (in thousands) $43,980
Per square foot improved 11.24 (1)
Per total square foot .80 (2)
</TABLE>
(1) The per square foot calculations as of September 30, 1998 are calculated
taking the total dollars anticipated to be incurred on tenant improvements
for tenants taking occupancy during the nine months ended September 30,
1998, divided by the total square footage being improved or total building
square footage. The actual amounts incurred as of September 30, 1998 for
revenue enhancing, non-revenue enhancing renewal and released space were
approximately $19.5 million, $18.4 million and $35.6 million, respectively.
(2) The amounts shown have been annualized to reflect a full year of comparable
operation. The actual costs per total square foot as of September 30, 1998
for revenue enhancing and non-revenue enhancing renewal and retenanted
space were $.38, $.28 and $.32, respectively.
28
<PAGE> 29
DEVELOPMENT
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 September 30, 1998, the Company has incurred approximately
$276.3 million of costs in connection with the Properties being developed.
The Company has entered into agreements to purchase the following
properties upon their completion:
1) The Rand Tower Garage located in Minneapolis, Minnesota will be purchased
upon completion anticipated to be in March 1999. The purchase price for
this 589 space parking facility will be approximately $19.2 million.
2) The Prominence in Buckhead, an office building under development in the
Buckhead sub-market of Atlanta, Georgia, will consist of a 430,000 square
foot office building and 1,350 parking spaces, will be acquired upon its
completion anticipated to be in August 1999. The purchase price will
also include an 11.88-acre site that may be used to develop Phase II of
Prominence. There are no immediate plans to develop the 11.88-acre site,
which is zoned for a 420,000 square foot office tower. The purchase price
for the described assets and amounts to be incurred for tenanting the
property will be approximately $88.2 million.
3) In July 1998, the Company's Board of Trustees approved the purchase of
the World Trade Center East Project in Seattle, Washington upon its
anticipated completion in March 1999. The property will consist of
187,000 square feet and will cost approximately $38.6 million.
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 to the properties described above, the Company also 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.
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 over the remainder of 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.
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 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 systems has been completed by our
information services department and building engineers through a combination of
physical inspections and informational interviews with Company employees. A
portion of such work with respect to the Company's secondary systems (described
below) remains to be done and will be handled with the assistance of an outside
consultant. A review of the telecommunications systems is being conducted by
one of our affiliates.
After identifying systems that could have a potential Y2K problem, the
Company is attempting 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 are being contacted through
standard form letters and telephone calls requesting information. In the case
of building management systems, a database was compiled for the types of
equipment, names of manufacturers and model numbers. The Company's regional
engineers are each responsible for gathering information on the Y2K compliance
of specific systems. In addition to examining the
29
<PAGE> 30
Company's systems for compliance, we continue 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 we have 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
- - Office equipment
In April 1998, our field staff began gathering data to catalog the
equipment in all of our buildings. To date, we have received approximately 75%
of the information requested. We do not expect to receive 100% of the
information requested due to a number of non-responsive vendors or unavailable
information. By the end of November 1998, a preliminary Y2K compliance study
of the building management systems outlined above is expected to be completed
for all the Company's buildings. Following review of such studies, management
expects to be able to determine the Company's state of readiness as to the
building management systems.
Information Systems
Our information systems fall into four general categories: accounting and
property management, network operating systems, desktop software and secondary
systems.
Accounting and Property Management
Management believes that we have determined our exposure with respect to our
accounting and property management software. Specifically, although the
general ledger system is compliant, the accounts payable and property
management systems are not. Upgrades from the vendor will be available in the
fourth quarter of 1998. Our current expected schedule for compliance is as
follows:
- - System testing - Complete
- - Test software upgrades - November 1998
- - Begin installation of upgrades -- First Quarter 1999
- - Full Y2K compliance - Second Quarter 1999
Network Operating Systems
Management believes that our network operating servers are currently
approximately 75% compliant. For the remaining 25%, Novell, the manufacturer,
is providing software that is expected to bring the servers into Y2K
compliance. Upgrades of our network operating systems are expected to be
installed in the first and second quarters of 1999, bringing the network
operating servers into full compliance. Management believes that testing of
this new software will not be necessary, as it has already been proven in the
industry to be Y2K compliant.
Desktop Software
We believe we have reviewed all of our desktop systems and software
applications, identified those that are not in compliance and compiled a list
of necessary upgrades. The efforts to ready our desktop systems for Y2K are
being directed towards a broader Company initiative referred to as EO 2000. As
part of the EO 2000 program, we currently intend to install Windows 98 and
Microsoft Office 97 in all field and home office desktop systems.
Our time frame for EO 2000 is expected to be as follows:
- - Systems (hardware and software) testing for Y2K compliance - complete
- - Begin installing updated software that will also provide Y2K compliance -
November 1998
- - Complete installation/full compliance - October 1999
30
<PAGE> 31
Secondary Information Systems
Our "secondary" information systems include, but are not limited to: payroll,
human resources, fixed-asset system, and forecasting modeling software, which
provides projections on property returns and other items. We are also reviewing
internally developed software, such as our budget program and tenant-services
system. As discussed above, we intend to retain a third party consultant during
the fourth quarter of 1998 to assist us in identifying and assessing the Y2K
compliance of the secondary systems. Thereafter, a time table for the
replacement or upgrade of any non-compliant secondary systems will be developed.
Telecommunication Systems
In general, we believe that our 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
In large part, the work to date on Phase One of the Program has been performed
by our employees without additional cost to the Company. Although we intend to
retain a third party consultant to assist us in completing Phase One, the cost
of such consultant cannot currently be determined. Likewise, we have not yet
analyzed the studies of the building management systems or completed the action
plan for the 1999 property budgets. Such information should be available by the
end of November 1998. It is our belief that a large part of the cost of bringing
the building management systems into compliance will be considered to be an
operating expense that is reimbursable to the Company under most tenant leases.
The estimated cost of the EO 2000 initiative is $1.7 million. Most of the work
related to EO 2000 is not Y2K related. Based upon review of the studies and the
formulation of the building operational budgets for 1999, management will
develop an action plan for bringing the building management systems into
compliance.
Phase Three - Assessing the Risks to the Company of Non-Compliance
Management does not 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 our analysis of the risks to the Company
related to our own potential Y2K problems discussed above and our assessment of
the Y2K problems of our 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 each of the Company's Properties have, for the most part,
separate building management systems. Accordingly, a Y2K problem that is
experienced at one building should have no effect on the other Company
buildings. In addition, based upon the study results received to date, we
believe that we will have sufficient time to correct those system problems
within our control before the year 2000. We have already begun preliminary
testing of building systems at several of our buildings sites, including
Westbrook Corporate Center, Two California Plaza and State Street Bank Building.
Testing of essential building management systems will continue throughout 1999.
In the event we do experience a failure of essential building management systems
at one or more of our buildings, whether due to a failure of one of our systems
or an interruption of utilities, management believes that the individual tenant
leases will protect us 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 our 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 our belief that our efforts to identify and solve Y2K problems will
minimize such risk. We have 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. Management believes that
although there is no assurance that adequate coverage will be available at a
commercially reasonable cost, we may attempt to contract for insurance to
minimize the risks of Y2K liability.
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 we were to experience problems with the information
systems, the payment of rent under the leases would not be excused. In addition,
we expect to correct those information system problems within our control before
the year 2000, thereby minimizing or avoiding the increased cost of correcting
problems after the fact.
<PAGE> 32
The Y2K Problems of our Vendors
The success of our business is not closely tied to the operations of any one
manufacturer, vendor or supplier. Accordingly, if any of our manufacturers,
vendors or suppliers ceases to conduct business due to Y2K related problems, we
expect 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 our Customers
Due to our broad customer/tenant base, the success of our 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 our tenants ceases
to conduct business (and pay rent) due to Y2K related problems. As part of our
efforts to keep our tenants advised as to the steps we are taking to address
potential Y2K problems, we have also requested that such tenants provide us with
periodic updates as to their Y2K readiness.
Doomsday Scenario
We are aware that it is generally believed that the world's Y2K problem, if
uncorrected, may result in an economic crisis of global proportions. We are
unable to determine whether such predictions are true or false. As mentioned
above, we expect that the nature of our 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, we
assume that all companies (including ours) will experience the effects in one
way or another.
Phase Four - Developing Contingency Plans
We currently do not have a contingency plan in place. Once we have proceeded
further in the completion of the initial phases of the Program, contingency
plans are expected to be developed.
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.
32
<PAGE> 33
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 and Equity
Office Predecessors' Funds from Operations for the three month periods ended
September 30, 1998 and 1997 on a historical basis:
<TABLE>
<CAPTION>
THREE MONTHS ENDED SEPTEMBER 30,
-----------------------------------
(Dollars in thousands) 1998 1997 (a)
- ---------------------------------------------------------------------------------------------------
<S> <C> <C>
Income before allocation to minority interests,
income from investment in unconsolidated joint
ventures and extraordinary items: $ 96,176 $ 45,736
Add back (deduct):
(Income) allocated to minority interests for
partially owned properties (572) (312)
Income from investment in unconsolidated
joint ventures 3,129 1,383
Depreciation and amortization (real estate
related) 80,388 26,715
Net amortization of net premium on mortgage debt 285 1,267
Preferred distributions (8,427) -
------------- -------------
Funds from Operations before effect of adjusting
straight-line rental revenue and expense included in
Funds from Operations to a cash basis (b) 170,979 74,789
Deferred rental revenue (17,686) (8,705)
Deferred rental expense 654 549
------------- -------------
Funds from Operations excluding straight-line rental
revenue and expense adjustments $ 153,947 $ 66,633
============= =============
Cash Flow Provided By (Used For):
Operating Activities $ 160,449 $ 64,952
Investing Activities $(650,384) $ (84,069)
Financing Activities (c) $ 577,540 $ 89,919
Ratio of earnings to combined fixed charges and
preferred share distributions 1.8 2.3
</TABLE>
(a) Represents the combined results of Equity Office Predecessors for the
period from July 1, 1997 to July 10, 1997 and the Company from July 11,
1997 to September 30, 1997.
(b) 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.
(c) For the quarter ended September 30, 1997, cash flow provided by financing
activities includes approximately $181.1 million in cash contributed from
Equity Office Predecessors in connection with the Consolidation.
33
<PAGE> 34
The following table reflects the calculation of the Company's and Equity
Office Predecessors' Funds from Operations for the nine month periods ended
September 30, 1998 and 1997 on a historical basis:
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30,
------------------------------------
(Dollars in thousands) 1998 1997 (a)
- ---------------------------------------------------------------------------------------------
<S> <C> <C>
Income before allocation to minority interests,
income from investment in unconsolidated joint
ventures, gain on sales of real estate and
extraordinary items: $ 278,386 $ 93,977
Add back (deduct):
(Income) allocated to minority interests for
partially owned properties (1,608) (1,191)
Income from investment in unconsolidated
joint ventures 8,155 3,408
Depreciation and amortization (real estate
related) 223,386 85,709
Net amortization of net premium on mortgage debt 816 1,267
Preferred distributions (23,130) -
------------ ------------
Funds from Operations before effect of adjusting
straight-line rental revenue and expense included in
Funds from Operations to a cash basis (b) 486,005 183,170
Deferred rental revenue (50,406) (16,395)
Deferred rental expense 1,960 1,647
------------ ------------
Funds from Operations excluding straight-line rental
revenue and expense adjustments $ 437,559 $ 168,422
============ ============
Cash Flow Provided By (Used For):
Operating Activities $ 506,140 $ 155,625
Investing Activities $(1,926,369) $(656,702)
Financing Activities (c) $ 1,331,732 $ 404,444
Ratio of earnings to combined fixed charges and
preferred share distributions 1.9 1.8
</TABLE>
(a) Represents the combined results of Equity Office Predecessors for the
period from January 1, 1997 to July 10, 1997 and the Company from July 11,
1997 to September 30, 1997.
(b) 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.
(c) For the nine months ended September 30, 1997, cash flow provided by
financing activities includes approximately $181.1 million in cash
contributed from Equity Office Predecessors in connection with the
Consolidation.
34
<PAGE> 35
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 September 3, 1998 containing Item 7.
(2) A report of Form 8-K, dated September 30, 1998 containing Item 7.
35
<PAGE> 36
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.
EOP OPERATING LIMITED PARTNERSHIP
Date: November 10, 1998 By: /s/ Stanley Stevens
-------------------------------
Stanley Stevens
Executive Vice President, Chief
Legal Counsel and Secretary
Date: November 10, 1998 By: /s/ Richard Kincaid
-------------------------------
Richard Kincaid
Executive Vice President, Chief
Financial Officer
36
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 177,131
<SECURITIES> 0
<RECEIVABLES> 113,156
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 564,418
<PP&E> 13,049,809
<DEPRECIATION> (272,680)
<TOTAL-ASSETS> 13,631,834
<CURRENT-LIABILITIES> 473,079
<BONDS> 5,672,115
0
500,000
<COMMON> 0
<OTHER-SE> 6,986,640
<TOTAL-LIABILITY-AND-EQUITY> 13,631,834
<SALES> 0
<TOTAL-REVENUES> 1,210,697
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 711,700
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 237,194
<INCOME-PRETAX> 0
<INCOME-TAX> 0
<INCOME-CONTINUING> 261,803
<DISCONTINUED> 0
<EXTRAORDINARY> (7,506)
<CHANGES> 0
<NET-INCOME> 254,297
<EPS-PRIMARY> 0.91
<EPS-DILUTED> 0.90
</TABLE>
