<PAGE>
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: 0-24123
--------------------------------
HORIZON GROUP PROPERTIES, INC.
------------------------------
(Exact name of Registrant as specified in its Charter)
MARYLAND 38-3407933
- --------------------------------- -------------------
(State or other jurisdiction (I.R.S. employer
of incorporation or organization) identification no.)
77 WEST WACKER DRIVE, SUITE 3900, CHICAGO , IL 60601
- ---------------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
(312) 917-1500
--------------
(Registrant's telephone number, including area code)
Not Applicable
--------------
Former name, former address and former fiscal year, if changed since last report
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
---
NUMBER OF COMMON SHARES OUTSTANDING AT NOVEMBER 13, 1998 2,782,075
---------
---------
1
<PAGE>
HORIZON GROUP PROPERTIES, INC.
Index to Form 10-Q
September 30, 1998
<TABLE>
<CAPTION>
<S> <C>
Part I. Financial Information: Page No.
--------
Item 1. Financial Statements (unaudited)
Consolidated Condensed Statement of Operations of the Company for the
Three Months Ended September 30, 1998 and Combined Condensed
Statement of Operations of the Predecessor Properties for the
Three Months Ended September 30, 1997.................................. 3
Consolidated Condensed Statement of Operations of the Company
for the period June 15, 1998 to September 30, 1998 and
Combined Condensed Statements of Operations of the
Predecessor Properties for the periods
January 1, 1998 to June 14, 1998 and
the Nine Months Ended September 30, 1997............................... 4
Consolidated Condensed Balance Sheet of the
Company at September 30, 1998 and
Combined Condensed Balance Sheet of the Predecessor
Properties at December 31, 1997........................................ 5
Consolidated Condensed Statement of Cash Flows of the Company
for the period June 15, 1998 to September 30, 1998 and
Combined Condensed Statements of Cash Flows of the
Predecessor Properties for the periods
January 1, 1998 to June 14, 1998 and
for the Nine Months Ended September 30, 1997........................... 6
Notes to Consolidated and Combined Condensed Financial Statements........... 7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................................... 15
Part II. Other Information:
Item 1. Legal Proceedings....................................................... 22
Item 2. Changes in Securities................................................... 22
Item 3. Defaults Upon Senior Securities......................................... 22
Item 4. Submission of Matters to a Vote of Security Holders..................... 22
Item 5. Other Information....................................................... 22
Item 6. Exhibits or Reports on Form 8-K......................................... 23
Signatures....................................................................... 25
</TABLE>
2
<PAGE>
HORIZON GROUP PROPERTIES, INC.
Consolidated and Combined Condensed Statements of Operations
(unaudited)
<TABLE>
<CAPTION>
Horizon Group
Properties, Inc. Predecessor Properties
for the three months for the three months
ended September 30, 1998 ended September 30, 1997
------------------------ ------------------------
(thousands, except per share data)
<S> <C> <C>
REVENUE
Base rent $ 5,721 $ 4,236
Percentage rent 57 57
Expense recoveries 1,473 1,694
Other 445 1,022
-------- --------
Total revenue 7,696 7,009
-------- --------
EXPENSES
Property operating 1,722 1,337
Real estate taxes 905 673
Land leases and other 207 122
Depreciation and amortization 1,250 2,680
General and administrative 1,157 779
Provision for impairment - 6,028
Interest 2,405 2,974
-------- --------
Total expenses 7,646 14,593
-------- --------
Income (loss) before minority interest 50 (7,584)
Minority interest (16) -
-------- --------
NET INCOME (loss) $ 34 $ (7,584)
-------- --------
-------- --------
PER COMMON SHARE - BASIC AND DILUTED:
Net income $ .01
--------
--------
Weighted average common shares outstanding - basic 2,754,355
---------
---------
</TABLE>
See accompanying notes to consolidated and combined condensed
financial statements.
3
<PAGE>
HORIZON GROUP PROPERTIES, INC.
Consolidated and Combined Condensed Statements of Operations
(unaudited)
<TABLE>
<CAPTION>
Horizon Group Predecessor Properties
Properties, Inc. for the for the period from Predecessor Properties
period from June 15, 1998 January 1, 1998 for the nine months
to September 30, 1998 to June 14, 1998 ended September 30, 1997
------------------------- ---------------------- ------------------------
(thousands, except per share data)
<S> <S> <S> <S>
REVENUE
Base rent $ 6,674 $ 9,167 $ 13,766
Percentage rent 57 44 96
Expense recoveries 1,624 2,631 4,920
Other 503 534 1,702
-------- -------- --------
Total revenue 8,858 12,376 20,484
-------- -------- --------
EXPENSES
Property operating 1,921 2,634 4,182
Real estate taxes 1,042 1,379 2,212
Land leases and other 230 785 498
Depreciation and amortization 1,494 4,640 6,784
General and administrative 1,383 1,101 2,018
Provision for impairment - - 6,028
Interest 2,775 5,684 7,876
-------- -------- --------
Total expenses 8,845 16,223 29,598
-------- -------- --------
Income (loss) before minority interest
and extraordinary charge 13 (3,847) (9,114)
Minority interest (10) - -
-------- -------- --------
Net income (loss) before extraordinary
charge 3 (3,847) (9,114)
Extraordinary charge on debt prepayment - - (763)
-------- -------- --------
NET INCOME (loss) $ 3 $ (3,847) $ (9,877)
-------- -------- --------
-------- -------- --------
PER COMMON SHARE - BASIC AND DILUTED:
Net income $ -
--------
--------
Weighted average common shares
outstanding - basic 2,752,165
---------
---------
</TABLE>
See accompanying notes to consolidated and combined condensed
financial statements.
4
<PAGE>
HORIZON GROUP PROPERTIES, INC.
Consolidated and Combined Balance Sheets
(unaudited)
<TABLE>
<CAPTION>
Horizon Group Predecessor Properties
Properties, Inc. at at
September 30, 1998 December 31, 1997
------------------- ----------------------
(thousands)
<S> <C> <C>
ASSETS
Real estate - at cost:
Land $ 12,197 $ 16,421
Buildings and improvements 130,754 200,058
Less accumulated depreciation (1,494) (17,951)
-------- --------
Total net real estate 141,457 198,528
Cash and cash equivalents 2,502 3,729
Restricted cash 3,446 -
Tenant accounts receivable 360 368
Due from joint venture 8,726 11,639
Assets held for sale 2,500 1,933
Deferred costs 769 4,696
Other assets 5,374 954
-------- --------
Total assets $165,134 $221,847
-------- --------
-------- --------
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES:
Mortgages and other debt $115,200 $139,636
Accounts payable and accrued expenses 5,154 4,790
Prepaid rents and other tenant liabilities 897 959
Other liabilities 3,305 1,272
-------- --------
Total liabilities 124,556 146,657
--------
NET ASSETS OF PREDECESSOR PROPERTIES $ 75,190
--------
--------
MINORITY INTEREST 7,280
SHAREHOLDERS' EQUITY:
Common shares 28
Additional paid-in capital 33,267
Accumulated earnings 3
--------
Total shareholders' equity 33,298
--------
Total liabilities and shareholders' equity $165,134
--------
--------
</TABLE>
See accompanying notes to consolidated and combined condensed
financial statements.
5
<PAGE>
HORIZON GROUP PROPERTIES, INC.
Consolidated and Combined Condensed Statements of Cash Flows
(unaudited)
<TABLE>
<CAPTION>
Horizon Group Predecessor Properties
Properties, Inc. for the for the period from Predecessor Properties
period from June 15, 1998 January 1, 1998 for the nine months
to September 30, 1998 to June 14, 1998 ended September 30, 1997
------------------------- ---------------------- ------------------------
(thousands)
<S> <S> <S> <S>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) before minority interest
and extraordinary charge $ 13 $ (3,847) $ (9,114)
Adjustments to reconcile net income (loss)
before minority interest and extraordinary charge
to net cash provided by operating activities:
Depreciation and amortization 1,494 5,031 7,496
Provision for impairment - - 6,028
Changes in assets and liabilities:
Restricted cash 91 - -
Tenant accounts receivable (299) (409) 473
Due from joint venture 882 2,032 2,357
Deferred costs and other assets (2,628) 409 (297)
Accounts payable and accrued expenses 1,993 (704) (553)
Other liabilities (17) (47) 2,454
Prepaid rents and other tenant liabilities 220 (366) (859)
------- --------- --------
Net cash provided by operating activities 1,749 2,099 7,985
------- --------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Expenditures for real estate and improvements (2,101) (2,305) (9,641)
------- --------- --------
Net cash used in investing activities (2,101) (2,305) (9,641)
------- --------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net contributions/(distributions) - (4,044) (13,307)
Proceeds from net increase in debt - 4,459 13,861
Repayment of borrowings (314) - -
Debt issue costs - (140) (390)
------- --------- --------
Net cash provided by (used in) financing
activities (314) 275 164
------- --------- --------
Net increase (decrease) in cash and
cash equivalents (666) 69 (1,492)
CASH AND CASH EQUIVALENTS:
Beginning of period 3,168 3,729 4,511
------- --------- --------
End of period $ 2,502 $ 3,798 $ 3,019
------- --------- --------
------- --------- --------
</TABLE>
See accompanying notes to consolidated and combined condensed
financial statements.
6
<PAGE>
HORIZON GROUP PROPERTIES, INC.
Notes to Consolidated and Combined Condensed Financial Statements
(unaudited)
NOTE 1 - FORMATION OF THE COMPANY
Horizon Group Properties, Inc. (together with its subsidiaries "HGP" or the
"Company") is a self-administered and self-managed Maryland corporation that
was established in connection with the merger of Horizon Group, Inc., a
Michigan corporation ("Horizon") with and into Prime Retail, Inc., a Maryland
corporation ("Prime") which was consummated on June 15, 1998 ("the Merger").
HGP's portfolio consists of 14 factory outlet centers and one power center
located in 12 states. Twelve of the factory outlet centers and the power
center were contributed to the Company by Horizon immediately prior to the
consummation of the Merger pursuant to a Contribution Agreement entered into
in connection with the Merger (the "Contribution Agreement") and two factory
outlet centers were purchased by the Company from Prime immediately
subsequent to the consummation of the Merger.
Also in connection with the Merger and pursuant to the Amended and Restated
Agreement and Plan of Merger dated as of February 1, 1998 by and among Prime,
Horizon, HGP and other parties thereto (the "Merger Agreement"), the common
shares of the Company were distributed to the holders of Prime common stock,
Prime Series B Preferred stock, Prime Series C Preferred stock and Horizon
common stock in accordance with the applicable exchange ratio for each such
security.
The operations of the Company are primarily conducted through a subsidiary
limited partnership, Horizon Group Properties, L.P. ("HGP LP") in which the
Company is the sole general partner and, as of September 30, 1998, owns
approximately 82% of the partnership interests (the "Common Units"). In
connection with the Merger, the Common Units were distributed to the original
holders (other than Prime) of partnership interests of a limited partnership
affiliate of Prime and a limited partnership affiliate of Horizon,
respectively, in accordance with the exchange ratios set forth in the Merger
Agreement. Common Units are exchangeable for shares of HGP common stock on a
one-for-one basis at any time (or for an equivalent cash amount at the
Company's election).
The Company owns Horizon's former administrative offices located in Norton
Shores, Michigan and the following centers which were owned by Horizon prior
to the Merger and contributed to the Company pursuant to the Contribution
Agreement (collectively, such assets are referred to as the "Predecessor
Properties" for periods prior to the Merger):
Bellport Outlet Center in Patchogue, New York (held in joint ventures)
Dry Ridge Outlet Center in Dry Ridge, Kentucky
Horizon Outlet Center--Holland in Holland, Michigan
Horizon Outlet Center--Laughlin in Laughlin, Nevada
Horizon Outlet Center--Monroe in Monroe, Michigan
Horizon Outlet Center--Somerset in Somerset, Pennsylvania
Horizon Outlet Center--Traverse City in Traverse City, Michigan
Horizon Outlet Center--Tulare in Tulare, California
Lakeshore Marketplace in Norton Shores, Michigan
Medford Outlet Center in Medford, Minnesota
New Mexico Outlet Center in Algodones, New Mexico (vacant)
Sealy Outlet Center in Sealy, Texas
Warrenton Outlet Center in Warrenton, Missouri
7
<PAGE>
HORIZON GROUP PROPERTIES, INC.
Notes to Consolidated and Combined Condensed Financial Statements
(unaudited)
Immediately after the Merger, the Company acquired the two properties listed
below. Each property was purchased from an affiliate of Prime.
<TABLE>
<CAPTION>
Approximate
Date Acquired Property Location Total Sq. Feet Purchase Price
<S> <C> <C> <C> <C>
June 15, 1998 Nebraska Crossing Gretna, Nebraska 192,000 $ 8,000,000
Factory Shops
June 15, 1998 Indiana Daleville, Indiana 234,000 $18,015,000
Factory Shops --------- -------------
Total 426,000 $26,015,000
</TABLE>
HGP currently intends to seek shareholder approval to be treated as a
subchapter C corporation for federal income tax purposes for its initial tax
year which will end December 31,1998. In conjunction with the Merger, the
Company had indicated its intent to be treated as a real estate investment
trust ("REIT") for federal income tax purposes and currently believes it
operates in the manner required to qualify for REIT status.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The accompanying unaudited consolidated and combined financial statements of
the Company have been prepared in accordance with generally accepted
accounting principles ("GAAP") for interim financial information and the
instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they
do not include all of the information and footnotes required by GAAP for
complete financial statements. In the opinion of management, the consolidated
and combined financial statements contain all normal, recurring adjustments
necessary for a fair statement of financial results for the interim period
presented. The preparation of these financial statements requires management
to make estimates and assumptions that affect the amounts reported in the
financial statements and accompanying notes. Actual results could differ
from these estimates.
STATEMENTS OF PREDECESSOR PROPERTIES
The financial statements for the dates and periods prior to the Merger
reflect the results of operations, financial position, and cash flows of the
Predecessor Properties prior to the Merger as if the Company had been a
separate entity and owned such assets for all periods presented. The
historical results of operations and financial condition of the Predecessor
Properties are based on the manner in which Horizon historically managed such
net assets. Accordingly, the combined condensed financial statements of the
Predecessor Properties have been prepared using Horizon's historical basis of
the assets and liabilities and historical results of operations related to
the Predecessor Properties. In this regard, because Horizon owned the
Predecessor Properties, together with other properties which were not
contributed to the Company prior to the Merger, the Predecessor Properties
were not insulated from the obligations and commitments of Horizon. Certain
assumptions relating to the allocation of cash and cash equivalents, debt and
financing costs, interest expense and general and administrative expenses,
all of which were historically aggregated by Horizon, have been made in the
combined financial statements for the periods prior to the Merger. These
statements have been combined based upon the historical common ownership and
management of the outlet centers.
These statements include an allocation of the aggregate debt balances of
Horizon (which had historically been secured by a pool of Horizon's assets)
based upon the proportionate use of debt proceeds by the Predecessor
Properties compared to Horizon's total historical portfolio of outlet
centers. Financing costs were allocated based upon the same ratio. Interest
expense has been estimated based upon the aforementioned proportionate debt
balances and the historical weighted average interest rate incurred by
Horizon on its debt balances. The allocation was made in this manner because
management believes it best represented the use of funds borrowed during the
periods presented and
8
<PAGE>
HORIZON GROUP PROPERTIES, INC.
Notes to Consolidated and Combined Condensed Financial Statements
(unaudited)
because allocating the debt in this manner results in the statements of
operations of the Predecessor Properties reflecting the stand-alone interest
cost of doing business. General and administrative expenses of Horizon have
been allocated to the Predecessor Properties based upon the ratio of GLA of
the Predecessor Properties portfolio of outlet centers compared to Horizon's
total historical portfolio of outlet centers.
Cash and cash equivalents have been included in the combined condensed
financial statements of the Predecessor Properties based upon the respective
periods' ratio of GLA of the Predecessor Properties compared to Horizon's
total historical portfolio of outlet centers. Horizon considered all highly
liquid investments with a maturity of three months or less when purchased to
be cash and cash equivalents.
Net contributions (distributions) are the net amounts advanced from and
repaid to Horizon. Excess cash flows have been reflected as being distributed
back to Horizon. Net contributions represent Horizon's funding of the
Predecessor Properties' development cost needs in excess of cash flows
generated from the Predecessor Properties' operations.
The aforementioned allocations may not reflect actual balances had the
Company existed as a separate entity.
REAL ESTATE AND DEPRECIATION
The carrying values of the Predecessor Properties for the period prior to the
Merger are stated at Horizon's historic cost, less accumulated depreciation.
For the period subsequent to the Merger, the Predecessor Properties are
stated on the books of the Company at fair value as of June 15, 1998, the
date the Predecessor Properties were contributed to the Company, less
accumulated depreciation. The two centers purchased from an affiliate of
Prime are stated at their purchase prices less accumulated depreciation. The
carrying values as of September 30, 1998 are preliminary. Costs incurred for
the acquisition, development, construction and improvement of properties, as
well as significant renovations and betterments to the properties, are
capitalized. Maintenance and repairs are charged to expense as incurred.
Interest costs incurred with respect to qualified expenditures relating to
the construction of assets are capitalized during the construction period.
In accordance with FASB Statement No. 121, "Accounting for the Impairment of
Long-lived Assets and for Long-lived Assets to be Disposed of", the financial
statements of HGP and the Predecessor Properties reflect impairment losses on
long-lived assets used in operations when events and circumstances indicate
that the assets might be impaired and the undiscounted cash flows estimated
to be generated by those assets are less than the carrying amounts of those
assets. Impairment losses are measured as the difference between carrying
value and fair value for assets to be held in the portfolio. For assets to be
sold, impairment is measured as the difference between carrying value and
fair value, less costs to dispose. Fair value is based on estimated cash
flows discounted at a risk-adjusted rate of interest or a value derived from
comparable sales transactions in the marketplace.
Periodically, in the course of reviewing the performance of its outlet
centers, management may determine that certain outlet centers no longer meet
the parameters set forth for its operating properties and accordingly, such
outlet centers will be classified as held for sale. As of December 31, 1997
and September 30, 1998 the Algodones, New Mexico outlet center is classified
as held for sale.
REVENUE RECOGNITION
Leases with tenants are accounted for as operating leases. Minimum annual
rentals are generally recognized on a straight-line basis over the term of
the respective lease. Rents which represent basic occupancy costs, including
fixed amounts and amounts computed as a function of sales, are classified as
base rent. Amounts which may become payable in addition to base rent and
which are computed as a function of sales in excess of certain thresholds are
classified as percentage rents. Expense recoveries based on common area
maintenance expenses and certain other expenses are accrued in the period in
which the related expense is incurred. For periods beginning on and after
April 1, 1998, percentage rents are accrued on the basis of reported tenant
sales only after the sales exceed the thresholds
9
<PAGE>
HORIZON GROUP PROPERTIES, INC.
Notes to Consolidated and Combined Condensed Financial Statements
(unaudited)
above which such rent is due. For periods prior to April 1, 1998, percentage
rents were accrued based upon an estimate of total percentage rent expected
to be collected for the year.
OTHER REVENUE
Other revenue consists primarily of interest income and income related to
marketing services that is recovered from tenants pursuant to lease agreements.
DEFERRED COSTS AND OTHER ASSETS
Leasing and deferred financing costs are capitalized at cost. Amortization is
recorded on the straight-line method over the life of the lease or the debt,
respectively.
INVESTMENT IN UNCONSOLIDATED JOINT VENTURES
The Company accounts for its investment in two joint ventures using the equity
method of accounting. Under this method of accounting, the net equity
investment of the Company is reflected on the balance sheet and the statements
of operations include the Company's share of the net income or loss from such
joint ventures.
INCOME TAXES
The Company currently intends to seek shareholder approval to not elect status
as a REIT under Sections 856 through 860 of the Internal Revenue Code of 1986,
as amended. If the Company were a REIT, it generally would not be subject to
federal income tax if it were to distribute at least 95% of its taxable income
for each tax year to its shareholders. REITs are subject to a number of
organizational and operational requirements. The Company expects it will report
a loss for federal income tax purposes for the period ending December 31, 1998
whether or not it elects REIT status.
RECLASSIFICATIONS
Certain reclassifications have been made to the previously reported statements
of the Predecessor Properties in order to provide comparability with the
Company's statements reported herein. These reclassifications have not changed
the previously reported results.
10
<PAGE>
HORIZON GROUP PROPERTIES, INC.
Notes to Consolidated and Combined Condensed Financial Statements
(unaudited)
NOTE 3 - EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted earnings per
share:
<TABLE>
<CAPTION>
Three months ended Period from June 15, 1998
September 30, 1998 to September 30, 1998
------------------ -------------------------
<S> <C> <C>
NUMERATOR:
Net income - basic $ 34 $ 3
Minority interest of unitholders 16 10
------ ------
Net income - diluted $ 50 $ 13
------ ------
------ ------
DENOMINATOR:
Weighted average common shares outstanding - basic 2,754 2,752
Effect of converting units to shares 636 638
------ ------
Weighted average common shares outstanding - diluted 3,390 3,390
------ ------
------ ------
Net income per share - basic and diluted $ .01 $ -
------ ------
------ ------
</TABLE>
Outstanding options were excluded because the effect of such items was
anti-dilutive for the periods presented.
NOTE 4 - LONG TERM STOCK INCENTIVE PLAN
The Company has adopted the HGP 1998 Long Term Stock Incentive Plan (the "HGP
Stock Plan") to advance the interests of the Company by encouraging and
enabling the acquisition of a financial interest in the Company by key
employees and officers of the Company and its subsidiaries through equity
awards. The Company reserved 338,900 common shares for issuance pursuant to
the HGP Stock Plan, an amount equal to approximately 10% of the aggregate of
the total outstanding common shares of the Company and outstanding Common
Units of HGP LP as of November 13, 1998.
NOTE 5 - MORTGAGE DEBT AND OTHER LIABILITIES
On June 15, 1998, certain wholly owned affiliates of the Company entered into
a credit facility (the "HGP Credit Facility") with Nomura Asset Capital
Corporation ("Nomura") providing for initial borrowings of $108,205,000. The
HGP Credit Facility is guaranteed by HGP and HGP LP. The HGP Credit Facility
has a term of three years and bears interest at the 30-day LIBOR Rate (as
defined in the HGP Credit Facility) plus 1.90% per annum. The HGP Credit
Facility is cross-collateralized by mortgages on the Company's 12 wholly
owned outlet centers and one power center. The HGP Credit Facility requires
monthly payments of interest. In addition, the HGP Credit Facility requires
principal payments totaling $1.5 million, $1.5 million and $2.0 million
during the first, second and third years, respectively, payable in equal
monthly installments. A principal payment of $2.2 million which was due on
October 31, 1998 was paid on November 10, 1998 with the proceeds of a loan
from Prime. The HGP Credit Facility also contains a contingent repayment
penalty equal to 1% of amounts repaid during the first loan year and 2% of
amounts repaid thereafter through the stated maturity date. Such penalty is
not payable in the event the Company refinances the HGP Credit Facility with
Nomura. The Company currently intends to seek such financing from Nomura on
or before the maturity of the HGP Credit Facility and accordingly does not
currently anticipate that such fee will be paid. As a result, the condensed
consolidated financial statements do not include any adjustment relating to
this penalty. The HGP Credit Facility contains restrictions on the ability
of HGP and HGP LP to incur additional indebtedness, and
11
<PAGE>
HORIZON GROUP PROPERTIES, INC.
Notes to Consolidated and Combined Condensed Financial Statements
(unaudited)
under certain circumstances, requires the Company to enter into an interest
rate lock arrangement which would fix the interest rate on the full
outstanding amount of the HGP Credit Facility.
In connection with the HGP Credit Facility, the Company established certain
escrow accounts and cash collection accounts for the benefit of Nomura which
are classified on the balance sheet of the Company as restricted cash.
Prime has guaranteed approximately $10 million of obligations under the HGP
Credit Facility (after the $2.2 million principal payment made on November
10, 1998) and together with other indebtedness (the "Prime Guarantee"). In
connection with the Prime Guarantee, HGP has agreed to pay Prime a fee of
$400,000 per annum until the Prime Guarantee terminates.
The Company has loans totaling $3.0 million as of September 30, 1998 secured
by a mortgage on the office building and related equipment which the Company
utilizes as a corporate office in Norton Shores, Michigan. This building was
previously owned by an affiliate of Horizon and was contributed to the
Company pursuant to the Contribution Agreement. The consent of the lender to
the previous owner of the property is required in connection with the
transfer of the property to the Company. The Company is currently seeking
such consent but as of November 13, 1998, such consent has not been obtained.
The Company also has a $4.0 million revolving credit facility that matured
October 31, 1998. Prime is obligated to lend the Company $4.0 million at an
interest rate of 10% (the "Prime Loan") in order to repay such indebtedness
pursuant to the terms of a Working Capital Agreement between the Company and
Prime (the "Working Capital Agreement"). The Company has requested such
funds from Prime, but as of November 13, 1998, Prime had not lent the funds
to the Company. The terms of the Working Capital Agreement require the
Company to repay the Prime Loan or other related indebtedness on which Prime
is contingently liable to the extent of net proceeds from an equity offering
or the sale of the Company's Algodones, New Mexico Outlet Center.
Pursuant to the Contribution Agreement, the Company agreed to assume,
undertake to pay, satisfy and discharge when due in accordance with their
terms certain assumed liabilities (the "Assumed Liabilities"), which are
defined to include all liabilities of Horizon which arise from the ownership
and operation of the Predecessor Properties and include (i) all obligations
to indemnify present and former officers and directors of Horizon under
certificates or articles of incorporation, by-laws, partnership agreements,
employment agreements, indemnification agreements or otherwise, for any
matter existing or occurring after the Merger, (ii) all leases and related
contracts, and service contracts, relating to any Contributed Asset (as
defined in the Contribution Agreement) and (iii) certain other specified
obligations.
Also pursuant to the Contribution Agreement, certain partnership interests in
two joint ventures, MG Patchogue Limited Partnership and MG Patchogue II
Limited Partnership, which own the Bellport Factory Outlet Center, were
transferred from an affiliate of Horizon to HGP LP and an affiliate of HGP
LP. The Company is currently seeking the consents of the limited partners to
such transfers but as of November 13, 1998, such consents had not been
obtained.
Additionally, the transfer of the general partnership interest in MG
Patchogue Limited Partnership pursuant to the Contribution Agreement required
the consent of MG Patchogue Limited Partnership's mortgage lender. The
Company is currently seeking such consent but, as of November 13, 1998, such
consent had not been obtained. The Company accounts for its investment in
these partnerships using the equity method of accounting.
MG Patchogue II Limited Partnership, of which the Company is 1% general
partner and 44% limited partner, is subject to indebtedness totaling
approximately $11.8 million which originally matured August 14, 1998. The
lender has indicated its willingness to extend such facility to November 12,
1998. The Company is seeking to further extend the maturity date. Nomura
originally issued a commitment to lend the partnership $14 million under the
HGP Credit Facility on or before September 1, 1998 and has verbally indicated
that it may consider such refinancing after such date. The consent of the
limited partners is required in order to complete such financing with Nomura.
The Company is currently seeking such consent, but as of November
12
<PAGE>
HORIZON GROUP PROPERTIES, INC.
Notes to Consolidated and Combined Condensed Financial Statements
(unaudited)
13, 1998 such consent had not been obtained. Prime is a guarantor on the
indebtedness. If the financing with Nomura is completed, the Company will
utilize the proceeds of such financing to repay the existing indebtedness and
repay the $2.2 million loan which it received from Prime as discussed above
in connection with the HGP Credit Facility. The Company accounts for its
investment in this partnership using the equity method of accounting.
The Company can give no assurances that it will be able to obtain the above
mentioned consents or that it will be able to finance or refinance its
indebtedness as it matures or that any such financing will be obtained will
be on favorable terms. Any such failure to obtain such consents or such
financings could have a material adverse effect upon the Company. The
condensed consolidated financial statements of the Company do not include any
adjustments that may result from the ultimate outcome of these uncertainties.
Prior to the Merger, Horizon entered into an agreement (the "PVH Agreement")
with Phillips Van Heusen, Inc. ("PVH") which deleted or delayed the effective
date of certain provisions of PVH leases in exchange for certain payments.
Prime is liable for future payments relating to the PVH Agreement. The
Company is obligated to reimburse Prime for two payments relating to the PVH
Agreement totaling $2,334,000, payable in the amounts of $1,167,000 on each
of June 15, 1999 and June 15, 2000.
NOTE 6 - RELATED PARTY TRANSACTIONS
The Company utilizes Thilman & Filippini as agent for its insurance and risk
management programs. E. Thomas Thilman is a Director of the Company and a
partner in Thilman & Filippini. During the period June 15, 1998 to September
30, 1998, the Company paid premiums totaling approximately $340,000 on
insurance policies placed by Thilman & Filippini.
The Company leases office space for its senior executives at 77 W. Wacker,
Chicago, Illinois from Prime Group Realty Trust. Prime Group Realty Trust is
an affiliate of Michael W. Reschke, a Director of the Company.
NOTE 7 - PRO FORMA INFORMATION
The Pro Forma Consolidated Condensed Statements of Operations for the nine
months ended September 30, 1998 and 1997 reflect the following transactions,
which occurred June 15, 1998, as if they had occurred on January 1, 1997: (a)
the contribution of the Predecessor Properties and the acquisition of the two
centers from Prime; (b) the entry into the HGP Credit Facility; and (c) the
issuance of stock of HGP and Common Units.
The accompanying Pro Forma Consolidated Condensed Statements of Operations
are not necessarily 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.
<TABLE>
<CAPTION>
Nine months ended September 30,
-------------------------------
1998 1997
---- ----
<S> <C> <C>
Total Revenue $ 24,443 $ 25,723
Income (Loss) Before Extraordinary Items
and Minority Interests 1,392 (2,940)
Net Income (Loss) 1,117 (2,376)
Net Income (Loss) per Share .41 (.86)
</TABLE>
13
<PAGE>
HORIZON GROUP PROPERTIES, INC.
Notes to Consolidated and Combined Condensed Financial Statements
(unaudited)
NOTE 8 - NON-CASH INVESTING AND FINANCING ACTIVITIES
Additional supplemental disclosures of non-cash investing and financing
activities for the period ended June 30, 1998 are as follows:
The following summarizes the assets, liabilities and equity contributed to
and assumed by the Company pursuant to the Contribution Agreement and the
acquisition of the two centers from Prime referred to in Note 1:
<TABLE>
<CAPTION>
(in thousands)
<S> <C>
Investment in real estate 141,646
Other assets 21,575
-------
163,221
-------
-------
Debt 115,514
Other liabilities 7,142
Minority interests 7,513
Owners' equity 33,052
-------
163,221
-------
-------
</TABLE>
The above allocations are preliminary.
NOTE 9 - WORKING CAPITAL AGREEMENT
In connection with the Merger, the Company entered into a Working Capital
Agreement with Prime (the "Working Capital Agreement"). The Working Capital
Agreement provides that Prime will transfer to the Company net working
capital of $545,000. This amount is net of the current assets and current
liabilities of the Predecessor Properties and the two centers which the
Company purchased from Prime as of the date of the Merger. Prime transferred
$3,000,000 to the Company at the closing of the Merger as a portion of the
estimated amount due under the Working Capital Agreement. The Company has
recorded a receivable from Prime for the balance of the amount due under the
Working Capital Agreement and expects that such amount will be paid during
the fourth quarter of 1998.
14
<PAGE>
HORIZON GROUP PROPERTIES, INC.
Management's Discussion and Analysis of Financial Condition
and Results of Operations
For the three and nine months ended September 30, 1998
(unaudited)
INTRODUCTION
The following discussion and analysis of the consolidated financial condition
and results of operations of Horizon Group Properties, Inc. (together with
its subsidiaries "HGP" or the "Company") and the Predecessor Properties (as
herein after defined) should be read in conjunction with the Consolidated and
Combined Condensed Financial Statements and Notes thereto. The Company's
operations are conducted primarily through a subsidiary limited partnership,
Horizon Group Properties, L.P. ("HGP LP"). The Company is the sole general
partner of HGP LP and, as of September 30, 1998, owns approximately 82% of
the HGP LP partnership interests ("Common Units"). Common Units of HGP LP are
exchangeable for shares of HGP common stock on a one-for-one basis at any
time (or for an equivalent cash amount at the Company's election). The
Company controls HGP LP and is dependent on distributions or other payments
from HGP LP to meet its financial obligations.
CAUTIONARY STATEMENTS
The following discussion in "Management's Discussion and Analysis of
Financial Condition and Results of Operations" contains certain
forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995 which reflect management's current views with
respect to future events and financial performance. Such forward-looking
statements are subject to certain risks and uncertainties; including, but not
limited to, the effects of future events on the Company's financial
performance; the risk that the Company may be unable to finance its planned
acquisition and development activities; risks related to the retail industry
in which the Company's outlet centers compete, including the potential
adverse impact of external factors, such as inflation, consumer confidence,
unemployment rates and consumer tastes and preferences; risks associated with
the Company's property acquisitions, such as the lack of predictability with
respect to financial returns; risks associated with the Company's property
development activities, such as the potential for cost overruns, delays and
the lack of predictability with respect to the financial returns associated
with these development activities; the potential impact of Year 2000 issues,
the risk of potential increase in market interest rates from current levels;
and risks associated with real estate ownership, such as the potential
adverse impact of changes in local economic climate on the revenues and the
value of the Company's properties. For further information on factors which
could impact the Company and the statements contained herein, reference is
made to the Company's other filings with the Securities and Exchange
Commission, including the Company's Registration Statement on Form 10, as
amended, dated as of June 4, 1998, with respect to the Company's initial
registration of its common stock under the Securities Exchange Act of 1934,
as amended and the Sky Merger Corp. Registration Statement on Form S-4, as
filed with the Securities and Exchange Commission on May 12, 1998
(Registration No. 333-51285).
GENERAL OVERVIEW
The Company is a self-administered and self-managed corporation that was
established in connection with the merger of Horizon Group, Inc., a Michigan
corporation ("Horizon") with and into Prime Retail, Inc., a Maryland corporation
("Prime") which was consummated on June 15, 1998 ("the Merger"). HGP's
portfolio consists of 14 factory outlet centers and one power center located in
12 states comprising an aggregate of approximately 3.0 million square feet of
gross leasable area ("GLA"). Twelve of the factory outlet centers and the power
center were contributed to the Company immediately prior to the consummation of
the Merger by Horizon pursuant to a Contribution Agreement entered into in
connection with the Merger (the "Contribution Agreement") and two factory outlet
centers were purchased by the Company from Prime immediately subsequent to the
consummation of the Merger.
15
<PAGE>
HORIZON GROUP PROPERTIES, INC.
Management's Discussion and Analysis of Financial Condition
and Results of Operations
For the three and nine months ended September 30, 1998
(unaudited)
RESULTS OF OPERATIONS
The statements for the periods subsequent to June 15, 1998, the date of the
Company's acquisition of the 12 outlet centers, one power center and
Horizon's former administrative office from Horizon (the "Predecessor
Properties") pursuant to the Contribution Agreement, reflect the operation of
the Company as a separate entity with its current assets. The financial
statements of the Company for the periods subsequent to June 15, 1998 are not
directly comparable to the statements of the Predecessor Properties for
periods prior to the Merger due to a number of factors, including (1) a
significant change in the indebtedness of the Company which occurred in
conjunction with the Merger; (2) the acquisition by the Company of two
additional outlet centers immediately after the Merger, the results of which
are not included in the financial statements of the Predecessor Properties;
(3) the fact that the outlet center in Algodones, New Mexico was
substantially occupied during the periods presented prior to the Merger but
was completely vacant during the periods subsequent to June 15, 1998 and (4)
the carrying value of the Predecessor Properties for the periods prior to the
Merger are stated at Horizon's historic cost and depreciation expense is
based on those costs. For the period subsequent to the Merger, the
Predecessor Properties are stated at the fair value as of the date of the
Merger, resulting in a substantial decrease in value and a related decrease
in depreciation expense. For these and other reasons, the combination of the
results of operation for the periods prior to the Merger with those for the
periods subsequent to the Merger is not indicative of the ongoing results of
the Company for future periods.
The financial statements for the periods prior to the Merger reflect the
results of operations, financial position, and cash flows of the Predecessor
Properties prior to the Merger as if the Predecessor Properties had been a
separate entity which owned such assets for all periods presented. The
historical results of operations and financial condition of the Predecessor
Properties are based on the manner in which Horizon historically managed such
net assets. Accordingly, the combined condensed financial statements of the
Predecessor Properties have been prepared using Horizon's historical basis of
the assets and liabilities and historical results of operations related to
the Predecessor Properties. In this regard, because Horizon owned the
Predecessor Properties, together with other properties which were not
contributed to the Company, the Predecessor Properties were not insulated
from the obligations and commitments of Horizon. Certain assumptions
relating to the allocation of cash and cash equivalents, debt and financing
costs, interest expense and general and administrative expenses, all of which
were historically aggregated by Horizon, have been made in the combined
financial statements for the periods prior to the Merger. See Note 2 to the
Financial Statements. These statements have been combined based upon the
historical common ownership and management of the outlet centers.
Rental revenue for the Predecessor Properties (excluding the Algodones, New
Mexico Center which was vacant in 1998) for the nine months ended September
30, 1998 increased 6% compared to the same period in the prior year. Rental
revenue for the Algodones, New Mexico center totaled $1,235,000 for the nine
months ended September 30, 1997. Operating expenses and real estate taxes
for the nine months ended September 30, 1998 for the Predecessor Properties
(excluding the Algodones, New Mexico center) decreased slightly less than 4%
compared to the same period in the prior year. Operating expenses and real
estate taxes for the Algodones, New Mexico center were $312,000 for the nine
months ended September 30, 1997.
Rental revenue for the Predecessor Properties (excluding the New Mexico
center) for the three months ended September 30, 1998 increased 2% compared
to the same period in the prior year. Rental revenue for the New Mexico
center totaled $487,000 for the three months ended September 30, 1997.
Operating expenses and real estate taxes for the three months ended September
30, 1998 for the Predecessor Properties (excluding New Mexico) decreased 11%
compared to the same period in the prior year. Operating expenses for the New
Mexico center were $42,000 for the three months ended September 30, 1997.
Average occupancy for the Predecessor Properties (excluding the Algodones,
New Mexico Center) for the nine months ended September 30, 1998 was 77.4%
compared to 74.4% for the same period in the prior year. Average
16
<PAGE>
HORIZON GROUP PROPERTIES, INC.
Management's Discussion and Analysis of Financial Condition
and Results of Operations
For the three and nine months ended September 30, 1998
(unaudited)
occupancy for the Predecessor Properties (excluding the New Mexico center)
for the three month period ended September 30, 1998 was 79.1% compared to
74.3% for the same period in the prior year. As of September 30, 1998,
occupancy of the Company's total operating portfolio was 81.3%.
The financial statements for the three months ended September 30, 1998
include a net $221,000 charge as part of a budgeted 1998 marketing landlord
contribution. This $600,000 total contribution will supplement the
insufficient funds received from tenants to market five key centers. The
remainder of the costs will be reflected in the fourth quarter financial
statements.
The Company operates primarily from the former headquarters of Horizon in
Norton Shores, Michigan in an office building previously owned by Horizon and
now owned by the Company. Most employees of the Company, with the exception
of some of its senior management, were former employees of Horizon. In
connection with the Merger, a substantial number of former Horizon employees
were either not offered employment with the Company or offered continued
employment for a limited period of time. The Company has currently leased a
small portion of its office building to an unrelated tenant and is seeking
additional tenants to occupy the space not required by the Company to
accommodate its operations. The Company also leases office space in Chicago
for its senior management and leases office space in McLean, Virginia for its
leasing staff. During the third quarter of 1998, the Company amended its
lease in Virginia and relocate to smaller offices. As a result of the above
mentioned factors, among others, the general and administrative expenses of
the Company for the periods subsequent to June 15, 1998 are not necessarily
representative of the expenses which will be incurred on an ongoing basis.
LIQUIDITY AND CAPITAL RESOURCES
As of September 30, 1998, the aggregate amount of outstanding mortgages and
other debt on the Company's balance sheet was approximately $115.2 million.
While the Company is contemplating the expansion of the Tulare Outlet Center,
during the remainder of 1998, the Company does not plan to expand its other
outlet centers. However, the Company does plan to spend approximately $3
million for tenant allowances, capital improvements and repairs to its outlet
centers over the next twelve months, of which $1.2 million will come from an
escrow which was established at the closing of the HGP Credit Facility with
Nomura (each as hereinafter defined). The Company plans to fund the remaining
costs with existing cash balances and cash flow from operations.
In connection with the Merger, the Company entered into a Working Capital
Agreement with Prime (the "Working Capital Agreement"). The Working Capital
Agreement provides that Prime will transfer to the Company net working
capital of $545,000. This amount is net of the current assets and current
liabilities of the Predecessor Properties and the two centers which the
Company purchased from Prime as of the date of the Merger. Prime transferred
$3,000,000 to the Company at the closing of the Merger as a portion of the
estimated amount due under the Working Capital Agreement. The Company has
recorded a receivable from Prime for the balance of the amount due under the
Working Capital Agreement and expects that such amount will be paid during
the fourth quarter of 1998.
The Company expects to meet its short-term liquidity requirements generally
through working capital, cash flows from operations and from the proceeds of
a loan which Prime is obligated to make to the Company pursuant to the terms
of the Working Capital Agreement. The Company expects to meet its long-term
requirements, such as tenant allowances for new leases and capital
improvements, through the additional borrowing of long-term debt and the
potential offering of equity securities in the private or public capital
markets. As a result of the Company's leverage, the Company's ability to
obtain additional financing sources is limited. There can be no assurance
that the Company will be able to successfully obtain such funding sources or,
if obtained, on favorable terms.
17
<PAGE>
HORIZON GROUP PROPERTIES, INC.
Management's Discussion and Analysis of Financial Condition
and Results of Operations
For the three and nine months ended September 30, 1998
(unaudited)
On June 15, 1998, certain wholly owned affiliates of the Company entered into
a credit facility (the "HGP Credit Facility") with Nomura Asset Capital
Corporation ("Nomura") providing for initial borrowings of $108,205,000. The
HGP Credit Facility is guaranteed by HGP and HGP LP. The HGP Credit Facility
has a term of three years and bears interest at the 30-day LIBOR Rate (as
defined in the HGP Credit Facility) plus 1.90% per annum. The HGP Credit
Facility is cross-collateralized by mortgages on the Company's 12 wholly
owned outlet centers and one power center. The HGP Credit Facility requires
monthly payments of interest. In addition, the HGP Credit Facility requires
principal payments totaling $1.5 million, $1.5 million and $2.0 million
during the first, second and third years, respectively, payable in equal
monthly installments. A principal payment of $2.2 million which was due on
October 31, 1998 was paid on November 10, 1998 with the proceeds of a loan
from Prime. The HGP Credit Facility also contains a contingent repayment
penalty equal to 1% of amounts repaid during the first loan year and 2% of
amounts repaid thereafter through the stated maturity date. Such penalty is
not payable in the event the Company refinances the HGP Credit Facility with
Nomura. The Company currently intends to seek such financing from Nomura on
or before the maturity of the HGP Credit Facility and accordingly does not
currently anticipate that such fee will be paid. As a result, the condensed
consolidated financial statements do not include any adjustment relating to
this penalty. The HGP Credit Facility contains restrictions on the ability
of HGP and HGP LP to incur additional indebtedness, and under certain
circumstances, requires the Company to enter into an interest rate lock
arrangement which would fix the interest rate on the full outstanding amount
of the HGP Credit Facility.
Prime has guaranteed approximately $10 million of obligations under the HGP
Credit Facility (after the $2.2 million principal payment made on November
10, 1998) and together with other indebtedness (the "Prime Guarantee"). In
connection with the Prime Guarantee, HGP has agreed to pay Prime a fee of
$400,000 per annum until the Prime Guarantee terminates.
The Company has loans totaling $3.0 million as of September 30, 1998 secured
by a mortgage on the office building and related equipment which the Company
utilizes as a corporate office in Norton Shores, Michigan. This building was
previously owned by an affiliate of Horizon and was contributed to the
Company pursuant to the Contribution Agreement. The consent of the lender to
the previous owner of the property was required in connection with the
transfer of the property to the Company. The Company is currently seeking
such consent but as of November 13, 1998, such consent has not been obtained.
The Company also has a $4.0 million revolving credit facility that matured
October 31, 1998. Prime is obligated to lend the Company $4.0 million at an
interest rate of 10% (the "Prime Loan") in order to repay such indebtedness
pursuant to the terms of a Working Capital Agreement between the Company and
Prime (the "Working Capital Agreement"). The Company has requested such
funds from Prime, but as of November 13, 1998, Prime had not lent the funds
to the Company. The terms of the Working Capital Agreement require the
Company to repay the Prime Loan or other related indebtedness on which Prime
is contingently liable to the extent of net proceeds from an equity offering
or the sale of the Company's Algodones, New Mexico Outlet Center.
The transfer of the general partnership interest in MG Patchogue Limited
Partnership pursuant to the Contribution Agreement also required the consent
of MG Patchogue Limited Partnership's mortgage lender. The Company is
currently seeking such consent but, as of November 13, 1998 such consent had
not been obtained.
MG Patchogue II Limited Partnership, of which the Company is 1% general
partner and 44% limited partner, is subject to indebtedness totaling
approximately $11.8 million which originally matured August 14, 1998. The
lender has indicated its willingness to extend such facility to November 12,
1998. The Company is seeking to further extend the maturity date. Nomura
originally issued a commitment to lend the partnership $14 million under the
HGP Credit Facility on or before September 1, 1998 and has verbally indicated
that it may consider such refinancing after such date. The consent of the
limited partners is required in order to complete such financing with Nomura.
The Company is currently seeking such consent, but as of November 13, 1998
such consent had not been obtained. Prime is a guarantor on the
indebtedness. If the financing with
18
<PAGE>
HORIZON GROUP PROPERTIES, INC.
Management's Discussion and Analysis of Financial Condition
and Results of Operations
For the three and nine months ended September 30, 1998
(unaudited)
Nomura is completed, the Company will utilize the proceeds of such financing
to repay the existing indebtedness and repay the $2.2 million loan which it
received from Prime as discussed above in connection with the HGP Credit
Facility. The Company accounts for its investment in this partnership using
the equity method of accounting.
The Company can give no assurances that it will be able to obtain the above
mentioned consents or that it will be able to finance or refinance its
indebtedness as it matures or that any such financing will be obtained will
be on favorable terms. Any such failure to obtain such consents or such
financings could have a material adverse effect upon the Company.
Prior to the Merger, Horizon entered into an agreement (the "PVH Agreement")
with Phillips Van Heusen, Inc. ("PVH") which deleted or delayed the effective
date of certain provisions of PVH leases for the benefit of Horizon in
exchange for certain payments. Prime is liable for future payments relating
to the PVH Agreement. The Company is obligated to reimburse Prime for two
payments relating to the PVH Agreement totaling $2,334,000, payable each in
the amount of $1,167,000 on June 15, 1999 and June 15, 2000.
The Company intends to seek shareholder approval to not elect REIT status on
its initial tax return. Until such consent is obtained, the Company intends
to operate so as to qualify as a REIT, if it were to so elect. In order to
qualify as a REIT for federal income tax purposes, the Company would be
required to pay dividends to its shareholders of at least 95% of its REIT
taxable income in addition to satisfying other requirements. Although the
Company intends to make distributions to its shareholders in accordance with
the requirements of the Internal Revenue Code of 1986, as amended, it also
intends to retain such amounts as it considers necessary from time to time
for the acquisition or development of new properties as suitable
opportunities arise, for the expansion and renovation of its existing
properties and for the retirement of debt. As of November 13, 1998, HGP is
not required to pay a dividend to its shareholders in order to be in
compliance with the regulations applicable to REITs.
YEAR 2000
GENERAL DESCRIPTION OF THE YEAR 2000 ISSUE AND THE NATURE AND EFFECTS OF THE
YEAR 2000 ON INFORMATION TECHNOLOGY (IT) AND NON-IT SYSTEMS
The Year 2000 Issue is the result of computer programs being written using
two digits rather than four to define the applicable year. Any of the
Company's computer programs that have time-sensitive software may recognize a
date using "00" as the year 1900 rather than the year 2000. This could
result in a system failure or miscalculations causing disruptions of
operations, including, among other things, a temporary inability to process
transactions, send invoices or engage in similar normal business activities.
Based on recent assessments, the Company has determined that it will be
required to modify or replace certain portions of its software and certain
hardware so that those systems will properly utilize dates beyond December
31, 1999. The Company presently believes that with the modifications or
replacements of existing software and certain hardware, the Year 2000 Issue
can be mitigated. However, if such modifications and replacements are not
completed timely, the Year 2000 Issue could have a material impact on the
operations of the Company.
The Company's plan to resolve the Year 2000 Issue involves the following four
phases: assessment, remediation, testing and implementation. To date, the
Company has completed the assessment of the critical information technology
systems and has initiated the assessment of all systems that could be
significantly affected by the Year 2000. The results of the assessment
completed to date indicate that most of the Company's significant information
processing technology systems could be affected, particularly the general
ledger and billing systems. That assessment also indicated that software and
hardware used in certain equipment at the Company's properties are also at
risk. Potentially affected systems include security, lighting, automatic
sprinklers, and heating and ventilating systems.
19
<PAGE>
HORIZON GROUP PROPERTIES, INC.
Management's Discussion and Analysis of Financial Condition
and Results of Operations
For the three and nine months ended September 30, 1998
(unaudited)
STATUS OF PROGRESS IN BECOMING YEAR 2000 COMPLIANT, INCLUDING TIMETABLE FOR
COMPLETION OF EACH REMAINING PHASE
The Company has completed the assessment of its most critical information
technology systems and determined that most of the IT systems could be
affected, particularly the general ledger and billing systems. The Company
uses a JD Edwards based accounting system which is currently Year 2000
compliant. The accounting system is run on an IBM AS/400 which requires an
updated operating system in order to be Year 2000 compliant. The Company
expects to install such software by the end of the first quarter of 1999.
The Company has numerous desktop computers which are connected via a network
to the AS/400. Most of these computers are Year 2000 compliant, but certain
older computers may require software upgrades to be fully Year 2000
compliant. Such upgrades are generally available at no charge and the
Company intends to install such upgrades by the end of the first quarter of
1999. The testing and implementation of the critical information technology
is expected to be completed by the end of the second quarter of 1999.
The assessment phase of the other components of the Company's information
technology hardware and software began in the fourth quarter of 1998 and is
expected to be completed by the end of the first quarter of 1999. The
remediation, testing and implementation of those components is expected to be
completed by the end of the third quarter of 1999.
The Company expects to have completed the assessment phase of non-information
technology exposures by the end of the first quarter of 1999. The
remediation, testing and implementation of those systems is expected to be
completed by the end of the third quarter of 1999.
NATURE AND LEVEL OF IMPORTANCE OF THIRD PARTIES AND THEIR EXPOSURE TO THE
YEAR 2000
The Company is in the process of identifying significant suppliers and other
third parties with which the Company does business to assess their compliance
with and the Company's exposure to their non-compliance with Year 2000
issues. The Company expects to have completed this assessment by the end of
the first quarter of 1999. There can be no guarantee that the systems of such
suppliers will be timely converted and would not have an adverse effect on
the Company.
RISKS
Management of the Company believes it has an effective program in place to
resolve Year 2000 issues in a timely manner. As noted above, the Company has
not yet completed all necessary phases of the Year 2000 program. In the
event the Company does not complete any additional phases of the Year 2000
program, the Company would be unable to fully utilize its general ledger and
billing computer systems. The Company could experience delays in collecting
rents from tenants in the event their systems are not Year 2000 compliant.
The Company also faces operational risks at its operating properties if
certain equipment located at or related to the operation of those properties
is not Year 2000 compliant. In addition, disruptions in the economy
generally resulting from Year 2000 issues could also materially adversely
affect the Company. The amount of lost revenue cannot be reasonably
estimated at this time.
CONTINGENCY PLANS
The Company has contingency plans for certain critical applications and is
working on such plans for others. These contingency plans include, among
other actions, utilizing offsite vendor hardware and software to process
general ledger and billing transactions related to the operation of
20
<PAGE>
HORIZON GROUP PROPERTIES, INC.
Management's Discussion and Analysis of Financial Condition
and Results of Operations
For the three and nine months ended September 30, 1998
(unaudited)
the Company and its properties and the manual operation of certain equipment
at the Company's operating properties. Since the Company cannot anticipate
all possible future outcomes of the year 2000 problem, nor predict the
readiness of entities with which it transacts business, there can be no
assurance these events will not have a material adverse effect on the
Company's business, financial condition, results of operations or cash flows.
OTHER YEAR 2000 ISSUES
The majority of actions previously taken and expected to be taken by the
Company to be Year 2000 compliant with respect to its software have been or
would have been made in the ordinary course of utilizing such software.
Typically, such actions involve updating existing software with newer
versions, which the Company typically does on an ongoing basis. The Company
maintains an agreement with JD Edwards which entitles it to upgrades of its
general ledger and billing systems on a periodic basis. The Company expects
to spend approximately $10,000 to upgrade the software used in its voicemail
system and the operating system and network software related to the Company's
AS/400 computer in order to make them Year 2000 compliant. The Company has
not fully completed the assessment phase related to other software and
hardware and cannot currently quantify the cost of other actions which may be
required to become Year 2000 compliant. The Company expects to internally
fund or lease the hardware or software required to become Year 2000 compliant.
The Company's IT department is conducting its Year 2000 compliance programs
simultaneously with its other functions. To date, such actions have not, and
the Company does not expect future actions in this regard, to significantly
impact other projects undertaken by the IT department.
21
<PAGE>
HORIZON GROUP PROPERTIES, INC.
Part II - Other Information
ITEM 1. LEGAL PROCEEDINGS - None.
ITEM 2. CHANGES IN SECURITIES - None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
The Company has loans totaling $3.0 million as of September 30, 1998 secured
by a mortgage on the office building and related equipment which the Company
utilizes as a corporate office in Norton Shores, Michigan. This building was
previously owned by an affiliate of Horizon and was contributed to the
Company pursuant to the Contribution Agreement. The consent of the lender to
the previous owner of the property was required in connection with the
transfer of the property to the Company. The Company is currently seeking
such consent but as of November 13, 1998, such consent has not been obtained.
The Company also has a $4.0 million revolving credit facility that matured
October 31, 1998. Prime is obligated to lend the Company $4.0 million at an
interest rate of 10% (the "Prime Loan") in order to repay such indebtedness
pursuant to the terms of a Working Capital Agreement between the Company and
Prime (the "Working Capital Agreement"). The Company has requested such
funds from Prime, but as of November 13, 1998, Prime had not lent the funds
to the Company. The terms of the Working Capital Agreement require the
Company to repay the Prime Loan or other related indebtedness on which Prime
is contingently liable to the extent of net proceeds from an equity offering
or the sale of the Company's Algodones, New Mexico Outlet Center.
The transfer of the general partnership interest in MG Patchogue Limited
Partnership pursuant to the Contribution Agreement also required the consent
of MG Patchogue Limited Partnership's mortgage lender. The Company is
currently seeking such consent but, as of November 13, 1998 such consent had
not been obtained.
MG Patchogue II Limited Partnership, of which the Company is 1% general
partner and 44% limited partner, is subject to indebtedness totaling
approximately $11.8 million which originally matured August 14, 1998. The
lender has indicated its willingness to extend such facility to November 12,
1998. The Company is seeking to further extend the maturity date. Nomura
originally issued a commitment to lend the partnership $14 million under the
HGP Credit Facility on or before September 1, 1998 and has verbally indicated
that it may consider such refinancing after such date. The consent of the
limited partners is required in order to complete such financing with Nomura.
The Company is currently seeking such consent, but as of November 13, 1998
such consent had not been obtained. Prime is a guarantor on the
indebtedness. If the financing with Nomura is completed, the Company will
utilize the proceeds of such financing to repay the existing indebtedness and
repay the $2.2 million loan which it received from Prime as discussed above
in connection with the HGP Credit Facility. The Company accounts for its
investment in this partnership using the equity method of accounting.
The Company can give no assurances that it will be able to obtain the above
mentioned consents or that it will be able to finance or refinance its
indebtedness as it matures or that any such financing will be obtained will
be on favorable terms. Any such failure to obtain such consents or such
financings could have a material adverse effect upon the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - None
ITEM 5. OTHER INFORMATION
22
<PAGE>
HORIZON GROUP PROPERTIES, INC.
Part II - Other Information
ITEM 6. EXHIBITS OR REPORTS ON FORM 8-K
(a) Exhibits
Exhibit 3(i) Articles of Incorporation of Horizon Group Properties, Inc.
(the "Company")(1)
Exhibit 3(ii) By-laws of the Company(1)
Exhibit 4.1 Specimen certificate for common stock, $.01 par value per
share, of the Company(1)
Exhibit 10.1 Sky Merger Corp. Registration Statement on Form S-4
(excluding exhibits thereto), as filed with the Securities
and Exchange Commission on May 12, 1998 (Registration No.
333-51285)(1)
Exhibit 10.2 Amended and Restated Agreement and Plan of Merger by and
among Prime Retail, Inc., Prime Retail, L.P., Horizon Group,
Inc., Sky Merger Corp., the Company, Horizon Group
Properties, L.P. and Horizon/Glen Outlet Centers Limited
Partnership dated as of February 1, 1998 (Incorporated
by reference to Exhibit 10(a) to Horizon Group, Inc.'s
current report on Form 8-K dated February 1, 1998 (SEC File
No. 1-12424)(1)
Exhibit 10.3 Form of 1998 Stock Option Plan of the Company(1)
Exhibit 10.4 Employment Agreement between Gary J. Skoien and the
Company(1)
Exhibit 10.5 Employment Agreement between David R. Tinkham and the
Company(1)
Exhibit 10.6 Form of Indemnification Agreement for the Board of Directors
of the Company(1)
Exhibit 10.7 Form of Registration Rights Agreement(1)
Exhibit 10.8 Form of Contribution Agreement (incorporated by reference to
Appendix E to Exhibit 10.1)(1)
Exhibit 10.9 Employment Agreement between Richard Berman and the Company
(3)
Exhibit 10.10 Working Capital Agreement with Prime Retail, Inc. (3)
Exhibit 10.11 Loan Agreement dated as of June 15, 1998 by and among Third
Horizon Group Limited Partnership, Nebraska Crossing Factory
Shops, L.L.C., and Indiana Factory Shops, L.L.C. and Nomura
Asset Capital Corporation(2)
Exhibit 10.12 Form of Deed of Trust, Assignment of Leases and Rents and
Security Agreement with Nomura Asset Capital Corporation(2)
Exhibit 10.13 Form of Mortgage, Assignment of Leases and Rents and Security
Agreement by and between Horizon Group Properties, Inc. and
Nomura Asset Capital Corporation(2)
Exhibit 10.14 Form of Assignment of Leases and Rents by and between Horizon
Group Properties, Inc. and Nomura Asset Capital
Corporation(2)
Exhibit 10.15 Guaranty dated as of June 15, 1998 by the Company and Horizon
Group Properties, L.P. to and for the benefit of Nomura Asset
Capital Corporation(2)
Exhibit 10.16 Guaranty and Indemnity Agreement dated as of June 15, 1998 by
and among the Company, Horizon Group Properties, L.P., Prime
Retail, Inc., and Prime Retail, L.P.(2)
Exhibit 10.17 Assignment and Assumption Agreement, dated as of June 15,
1998 by and among Prime Retail, Inc., Prime Retail, L.P.,
Indianapolis Factory Shops Limited Partnership, and Indiana
Factory Shops, L.L.C. (3)
Exhibit 10.18 Assignment and Assumption Agreement, dated as of June 15,
1998 by and among Prime Retail, Inc., Prime Retail, L.P.,
Nebraska Factory Shops Limited Partnership, and Nebraska
Factory Shops L.L.C. (3)
Exhibit 10.19 Form of Option Agreement (3)
Exhibit 27 Financial Data Schedule
Exhibit 99 Excerpt of Press Release issued by the Company on June 15,
1998 announcing the completion of
the debt financing with Nomura Asset Capital Corporation(2)
1 Incorporated by reference to the Company's Registration Statement on Form
10, as amended, dated as of June 4, 1998 (Commission file no. 0-24123).
2 Incorporated by reference to the Company's Current Report on Form 8-K dated
as of June 30, 1998 (Commission file no. 0-24123).
3 Incorporated by reference to the Company's Form 10-Q dated as of August 14,
1998 (Commission file no. 0-24123).
23
<PAGE>
HORIZON GROUP PROPERTIES, INC.
Part II - Other Information
(b) Reports on Form 8-K
None.
24
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HORIZON GROUP PROPERTIES, INC.
Registrant
Date: November 13, 1998 By: /s/ Gary J. Skoien
- ------------------------ ------------------------------------
Gary J. Skoien, President and
Chief Executive Officer
Date: November 13, 1998 By: /s/ David R. Tinkham
- ------------------------ ------------------------------------
David R. Tinkham, Chief Accounting
and Chief Financial Officer
25
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<PAGE>
<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> 2,502
<SECURITIES> 0
<RECEIVABLES> 360
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 142,951
<DEPRECIATION> 1,494
<TOTAL-ASSETS> 165,134
<CURRENT-LIABILITIES> 0
<BONDS> 115,200
0
0
<COMMON> 28
<OTHER-SE> 33,270
<TOTAL-LIABILITY-AND-EQUITY> 165,134
<SALES> 0
<TOTAL-REVENUES> 21,234
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 16,609
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 8,459
<INCOME-PRETAX> (3,834)
<INCOME-TAX> 0
<INCOME-CONTINUING> (3,834)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (3,844)
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
</TABLE>
