As filed with the Securities and Exchange Commission on October 23, 1998
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K/A
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934 For the fiscal year ended December 31, 1997
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[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the Transition period from _____________ to
_______________
Commission File Number 1-8063
Capital Trust
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(Exact name of registrant as specified in its charter)
California 94-6181186
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
605 Third Avenue, 26th Floor, New York, NY 10016
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (212) 655-0220
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Securities registered pursuant to Section 12(b) of the Act:
Name of Each Exchange
Title of Each Class on Which Registered
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Class A Common Shares of Beneficial Interest, New York Stock Exchange
$1.00 par value ("Class A Common Shares") Pacific Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
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 the filing
requirements for at least the past 90 days. Yes X No __
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K (ss.229.405 of this chapter) is not contained herein, and will
not be contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. [ ]
<PAGE>
MARKET VALUE
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Based on the closing sales price of $10.00 per share, the aggregate market value
of the outstanding Class A Common Shares held by non-affiliates of the
registrant as of February 18, 1998 was $111,433,570.
OUTSTANDING SHARES
------------------
As of February 18, 1998 there were 18,157,150 outstanding Class A Common Shares.
The Class A Common Shares are listed on the New York and Pacific Stock Exchanges
(trading symbol "CT"). Trading is reported in many newspapers as "CapitalTr".
DOCUMENTS INCORPORATED BY REFERENCE
-----------------------------------
Part III incorporates information by reference from the Registrant's definitive
Proxy Statement to be filed with the Commission within 120 days after the close
of the Registrant's fiscal year.
<PAGE>
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CAPITAL TRUST
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<TABLE>
<CAPTION>
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PART I PAGE
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<S> <C> <C>
Item 1. Business 1
Item 2. Properties 12
Item 3. Legal Proceedings 12
Item 4. Submission of Matters to a Vote of Security Holders 12
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PART II
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Item 5. Market for the Registrant's Common Equity and Related Security
Holder Matters 13
Item 6. Selected Financial Data 14
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations 15
Item 8. Financial Statements and Supplementary Data 22
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure 23
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Signatures 24
Index to Consolidated Financial Statements F-1
</TABLE>
-i-
<PAGE>
EXPLANATORY NOTE FOR PURPOSES OF THE "SAFE HARBOR PROVISIONS" OF SECTION 21E OF
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THE SECURITIES AND EXCHANGE ACT OF 1934, AS AMENDED
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EXCEPT FOR HISTORICAL INFORMATION CONTAINED HEREIN, THIS ANNUAL REPORT ON
FORM 10-K CONTAINS FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF THE SECTION
21E OF THE SECURITIES AND EXCHANGE ACT OF 1934, AS AMENDED, WHICH INVOLVE
CERTAIN RISKS AND UNCERTAINTIES. FORWARD-LOOKING STATEMENTS ARE INCLUDED WITH
RESPECT TO, AMONG OTHER THINGS, THE COMPANY'S CURRENT BUSINESS PLAN, BUSINESS
STRATEGY AND PORTFOLIO MANAGEMENT. THE COMPANY'S ACTUAL RESULTS OR OUTCOMES MAY
DIFFER MATERIALLY FROM THOSE ANTICIPATED. IMPORTANT FACTORS THAT THE COMPANY
BELIEVES MIGHT CAUSE SUCH DIFFERENCES ARE DISCUSSED IN THE CAUTIONARY STATEMENTS
PRESENTED UNDER THE CAPTION "FACTORS WHICH MAY AFFECT THE COMPANY'S BUSINESS
STRATEGY" IN ITEM 1 OF THIS FORM 10-K OR OTHERWISE ACCOMPANY THE FORWARD-LOOKING
STATEMENTS CONTAINED IN THIS FORM 10-K. IN ASSESSING FORWARD-LOOKING STATEMENTS
CONTAINED HEREIN, READERS ARE URGED TO READ CAREFULLY ALL CAUTIONARY STATEMENTS
CONTAINED IN THIS FORM 10-K.
-ii-
<PAGE>
PART I
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Item 1. Business
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General
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Capital Trust (together with its subsidiaries the "Company") is a recently
recapitalized specialty finance company designed to take advantage of
high-yielding lending and investment opportunities in commercial real estate and
related assets. The Company makes investments in various types of
income-producing commercial real estate and its current investment program
emphasizes senior and junior commercial mortgage loans, preferred equity
investments, direct equity investments and subordinated interests in commercial
mortgage-backed securities ("CMBS"). The Company's current business plan
contemplates that a majority of the loans and other assets held in its portfolio
for the long-term will be structured so that the Company's investment is
subordinate to third-party financing but senior to the owner/operator's equity
position. The Company also provides real estate investment banking, advisory and
asset management services through its wholly owned subsidiary, Victor Capital
Group, L.P. ("Victor Capital"). The Company anticipates that it will invest in a
diverse array of real estate and finance-related assets and enterprises,
including operating companies, which satisfy its investment criteria.
In executing its business plan, the Company utilizes the extensive real
estate industry contacts and relationships of Equity Group Investments, Inc.
("EGI"). EGI is a privately held real estate and corporate investment firm
controlled by Samuel Zell, who serves as chairman of the Board of Trustees of
the Company. EGI's affiliates include Equity Office Properties Trust and Equity
Residential Properties Trust, the largest U.S. real estate investment trusts
("REITs") operating in the office and multifamily residential sectors,
respectively. The Company also draws upon the extensive client roster of Victor
Capital for potential investment opportunities.
Developments with Respect to Implementation of the Company's Current Business
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Plan During Fiscal Year 1997
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During the past fiscal year, the Company ceased operations as a real
estate investment trust following full implementation of its current business
plan in July 1997. This action coincided with the appointment of a new
management team following the acquisition of Victor Capital and a private
placement of $33 million of preferred equity in the Company to Veqtor Finance
Company, LLC ("Veqtor"), an affiliate of certain members of the new management
team that currently owns 19,227,251 (or approximately 63%) of the outstanding
voting shares of the Company.
In connection with the implementation of its current business plan, in
September 1997, the Company entered into a credit arrangement with a commercial
lender that provides for a three-year $150 million line of credit (the "Credit
Facility"). In addition, in December 1997, the Company completed a public
securities offering (the "Offering") by issuing 9,000,000 new class A common
shares of beneficial interest, $1.00 par value ("Class A Common Shares"), in the
Company at $11.00 per share. The Company raised approximately $91.4 million in
net proceeds from the Offering. The Company believes that the Credit Facility
and the proceeds of the Offering provide the Company with the capital necessary
to expand and diversify its portfolio of loans and other investments and enable
the Company to compete for and consummate larger transactions meeting the
Company's target risk/return profile.
Since initiating full implementation of the current business plan, the
Company has completed twelve loan and investment transactions. The Company has
originated or acquired six Mortgage Loans (as defined herein) totaling $169.7
million (one of which was satisfied prior to December 31, 1997), five Mezzanine
Loans (as defined herein) totaling $75.0 million and one CMBS subordinated
interest for $49.6 million.
1
<PAGE>
As of December 31, 1997, the Company's portfolio of financial assets
consisted of five Mortgage Loans, five Mezzanine Loans and three Other Loans
originated prior to the commencement of the new business plan (collectively the
"Loan Portfolio") and one CMBS Subordinated Interest. There were no
delinquencies or losses on such assets as of December 31, 1997 and for the year
then ended. The table set forth below details the composition of the Loan
Portfolio at December 31, 1997.
<TABLE>
<CAPTION>
Underlying
Property Number Outstanding Unfunded
Type of Loan Type of Loans Commitment Balance Commitment Maturity Interest Rate
- ------------- ---------- -------- ---------- ------------- ---------- -------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
Senior Mortgage Office 2 $ 69,977,000 $ 54,642,000 $ 15,335,000 1998 to Fixed: 11.00%
Loans 2000 Variable: LIBOR +
3.75%
Subordinate Office 3 81,300,000 69,707,000 11,561,000 1999 to Variable: LIBOR +
Mortgage Loans 2000 5.00% to LIBOR +
8.66%
Mezzanine Office / 5 76,395,000 76,373,000 -- 2000 to Fixed: 11.62% to
Loans(1) Assisted 2007 12.00%
Living Variable: LIBOR +
5.50%
Other Loans Retail 3 2,550,000 2,062,000 -- 1999 to Fixed: 8.50% to 9.50%
2017
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Total $230,222,000 $202,784,000 $ 26,896,000
============ ============ ============
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</TABLE>
(1) Includes a $22.0 million mezzanine financing in the form of a customized
preferred equity interest in a property owning limited liability company.
Included in the Subordinate Mortgage Loans described in the table above is
a $45.3 million second mortgage loan (the "1325 Mortgage Loan") to 1325 Limited
Partnership (the "1325 Borrower"). Proceeds from the 1325 Mortgage Loan were
used to repay existing debt secured by the commercial office tower located at
1325 Avenue of the Americas in New York City (the "1325 Property"). The 1325
Mortgage Loan is secured by a second mortgage on the 1325 Property. In addition,
the 1325 Mortgage Loan is secured by various other collateral owned by a
principal of the 1325 Borrower as well as a limited personal guarantee of a
principal of the 1325 Borrower. Collection under the personal guarantee and the
other collateral is limited to $10.0 million. The 1325 Mortgage Loan is
subordinate to a first mortgage on the 1325 Property of approximately $185
million. The 1325 Mortgage Loan has a term of two years, which may be extended
by the 1325 Borrower for an additional year, upon payment of an extension fee,
and bears interest at a specified rate above LIBOR, which such rate increases
during the extension period. Under certain circumstances, the 1325 Borrower may
defer a portion of the interest accrued on the 1325 Mortgage Loan during the
initial two-year term subject to a specified minimum rate. The 1325 Mortgage
Loan is interest only during the initial two-year term with excess cash flow
after determined reserves going towards amortization during the extension term.
The 1325 Property, which was completed in 1990, is a 34-story office building in
New York City containing approximately 750,000 square feet. The 1325 Property is
approximately 99% occupied. In assessing the 1325 Property, the Company
considered several material factors, including, but not limited to those
described below.
With respect to sources of revenue, the Company considered: the 1325
Property's occupancy rate of 99% as compared to the overall sub-market occupancy
rate of approximately 91%; the 1325 Property's average annual rental rate of
approximately $37.60 per occupied square foot as compared to competitive office
rental rates in the sub-market ranging from $38.00 to $46.00 per square foot;
the principal businesses, occupations, and professions of the tenants operating
at the 1325 Property, including office tenants such as Warner Brothers, which
occupies approximately 18% of the 1325 Property (with a lease expiration date
which is no earlier than 2010, a base rental rate which compares favorably to
the marketplace, and two five-year renewal options); and the stability afforded
by the 1325 Property's long-term credit-oriented office tenants, nine of whom
occupy approximately 65% of the 1325 Property with lease expiration dates beyond
ten years. With respect to factors relating to expenses, the Registrant
considered: the utility rates at the 1325 Property for electricity, steam, and
water and sewer; the taxes at the 1325 Property which were comparable to tax
rates for similar properties; maintenance and operating expenses which were in
line for similar properties which are operated and maintained in a professional
manner; and the relatively recent construction of the 1325 Property including
significant expenditures for tenant improvement installations.
2
<PAGE>
Included in the Senior Mortgage Loans described in the table above is a
$62.6 million mortgage loan obligation (the "Cortlandt Mortgage Loan") purchased
at a premium of approximately 102%. The Cortlandt Mortgage Loan is secured by a
first mortgage on an approximately 668,000 square foot office and retail
property located at 22 Cortlandt Street in New York City (the "Cortlandt
Property"). Approximately $47.3 million of the loan has been funded and
approximately $15.3 million of the loan represents an unfunded obligation to
fund reserves for interest, tenant improvements, and leasing commissions. The
Cortlandt Mortgage Loan, which matures in January 2001, bears interest at a
fixed spread over LIBOR for its term. Prepayment of the Cortlandt Mortgage Loan
is permitted during the entire loan period. The Cortlandt Mortgage Loan is
subject to a prepayment penalty during the first eighteen months of the loan and
carries no prepayment premium or penalty for the final eighteen months of the
loan. A specified fee is due from the borrower to the Company upon the
satisfaction of the Cortlandt Mortgage Loan. In assessing the Cortlandt
Property, the Company considered several material factors, including, but not
limited to those described below.
With respect to sources of revenue, the Company considered the Cortlandt
Property's occupancy rate of 82.5% as compared to the overall sub-market
occupancy rate of approximately 91%; the Cortlandt Property's average annual
rental rate of approximately $17 per occupied square foot (including the retail
space) and an average annual rental rate of approximately $22 per occupied
square foot for office space as compared to competitive office rental rates in
the sub-market ranging from $22 to $26 per square foot, and the principal
businesses, occupations, and professions of the tenants operating at the
Cortlandt Property, including tenants such as Century 21, a retail tenant, which
occupies approximately 22% of the Cortlandt Property (with a lease expiration
beyond 50 years, a base rental rate which is below comparable base rental rates
in the marketplace, and no renewal options), the State of New York, an office
tenant, which occupies approximately 13% of the Cortlandt Property (with leases
expiring between 2000 and 2002, a base rental rate which compares favorably to
the marketplace, and no renewal options), and the Municipal Credit Union, an
office tenant, which occupies approximately 10% of the Cortlandt Property (with
a lease expiration date which is no earlier than 2014, a base rental rate which
compares favorably to the marketplace, and one five-year extension option).
During the next four years, three leases representing approximately 48,000
square feet or approximately 7% of the Cortlandt Property will mature. These
leases represent approximately $1.4 million of gross revenue per annum or
approximately 17% of the 1998 estimated annual gross revenue of the Cortlandt
Property. With respect to factors relating to expenses, the Company considered:
the utility rates at the Cortlandt Property for electricity, steam and water and
sewer which are comparable to utility rates for similar properties; the taxes at
the Cortlandt Property which were comparable to tax rates for similar
properties; maintenance and operating expenses which were in line for similar
properties which are operated and maintained in a professional manner; and the
recent expenditures for tenant improvement installations at the Cortlandt
Property.
The Company's portfolio of financial assets as of December 31, 1997 also
included an entire junior subordinated class of CMBS, known as the Class B Owner
Trust Certificates, that provides for both interest and principal repayments.
The CMBS investment consists of a security with a face value of $49.6 million
purchased at a discount for $49.2 million plus accrued fees. The investment was
originally collateralized by twenty short-term commercial notes receivable with
original maturities ranging from two to three years. At the time of acquisition,
the investment was subordinated to approximately $351.3 million of senior
securities. At December 31, 1997, the CMBS investment (including interest
receivable) was $49.5 million and had a yield of 8.96%.
Real Estate Lending and Investment Market
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The Company believes that the significant recovery in commercial real
estate property values, coupled with fundamental structural changes in the real
estate capital markets (primarily related to the growth in CMBS issuance), has
created significant market-driven opportunities for finance companies
specializing in commercial real estate lending and investing. Such opportunities
are expected to result from the following developments:
o Scale and Rollover. The U.S. commercial mortgage market--a market that
is comparable in size to the corporate and municipal bond markets--has
approximately $1 trillion in total mortgage debt outstanding, which
debt is primarily held privately. In addition, a significant amount of
commercial mortgage loans held by U.S. financial institutions is
scheduled to mature in the near future.
3
<PAGE>
o Rapid Growth of Securitization. With annual issuance volume of
approximately $44 billion, the total amount of CMBS currently
outstanding has grown to over $170 billion from approximately $6
billion in 1990. To date, the CMBS market expansion has been fueled in
large part by "conduits" which originate whole loans primarily for
resale to financial intermediaries, which in turn package the loans as
securities for distribution to public and private investors.
The Company believes that as securitized lenders replace traditional
lenders such as banks and life insurance companies as the primary
source for commercial real estate finance, borrowers are often
constrained by relatively inflexible underwriting standards, including
lower loan-to-value ratios, thereby creating significant demand for
mezzanine financing (typically between 65% and 90% of total
capitalization). In addition, since many high quality loans may not
immediately qualify for securitization, due primarily to rating agency
guidelines, significant opportunities are created for shorter-maturity
bridge and transition mortgage financings.
o Consolidation. As the real estate market continues to evolve, the
Company expects that consolidation will occur and efficiency will
increase. Over time, the Company believes that the market leaders in
the real estate finance sector will be fully integrated finance
companies capable of originating, underwriting, structuring, managing
and retaining real estate risk.
The Company believes that the commercial real estate capital markets for
both debt and equity are in the midst of dramatic structural change. Although
the issuance volume of CMBS has grown to $44 billion per annum, the terms and
conditions of securitized debt are driven significantly by rating agency
criteria, resulting in restrictive underwriting parameters and relatively
inflexible transaction structures. At the same time, existing equity owners are
faced with high levels of maturing debt that will need to be refinanced, and new
buyers are seeking greater leverage than is available from securitized or
traditional providers. As a result, the need for mezzanine investment capital
has grown significantly. The Company, through its current business plan, seeks
to capitalize on this market opportunity.
Business Strategy
- -----------------
The Company believes that it is well positioned to capitalize on the
resultant opportunities, which, if carefully underwritten, structured and
monitored, represent attractive investments that pose potentially less risk than
direct equity ownership of real property. Further, the Company believes that the
rapid growth of the CMBS market has given rise to opportunities for the Company
to selectively acquire non-investment grade tranches of such securities which
the Company believes are priced inefficiently in terms of their risk/reward
profile.
The Company seeks to generate returns from a portfolio of leveraged
investments. The Company currently pursues investment and lending opportunities
designed to capitalize on inefficiencies in the real estate capital, mortgage
and finance markets. The Company also earns revenue from its real estate
investment banking, investment and management services.
The Company's investment program emphasizes, but is not limited to, the
following general categories of real estate and finance-related assets:
o Mortgage Loans. The Company pursues opportunities to originate and fund
senior and junior mortgage loans ("Mortgage Loans") to commercial real
estate owners and property developers who require interim financing
until permanent financing can be obtained. The Company's Mortgage Loans
are generally not intended to be permanent in nature, but rather are
intended to be of a relatively short-term duration, with extension
options as deemed appropriate, and typically require a balloon payment
of principal at maturity. The Company may also originate and fund
permanent Mortgage Loans in which the Company intends to sell the
senior tranche, thereby creating a Mezzanine Loan.
o Mezzanine Loans. The Company originates high-yielding loans that are
subordinate to first lien mortgage loans on commercial real estate and
are secured either by a second lien mortgage or a pledge of the
ownership interests in the borrowing property owner. Alternatively, the
Company's mezzanine loans can take the form of a preferred equity
investment in the borrower with substantially similar terms
(collectively, "Mezzanine Loans"). Generally, the Company's Mezzanine
4
<PAGE>
Loans have a longer anticipated duration than its Mortgage Loans and
are not intended to serve as transitional mortgage financing.
o Subordinated Interests. The Company pursues rated and unrated
investments in public and private subordinated interests ("Subordinated
Interests") in commercial collateralized mortgage obligations ("CMOs"
or "CMO Bonds") and other CMBS.
o Other Investments. The Company intends to assemble an investment
portfolio of commercial real estate and finance-related assets meeting
the Company's target risk/return profile. The Company is not limited in
the kinds of commercial real estate and finance-related assets in which
it can invest and believes that it is positioned to expand
opportunistically its financing business. The Company may pursue
investments in, among other assets, construction loans, distressed
mortgages, foreign real estate and finance-related assets, operating
companies, including loan origination and loan servicing companies, and
fee interests in real property (collectively, "Other Investments").
The Company seeks to maximize yield through the use of leverage, consistent
with maintaining an acceptable level of risk. Although there may be limits to
the leverage that can be applied to certain of the Company's investments, the
Company does not intend to exceed a debt-to-equity ratio of 5:1. At December 31,
1997, the Company's debt-to-equity ratio was 1.17:1.
Other than restrictions which result from the Company's intent to avoid
regulation under the Investment Company Act of 1940, as amended (the "Investment
Company Act"), the Company is not subject to any restrictions on the particular
percentage of its portfolio invested in any of the above-referenced asset
classes, nor is it limited in the kinds of assets in which it can invest. The
Company has no predetermined limitations or targets for concentration of asset
type or geographic location. Instead of adhering to any prescribed limits or
targets, the Company makes acquisition decisions through asset and collateral
analysis, evaluating investment risks on a case-by-case basis. To the extent
that the Company's assets become concentrated in a few states or a particular
region, the Company's return on investment will become more dependent on the
economy of such states or region. Until appropriate investments are made, cash
available for investment may be invested in readily marketable securities or in
interest-bearing deposit accounts.
Principal Investment Categories
- -------------------------------
The discussion below describes the principal categories of assets
emphasized in the Company's current business plan.
Mortgage Loans. The Company actively pursues opportunities to originate and
fund Mortgage Loans to real estate owners and property developers who need
interim financing until permanent financing can be obtained. The Company's
Mortgage Loans generally are not intended to be "permanent" in nature, but
rather are intended to be of a relatively short-term duration, with extension
options as deemed appropriate, and generally require a balloon payment at
maturity. These types of loans are intended to be higher-yielding loans with
higher interest rates and commitment fees. Property owners or developers in the
market for these types of loans include, but are not limited to, promoters of
pre-formation REITs desiring to acquire attractive properties to contribute to
the REIT before the formation process is complete, traditional property owners
and operators who desire to acquire a property before it has received a
commitment for a long-term mortgage from a traditional commercial mortgage
lender, or a property owner or investor who has an opportunity to purchase its
existing mortgage debt or third party mortgage debt at a discount; in each
instance, the Company's loan would be secured by a Mortgage Loan. The Company
may also originate traditional, long-term mortgage loans and, in doing so, would
compete with traditional commercial mortgage lenders. In pursuing such a
strategy, the Company generally intends to sell or refinance the senior portion
of the mortgage loan, individually or in a pool, and retain a Mezzanine Loan. In
addition, the Company believes that, as a result of the recent increase in
commercial real estate securitizations, there are attractive opportunities to
originate short-term bridge loans to owners of mortgaged properties that are
temporarily prevented as a result of timing and structural reasons from securing
long-term mortgage financing through securitization.
Mezzanine Loans. The Company seeks to take advantage of opportunities to
provide mezzanine financing on commercial property that is subject to first lien
mortgage debt. The Company believes that there is a growing need for mezzanine
capital (i.e., capital representing the level between 65% and 90% of
5
<PAGE>
property value) as a result of current commercial mortgage lending practices
setting loan-to-value targets as low as 65%. The Company's mezzanine financing
takes the form of subordinated loans, commonly known as second mortgages, or, in
the case of loans originated for securitization, partnership loans (also known
as pledge loans) or preferred equity investments. For example, on a commercial
property subject to a first lien mortgage loan with a principal balance equal to
70% of the value of the property, the Company could lend the owner of the
property (typically a partnership) an additional 15% to 20% of the value of the
property. The Company believes that as a result of (i) the significant changes
in the lending practices of traditional commercial real estate lenders,
primarily relating to more conservative loan-to-value ratios, and (ii) the
significant increase in securitized lending with strict loan-to-value ratios
imposed by the rating agencies, there will continue to be an increasing demand
for mezzanine capital by property owners.
Typically in a Mezzanine Loan, as security for its debt to the Company, the
property owner would pledge to the Company either the property subject to the
first lien (giving the Company a second lien position typically subject to an
inter-creditor agreement) or the limited partnership and/or general partnership
interest in the owner. If the owner's general partnership interest is pledged,
then the Company would be in a position to take over the operation of the
property in the event of a default by the owner. By borrowing against the
additional value in their properties, the property owners obtain an additional
level of liquidity to apply to property improvements or alternative uses.
Mezzanine Loans generally provide the Company with the right to receive a stated
interest rate on the loan balance plus various commitment and/or exit fees. In
certain instances, the Company may negotiate to receive a percentage of net
operating income or gross revenues from the property, payable to the Company on
an ongoing basis, and a percentage of any increase in value of the property,
payable upon maturity or refinancing of the loan, or the Company will otherwise
seek terms to allow the Company to charge an interest rate that would provide an
attractive risk-adjusted return. Alternatively, the Mezzanine Loans can take the
form of a non-voting preferred equity investment in a single purpose entity
borrower with substantially similar terms.
In connection with its mezzanine lending and investing activities, the
Company may elect to pursue strategic alliances with lenders such as commercial
banks and Wall Street conduits who do not have a mezzanine lending capability
and are therefore perceived to be at a competitive disadvantage. The Company
believes that such alliances could accelerate the Company's loan origination
volume, assist in performing underwriting due diligence and reduce potential
overhead.
Subordinated Interests. The Company acquires rated and unrated Subordinated
Interests in commercial mortgage-backed securities issued in public or private
transactions. CMBS typically are divided into two or more classes, sometimes
called "tranches." The senior classes are higher "rated" securities, which are
rated from low investment grade ("BBB") to higher investment grade ("AA" or
"AAA"). The junior, subordinated classes typically include a lower rated,
non-investment grade "BB" and "B" class, and an unrated, high yielding, credit
support class (which generally is required to absorb the first losses on the
underlying mortgage loans). The Company currently invests in the non-investment
grade tranches of Subordinated Interests. The Company may pursue the acquisition
of performing and non-performing (i.e., defaulted) Subordinated Interests. CMBS
generally are issued either as CMOs or pass-through certificates that are not
guaranteed by an entity having the credit status of a governmental agency or
instrumentality, although they generally are structured with one or more of the
types of credit enhancement arrangements to reduce credit risk. In addition,
CMBS may be illiquid.
The credit quality of CMBS depends on the credit quality of the underlying
mortgage loans forming the collateral for the securities. CMBS are backed
generally by a limited number of commercial or multifamily mortgage loans with
larger principal balances than those of single family mortgage loans. As a
result, a loss on a single mortgage loan underlying a CMBS will have a greater
negative effect on the yield of such CMBS, especially the Subordinated Interests
in such CMBS.
Before acquiring Subordinated Interests, the Company performs certain
credit underwriting and stress testing to attempt to evaluate future performance
of the mortgage collateral supporting such CMBS, including (i) a review of the
underwriting criteria used in making mortgage loans comprising the Mortgage
Collateral for the CMBS, (ii) a review of the relative principal amounts of the
loans, their loan-to-value ratios as well as the mortgage loans' purpose and
documentation, (iii) where available, a review of the historical performance of
the loans originated by the particular originator and (iv) some level of
re-underwriting the underlying mortgage loans, including, selected site visits.
6
<PAGE>
Unlike the owner of mortgage loans, the owner of Subordinated Interests in
CMBS ordinarily does not control the servicing of the underlying mortgage loans.
In this regard, the Company attempts to negotiate for the right to cure any
defaults on senior CMBS classes and for the right to acquire such senior classes
in the event of a default or for other similar arrangements. The Company may
also seek to acquire rights to service defaulted mortgage loans, including
rights to control the oversight and management of the resolution of such
mortgage loans by workout or modification of loan provisions, foreclosure, deed
in lieu of foreclosure or otherwise, and to control decisions with respect to
the preservation of the collateral generally, including property management and
maintenance decisions ("Special Servicing Rights") with respect to the mortgage
loans underlying CMBS in which the Company owns a Subordinated Interest. Such
rights to cure defaults and Special Servicing Rights may give the Company, for
example, some control over the timing of foreclosures on such mortgage loans
and, thus, may enable the Company to reduce losses on such mortgage loans. The
Company is currently a special servicer with respect to one of its Subordinated
Interest investments, but is not currently a rated special servicer. The Company
may seek to become rated as a special servicer, or acquire a rated special
servicer. Until the Company can act as a rated special servicer, it will be
difficult to obtain Special Servicing Rights with respect to the mortgage loans
underlying Subordinated Interests. Although the Company's strategy is to
purchase Subordinated Interests at a price designed to return the Company's
investment and generate a profit thereon, there can be no assurance that such
goal will be met or, indeed, that the Company's investment in a Subordinated
Interest will be returned in full or at all.
The Company believes that it will not be, and intends to conduct its
operations so as not to become, regulated as an investment company under the
Investment Company Act. The Investment Company Act generally exempts entities
that are "primarily engaged in purchasing or otherwise acquiring mortgages and
other liens on and interests in real estate" ("Qualifying Interests"). The
Company intends to rely on current interpretations by the staff of the
Commission in an effort to qualify for this exemption. To comply with the
foregoing guidance, the Company, among other things, must maintain at least 55%
of its assets in Qualifying Interests and also may be required to maintain an
additional 25% in Qualifying Interests or other real estate-related assets.
Generally, the Mortgage Loans and certain of the Mezzanine Loans in which the
Company may invest constitute Qualifying Interests. While Subordinated Interests
generally do not constitute Qualifying Interests, the Company may seek to
structure such investments in a manner where the Company believes such
Subordinated Interests may constitute Qualifying Interests. The Company may
seek, where appropriate, (i) to obtain foreclosure rights or other similar
arrangements (including obtaining Special Servicing Rights before or after
acquiring or becoming a rated special servicer) with respect to the underlying
mortgage loans, although there can be no assurance that it will be able to do so
on acceptable terms or (ii) to acquire Subordinated Interests collateralized by
whole pools of mortgage loans. As a result of obtaining such rights or whole
pools of mortgage loans as collateral, the Company believes that the related
Subordinated Interests will constitute Qualifying Interests for purposes of the
Investment Company Act. The Company does not intend, however, to seek an
exemptive order, no-action letter or other form of interpretive guidance from
the Commission or its staff on this position. Any decision by the Commission or
its staff advancing a position with respect to whether such Subordinated
Interests constitute Qualifying Interests that differs from the position taken
by the Company could have a material adverse effect on the Company.
7
<PAGE>
Other Investments The Company may also pursue a variety of complementary
commercial real estate and finance-related businesses and investments in
furtherance of executing its current business plan. Such activities include, but
are not limited to, investments in other classes of mortgage-backed securities,
financial asset securitization investment trusts ("FASITs"), distressed
investing in non-performing and sub-performing loans and fee owned commercial
real property, whole loan acquisition programs, foreign real estate-related
asset investments, note financings, environmentally hazardous lending, operating
company investing/lending, construction and rehabilitation lending and other
types of financing activity. Any lending with regard to the foregoing may be on
a secured or an unsecured basis and will be subject to risks similar to those
attendant to investing in Mortgage Loans, Mezzanine Loans and Subordinated
Interests. The Company seeks to maximize yield by managing credit risk by
employing its credit underwriting procedures, although there can be no assurance
that the Company will be successful in this regard. The Company is actively
investigating potential business acquisition opportunities that it believes will
complement the Company's operations including firms engaged in commercial loan
origination, loan servicing, mortgage banking, financing activities, real estate
loan and property acquisitions and real estate investment banking and advisory
services similar to or related to the services provided by the Company. No
assurance can be given that any such transactions will be negotiated or
completed or that any business acquired can be efficiently integrated with the
Company's ongoing operations.
Portfolio Management
- --------------------
The following describes some of the portfolio management practices that the
Company may employ from time to time to earn income, facilitate portfolio
management (including managing the effect of maturity or interest rate
sensitivity) and mitigate risk (such as the risk of changes in interest rates).
There can be no assurance that the Company will not amend or deviate from these
policies or adopt other policies in the future.
Leverage and Borrowing. The success of the Company's current business plan
is dependent upon the Company's ability to grow its portfolio of invested assets
through the use of leverage. The Company intends to leverage its assets through
the use of, among other things, bank credit facilities including the Credit
Facility, secured and unsecured borrowings, repurchase agreements and other
borrowings, when there is an expectation that such leverage will benefit the
Company; such borrowings may have recourse to the Company in the form of
guarantees or other obligations. If changes in market conditions cause the cost
of such financing to increase relative to the income that can be derived from
investments made with the proceeds thereof, the Company may reduce the amount of
leverage it utilizes. Obtaining the leverage required to execute the current
business plan will require the Company to maintain interest coverage ratios and
other covenants meeting market underwriting standards. In leveraging its
portfolio, the Company plans not to exceed a debt-to-equity ratio of 5:1. The
Company has also agreed it will not incur any indebtedness if the Company's
debt-to-equity ratio would exceed 5:1 without the prior written consent of the
holders of a majority of the outstanding Class A Preferred Shares.
Leverage creates an opportunity for increased income, but at the same time
creates special risks. For example, leveraging magnifies changes in the net
worth of the Company. Although the amount owed will be fixed, the Company's
assets may change in value during the time the debt is outstanding. Leverage
will create interest expense for the Company that can exceed the revenues from
the assets retained. To the extent the revenues derived from assets acquired
with borrowed funds exceed the interest expense the Company will have to pay,
the Company's net income will be greater than if borrowing had not been used.
Conversely, if the revenues from the assets acquired with borrowed funds are not
sufficient to cover the cost of borrowing, the net income of the Company will be
less than if borrowing had not been used.
In order to grow and enhance its return on equity, the Company currently
utilizes two sources for liquidity and leverage: the Credit Facility and
repurchase agreements.
Credit Facility. As previously discussed, the Company entered into the
Credit Facility with a commercial lender in September 1997 that provides for a
three-year $150 million line of credit. The Credit Facility provides for
advances to fund lender-approved loans and investments made by the Company
("Funded Portfolio Assets").
The obligations of the Company under the Credit Facility are to be secured
by pledges of the Funded Portfolio Assets acquired with advances under the
Credit Facility. Borrowings under the Credit Facility bear interest at specified
rates over LIBOR, which rate may fluctuate based upon the credit quality of the
8
<PAGE>
Funded Portfolio Assets. Upon the signing of the credit agreement, a commitment
fee was due and when the total borrowings under the agreement exceed $75
million, an additional fee is due. In addition, each advance requires payment of
a drawdown fee. The Credit Facility provides for margin calls on asset-specific
borrowings in the event of asset quality and/or market value deterioration as
determined under the credit agreement. The Credit Facility contains customary
representations and warranties, covenants and conditions and events of default.
The Credit Facility also contains a covenant obligating the Company to avoid
undergoing an ownership change that results in Craig M. Hatkoff, John R. Klopp
or Samuel Zell no longer retaining their senior offices and trusteeships with
the Company and practical control of the Company's business and operations.
On December 31, 1997, the unused Credit Facility amounted to $70.1 million
providing the Company with adequate liquidity for its short term needs.
Repurchase Agreements. The Company has entered into four repurchase
agreements and may enter into other such agreements under which the Company
would sell assets to a third party with the commitment that the Company
repurchase such assets from the purchaser at a fixed price on an agreed date.
Repurchase agreements may be characterized as loans to the Company from the
other party that are secured by the underlying assets. The repurchase price
reflects the purchase price plus an agreed market rate of interest, which is
generally paid on a monthly basis.
Interest Rate Management Techniques
- -----------------------------------
The Company has engaged in and will continue to engage in a variety of
interest rate management techniques for the purpose of managing the effective
maturity or interest rate of its assets and/or liabilities. These techniques
also may be used to attempt to protect against declines in the market value of
the Company's assets resulting from general trends in debt markets. Any such
transaction is subject to risks and may limit the potential earnings on the
Company's investments in real estate-related assets. Such techniques include
interest rate swaps (the exchange of fixed rate payments for floating-rate
payments) and interest rate caps. The Company uses interest rate swaps and
interest rate caps to hedge mismatches in interest rate maturities, to reduce
the Company's exposure to interest rate fluctuations and to provide more stable
spreads between investment yields and the rates on their financing sources.
Amounts arising from the differential are recognized as an adjustment to
interest income related to the earning asset. In June 1998, The FASB issued
statement No. 133, "Accounting for Derivative Instruments and Hedging
Activities" ("SFAS No. 133"), effective for fiscal years beginning after June
15, 1999, although earlier application is permitted. The adoption of SFAS No.
133 is not expected to have a material impact on the Company's business strategy
or financial reporting.
Real Estate Investment Banking, Advisory and Asset Management Services
- ----------------------------------------------------------------------
The Company provides real estate investment banking, advisory and asset
management services through its Victor Capital subsidiary, which commenced
operations in 1989. Victor Capital provides such services to an extensive client
roster of real estate investors, owners, developers and financial institutions
in connection with mortgage financings, securitizations, joint ventures, debt
and equity investments, mergers and acquisitions, portfolio evaluations,
restructurings and disposition programs. Victor Capital's senior professionals
average 16 years of experience in the real estate financial services industry.
Real Estate Investment Banking and Advisory Services. Victor Capital
provides an array of real estate investment banking and advisory services to a
variety of clients such as financial institutions, including banks and insurance
companies, public and private owners of commercial real estate, creditor
committees and investment funds. In such transactions, Victor Capital typically
negotiates for a retainer and/or a monthly fee plus disbursements; these fees
are typically applied against a success-oriented fee, which is based on
achieving the client's goals. While dependent upon the size and complexity of
the transaction, Victor Capital's fees for capital raising assignments are
generally in the range of 0.5% to 3% of the total amount of debt and equity
raised. For pure real estate advisory assignments, a fee is typically negotiated
in advance and can take the form of a flat fee or a monthly retainer. In certain
instances, Victor Capital negotiates for the right to receive a portion of its
compensation in-kind, such as the receipt of stock in a publicly traded company.
Real Estate Asset Management Services. Victor Capital provides its real
estate asset management services primarily to institutional investors such as
public and private money management firms. Victor
9
<PAGE>
Capital's services may include the identification and acquisition of specific
mortgage loans and/or properties and the management and disposition of these
assets. As of the date hereof, Victor Capital had seven such assignments
representing an asset value of approximately $1 billion and of approximately 7
million square feet.
Factors which may Affect the Company's Business Strategy
- --------------------------------------------------------
The success of the Company's business strategy depends in part on important
factors, many of which are not within the control of the Company. The
availability of desirable loan and investment opportunities and the results of
the Company's operations will be affected by the amount of available capital,
the level and volatility of interest rates, conditions in the financial markets
and general economic conditions. There can be no assurances as to the effects of
unanticipated changes in any of the foregoing. The Company's business strategy
also depends on the ability to grow its portfolio of invested assets through the
use of leverage. There can be no assurance that the Company will be able to
obtain and maintain targeted levels of leverage or that the cost of debt
financing will increase relative to the income generated from the assets
acquired with such financing and cause the Company to reduce the amount of
leverage it utilizes. The Company risks the loss of some or all of its assets or
a financial loss if the Company is required to liquidate assets at a
commercially inopportune time.
The Company confronts the prospect that competition from other providers of
mezzanine capital may lead to a lowering of the interest rates earned on the
Company's interest-earning assets that may not be offset by lower borrowing
costs. Changes in interest rates are also affected by the rate of inflation
prevailing in the economy. A significant reduction in interest rates could
increase prepayment rates and thereby reduce the projected average life of the
Company's CMBS investments. While the Company may employ various hedging
strategies, there can be no assurance that the Company would not be adversely
affected during any period of changing interest rates. In addition, many of the
Company's assets will be at risk to the deterioration in or total losses of the
underlying real property securing the assets, which may not be adequately
covered by insurance necessary to restore the Company's economic position with
respect to the affected property.
Competition
- -----------
The Company is engaged in a highly competitive business. The Company
competes for loan and investment opportunities with many new entrants into the
specialty finance business emphasized in its current business plan, including
numerous public and private real estate investment vehicles, including financial
institutions (such as mortgage banks, pension funds, and REITs) and other
institutional investors, as well as individuals. Many competitors are
significantly larger than the Company, have well established operating histories
and may have access to greater capital and other resources. In addition, the
real estate services industry is highly competitive and there are numerous
well-established competitors possessing substantially greater financial,
marketing, personnel and other resources than Victor Capital. Victor Capital
competes with national, regional and local real estate service firms.
Government Regulation
- ---------------------
Capital Trust's activities, including the financing of its operations, are
subject to a variety of federal and state regulations such as those imposed by
the Federal Trade Commission and the Equal Credit Opportunity Act. In addition,
a majority of states have ceilings on interest rates chargeable to customers in
financing transactions.
Employees
- ---------
As of December 31, 1997, the Company employed 23 full-time professionals
and six other full-time employees. None of the Company's employees are covered
by a collective bargaining agreement and management considers the relationship
with its employees to be good.
10
<PAGE>
- ------------------------------------------------------------------------------
Item 2. Properties
- ------------------------------------------------------------------------------
The Company's principal executive and administrative offices are located in
approximately 18,700 square feet of office space leased at 605 Third Avenue,
26th Floor, New York, New York 10016 and its telephone number is (212) 655-0220.
The lease for such space expires in April 2000. The Company believes that this
office space is suitable for its current operations for the foreseeable future.
- ------------------------------------------------------------------------------
Item 3. Legal Proceedings
- ------------------------------------------------------------------------------
The Company is not a party to any material litigation or legal proceedings,
or to the best of its knowledge, any threatened litigation or legal proceedings,
which, in the opinion of management, individually or in the aggregate, would
have a material adverse effect on its results of operations or financial
condition.
- ------------------------------------------------------------------------------
Item 4. Submission of Matters to a Vote of Security Holders
- ------------------------------------------------------------------------------
There were no matters submitted to a vote of security holders during the
fourth quarter of 1997.
11
<PAGE>
PART II
- ------------------------------------------------------------------------------
Item 5. Market for the Registrant's Common Equity and Related
Security Holder Matters
- ------------------------------------------------------------------------------
Capital Trust's Shares are listed on the New York Stock Exchange ("NYSE)
and the Pacific Stock Exchange. The trading symbol for Capital Trust's Class A
Common Shares is "CT". The Trust had approximately 1,577 shareholders-of-record
at February 20, 1998.
The table below sets forth, for the calendar quarters indicated, the
reported high and low sale prices of the Company's Class A Common Shares and the
Company's common shares of beneficial interest, $1.00 par value (the "Old Common
Shares"), which were reclassified as the Class A Common Shares on July 15, 1997
in connection with the adoption of the Company's Amended and Restated
Declaration of Trust (the "Restated Declaration"), as reported on the NYSE based
on published financial sources.
High Low
---- ---
1995
First Quarter......................................$ 17/8.......$ 15/8
Second Quarter........................................17/8..........11/2
Third Quarter.........................................17/8..........11/2
Fourth Quarter........................................15/8..........11/8
1996
First Quarter.........................................11/2..........11/8
Second Quarter........................................17/8..........13/8
Third Quarter.........................................23/4..........15/8
Fourth Quarter........................................27/8..........17/8
1997
First Quarter.........................................67/8..........25/8
Second Quarter........................................61/8..........41/2
Third Quarter........................................113/8..........53/4
Fourth Quarter.......................................151/8........913/16
The Company paid no dividends to holders of Class A Common Shares (or Old
Common Shares) in 1997 and 1996.
The Company does not expect to declare or pay dividends on its Class A
Common Shares in the foreseeable future. The Company's current policy with
respect to dividends is to reinvest earnings to the extent that such earnings
are in excess of the dividend requirements on the Class A Preferred Shares.
Pursuant to the certificate of designation, preferences and rights (the
"Certificate of Designation") of the class A 9.5% cumulative preferred shares of
beneficial interest, $1.00 par value (the "Class A Preferred Shares"), and the
class B 9.5% cumulative preferred shares of beneficial interest, $1.00 par value
(the "Class B Preferred Shares and together with the Class A Preferred Shares,
the Preferred Shares"), in the Company unless all accrued dividends and other
amounts then accrued through the end of the last dividend period and unpaid with
respect to the Preferred Shares have been paid in full, the Company may not
declare or pay or set apart for payment any dividends on the Class A Common
Shares or Class B Common Shares. The Certificate of Designation provides for a
semi-annual dividend of $0.1278 per share on the Class A Preferred Shares based
on a dividend rate of 9.5%, amounting to an aggregate annual dividend of
$3,135,000 based on the 12,267,658 shares of Class A Preferred Shares currently
outstanding. There are no Class B Preferred Shares currently outstanding.
12
<PAGE>
- ------------------------------------------------------------------------------
Item 6. Selected Financial Data
- ------------------------------------------------------------------------------
Prior to July 1997, the Company operated as a REIT, originating, acquiring,
operating or holding income-producing real property and mortgage-related
investments. Therefore, the Company's historical financial information as of and
for the years ended December 31, 1996, 1995, 1994, and 1993 does not reflect any
operating results from its specialty finance or real estate investment banking
services operations. The following selected financial data relating to the
Company have been derived from the historical financial statements as of and for
the years ended December 31, 1997, 1996, 1995, 1994, and 1993. Other than the
data for the year ended December 31, 1997, none of the following data reflect
the results of the acquisition of Victor Capital and the issuance of 12,267,658
Class A Preferred Shares for $33 million, both of which occurred on July 15,
1997, or the Offering completed in December 1997. For these reasons, the Company
believes that the following information is not indicative of the Company's
current business.
<TABLE>
<CAPTION>
Years Ended December 31,
-------------------------------------------------------------
1997 1996 1995 1994 1993
------------ ----------- ------------------------ -----------
(in thousands, except for per share data)
STATEMENT OF OPERATIONS DATA:
REVENUES:
<S> <C> <C> <C> <C> <C>
Interest and investment income.................$6,445 $ 1,136 $1,396 $ 1,675 $ 924
Advisory and asset management fees..............1,698 -- -- -- --
Rental income.................................... 307 2,019 2,093 2,593 4,555
Gain (loss) on sale of investments...............(432) 1,069 66 (218) 131
Other............................................ -- -- 46 519 --
------------ ----------- ------------------------ -----------
Total revenues...............................8,018 4,224 3,601 4,569 5,610
------------ ----------- ------------------------ -----------
OPERATING EXPENSES:
Interest........................................2,379 547 815 1,044 1,487
General and administrative......................9,463 1,503 933 813 662
Rental property expenses......................... 124 781 688 2,034 2,797
Provision for possible credit losses............. 462 1,743 3,281 119 7,928
Depreciation and amortization.................... 92 64 662 595 847
------------ ----------- ------------------------ -----------
Total operating expenses....................12,520 4,638 6,379 4,605 13,721
------------ ----------- ------------------------ -----------
Loss before income tax expense.................(4,502) (414) (2,778) (36) (8,111)
Income tax expense (55) -- -- -- --
------------ ----------- ------------------------ -----------
NET LOSS.......................................(4,557) (414) (2,778) (36) (8,111)
Less: Class A Preferred Share dividend and
dividend requirement........................(1,471) -- -- -- --
------------ ----------- ------------------------ -----------
Net loss allocable to Class A Common Shares...$(6,028) $ (414) $(2,778) $ (36) $(8,111)
============ =========== ======================== ===========
PER SHARE INFORMATION:
Net loss per Class A Common Share, basic $ (0.63) $ (0.05) $ (0.30) $ (0.00) $ (0.88)
and diluted..............................============ =========== ======================== ===========
Weighted average Class A Common Shares
outstanding, basic and diluted........... 9,527 9,157 9,157 9,157 9,165
============ =========== ======================== ===========
</TABLE>
<TABLE>
<CAPTION>
As of December 31,
-------------------------------------------------------------
1997 1996 1995 1994 1993
------------ ----------- ------------------------ -----------
BALANCE SHEET DATA:
<S> <C> <C> <C> <C> <C>
Total assets..................................$317,366 $30,036 $33,532 $36,540 $42,194
Total liabilities............................. 174,077 5,565 8,625 8,855 13,583
Shareholders' equity.......................... 143,289 24,471 24,907 27,685 28,611
</TABLE>
The average net loss per Class A Common Share amounts prior to 1997 have
been restated as required to comply with Statement of Financial Standards No.
128, "Earnings per Share" ("Statement No. 128"). For further discussion of
Earnings per Class A Common Share and the impact of Statement No. 128, see Note
3 to the Company's consolidated financial statements.
13
<PAGE>
- ------------------------------------------------------------------------------
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
- ------------------------------------------------------------------------------
Overview
- --------
Prior to July 1997, the Company operated as a REIT, originating, acquiring,
operating or holding income-producing real property and mortgage-related
investments. Since the Company's 1997 annual meeting of shareholders held on
July 15, 1997 (the "1997 Annual Meeting"), the Company has pursued a new
strategic direction with a focus on becoming a specialty finance company
designed primarily to take advantage of high-yielding mezzanine investments and
other real estate asset and finance opportunities in commercial real estate. As
contemplated by its new business plan, the Company no longer qualifies for
treatment as a REIT for federal income tax purposes. Consequently, the
information set forth below with regard to historical results of operations for
the years ended December 31, 1996 and 1995 does not reflect any operating
results from the Company's specialty finance activities or real estate
investment banking services nor the Company's current loan and other investment
portfolio. The results for the year ended December 31, 1997 reflect partial
implementation of the Company's current business plan as discussed below.
The discussion contained herein gives effect to the reclassification on
July 15, 1997 of the Old Common Shares as Class A Common Shares.
Recent Developments Preceding Implementation of the New Business Plan
- ---------------------------------------------------------------------
On January 3, 1997, CRIL, an affiliate of EGI and Samuel Zell, purchased
from the Company's former parent 6,959,593 Class A Common Shares (representing
approximately 76% of the then-outstanding Class A Common Shares) for an
aggregate purchase price of $20,222,011. Prior to the purchase, which was
approved by the then-incumbent Board of Trustees, EGI and Victor Capital
presented to the Company's then-incumbent Board of Trustees a proposed new
business plan in which the Company would cease to be a REIT and instead become a
specialty finance company designed primarily to take advantage of high-yielding
mezzanine investment and other real estate asset opportunities in commercial
real estate. EGI and Victor Capital also proposed that they provide the Company
with a new management team to implement the business plan and that they invest
through an affiliate a minimum of $30.0 million in a new class of preferred
shares to be issued by the Company.
The Board of Trustees approved CRIL's purchase of the former parent's Class
A Common Shares, the new business plan and the issuance of a minimum of $30.0
million of a new class of preferred shares of the Company at $2.69 per share,
such shares to be convertible into Class A Common Shares of the Company on a
one-for-one basis. The Board of Trustees considered a number of factors in
approving the foregoing, including the attractiveness of the proposed new
business plan, the significant real estate investment and financing experience
of the proposed new management team and the significant amount of equity capital
the Company would obtain from the proposed preferred share investment. The Board
also considered the terms of previous alternative offers to purchase the former
parent's interest in the Company of which the Board was aware and the fact that
the average price of the Company's Old Common Shares during the 60 trading days
preceding the Board of Trustees meeting at which the proposed preferred equity
investment was approved was $2.38 per share. The Company subsequently agreed
that, concurrently with the consummation of the proposed preferred equity
investment, it would acquire for $5.0 million Victor Capital's real estate
investment banking, advisory and asset management businesses, including the
services of its experienced management team.
At the 1997 Annual Meeting, the Company's shareholders approved the
investment, pursuant to which the Company would issue and sell up to
approximately $34.0 million of Class A Preferred Shares to Veqtor, an affiliate
of Samuel Zell and the principals of Victor Capital (the "Investment"). The
Company's shareholders also approved the Restated Declaration, which, among
other things, reclassified the Company's Old Common Shares as Class A Common
Shares and changed the Company's name to "Capital Trust."
14
<PAGE>
Immediately following the 1997 Annual Meeting, the Investment was
consummated; 12,267,658 Class A Preferred Shares were sold to Veqtor for an
aggregate purchase price of $33,000,000 pursuant to the terms of the preferred
share purchase agreement, dated as of June 16, 1997, by and between the Company
and Veqtor. Concurrently with the foregoing transaction, Veqtor purchased the
6,959,593 Class A Common Shares held by CRIL for an aggregate purchase price of
approximately $21.3 million. As a result of these transactions, currently,
Veqtor beneficially owns 19,227,251 (or approximately 63%) of the outstanding
voting shares of the Company. Veqtor funded the approximately $54.3 million
aggregate purchase price for the Class A Common Shares and Class A Preferred
Shares with $5.0 million of capital contributions from its members and $50.0
million of borrowings under the 12% convertible redeemable notes (the "Veqtor
Notes") issued to four institutional investors. The Veqtor Notes may in the
future be converted into preferred interests in Veqtor that may in turn be
redeemed for an aggregate of 9,899,710 voting shares of the Company held by
Veqtor.
In addition, immediately following the 1997 Annual Meeting, the acquisition
of the real estate services businesses of Victor Capital was consummated and a
new management team was appointed by the Company from among the ranks of Victor
Capital's professional team and elsewhere. The Company thereafter immediately
commenced full implementation of its current business plan under the direction
of its newly elected board of trustees and new management team.
Overview of Financial Condition Following Implementation of the New Business
Plan
- ----------------------------------------------------------------------------
During 1997, the Company completed two significant equity capital raising
share issuance transactions and obtained its $150 million Credit Facility that
enabled the Company to grow its assets from $30.0 million to $317.4 million. On
July 15, 1997, the Company sold 12,267,658 Class A Preferred Shares to Veqtor
resulting in net proceeds to the Company of approximately $32.9 million. As of
September 30, 1997, the Company obtained the $150 million Credit Facility. On
December 16, 1997, the Company sold 9,000,000 Class A Common Shares in the
Offering resulting in net proceeds to the Company of approximately $91.4
million. This significant infusion of cash allowed the Company to fully
implement its current business plan as a specialty finance company. The Company
used a combination of its additional capital and borrowings under the Credit
Facility to make the investments described in the following paragraph.
Since June 30, 1997, the Company has identified, negotiated and committed
to fund or acquire twelve loan and investment in commercial mortgage-backed
securities transactions, including six Mortgage Loans totaling $169.7 million
(including unfunded commitments of $26.9 million which remain outstanding), five
Mezzanine Loans totaling $75.0 million and one CMBS subordinated interest
investment for $49.6 million. The Company believes that these investments will
provide investment yields within the Company's target range of 400 to 600 basis
points above LIBOR. The Company maximizes its return on equity by utilizing its
existing cash on hand and then employing leverage on its investments (employing
a cash optimization model). The Company may make investments with yields that
fall outside of the investment range set forth above, but that correspond with
the level of risk perceived by the Company to be inherent in such investments.
At December 31, 1997, the Company had loans and investments in commercial
mortgage-backed securities totaling in excess of $250 million outstanding
resulting from transactions completed since the implementation of its current
business plan and had existing commitments for approximately $26.9 million of
additional funding under certain of the loans originated in such transactions.
The Company received satisfaction on a Mortgage loan for $9.8 million and
sold portions of two Mortgage loans for $10.0 million (net of repurchases) and a
paid a premium of $1.4 million to acquire one Mortgage loan. The Company also
paid premiums totaling $1.4 million to acquire two Mezzanine loans and received
payments of $100,000 on the CMBS subordinated interest investment.
The Company's assets are subject to various risks that can affect results,
including the level and volatility of prevailing interest rates, adverse changes
in general economic conditions and real estate markets, the deterioration of
credit quality of borrowers and the risks associated with the ownership and
operation of real estate. Any significant compression of the spreads of the
interest rates earned on interest-earning assets over the interest rates paid on
interest-bearing liabilities could have a material adverse effect on the
Company's operating results. Adverse changes in national and regional economic
conditions can have an effect on real estate values increasing the risk of
undercollateralization to the extent that the fair market value of properties
serving as collateral security for the Company's assets are reduced. Numerous
factors, such as adverse changes in local market conditions, competition,
increases in operating expenses
15
<PAGE>
and uninsured losses, can affect a property owner's ability to maintain or
increase revenues to cover operating expenses and the debt service on the
property's financing and, consequently, lead to a deterioration in credit
quality or a loan default and reduce the value of the Company's asset. In
addition, the yield to maturity on the Company's CMBS assets are subject to the
default and loss experience on the underlying mortgage loans, as well as by the
rate and timing of payments of principal. If there are realized losses on the
underlying loans, the Company may not recover the full amount, or possibly, any
of its initial investment in the affected CMBS asset. To the extent there are
prepayments on the underlying mortgage loans as a result of refinancing at lower
rates, the Company's CMBS assets may be retired substantially earlier than their
stated maturities leading to reinvestment in lower yielding assets. There can be
no assurance that the Company's assets will not experience any of the foregoing
risks or that, as a result of any such experience, the Company will not suffer a
reduced return on investment or an investment loss.
When possible, in connection with the acquisition of investments, the
Company obtains seller financing in the form of repurchase agreements. Three of
the transactions described in the above paragraph were financed in this manner
for a total of $72.7 million. These financings are generally completed at
discounted terms from those available under the Credit Facility. The remaining
transactions were funded with cash on hand from the proceeds of the sale of the
Company's shares and through borrowings under the Credit Facility. At December
31, 1997, the Company had $79.9 million of outstanding borrowings under the
Credit Facility.
As of December 31, 1997, the Company's new investment and loan assets have
been hedged so that the assets and the corresponding liabilities were matched at
floating rates over LIBOR. The Company has entered into interest rate swap
agreements for notional amounts totaling approximately $49.9 million with
financial institution counterparties whereby the Company swapped fixed rate
instruments, which averaged approximately 6.22% at December 31, 1997 and 6.55%
for the year then ended, for floating rate instruments equal to the London
Interbank Offered Rate ("LIBOR") which averaged approximately 5.94% at December
31, 1997 and 5.72% for the year then ended. The agreements mature at varying
times from December 1998 to April 2006.
The Company purchased an interest rate cap for a notional amount of $18.75
million at a cost of approximately $71,000. The interest rate cap provides for
payments to the Company should LIBOR exceed 11.25% during the period from
November 2003 to November 2007.
The Company is exposed to credit loss in the event of non-performance by
the counterparties (which are banks whose securities are rated investment grade)
to the interest rate swap and cap agreements, although it does not anticipate
such non-performance. The counterparties would bear the interest rate risk of
such transactions as market interest rates increase. If an interest rate swap or
interest rate cap is sold or terminated and cash is received or paid, the gain
or loss is deferred and recognized when the hedged asset is sold or matures.
During the period from July 15, 1997 to December 31, 1997, significant
advisory income collected, as a result of the Company's acquisition of Victor
Capital was applied as a reduction of accounts receivable and thereby not
reflected as revenue.
Results of Operations
- ---------------------
Total Revenues. Total revenues were $8,450,000 in 1997, an increase from
$3,155,000 in 1996, which were down from $3,535,000 in 1995. The increase in
1997 was due to the implementation of the Company's current business plan in the
second half of the year. The Company began to collect interest on loans and
investments originated or acquired during this period and began to generate
advisory and management fees from its newly acquired subsidiary, Victor Capital.
The Company also generated additional interest income from bank deposits over
the amount earned the previous year due to significant cash balances on hand
from the sale of Class A Preferred Shares in the Investment and Class A Common
Shares in the Offering. These increases were offset by a decrease in rental
income resulting from the disposition of all rental properties during 1996 and
1997. The decrease reported in 1996 was primarily attributable to a decrease in
interest revenue as a result of the liquidation of a portion of the Company's
note portfolio and decreased rental revenues.
Interest and related income from loans and other investments was
$4,992,000, up from $470,000 in 1996, which was down from $1,148,000 in 1995.
The increase in 1997 was due to the implementation of the Company's business
plan in the second half of the year when the Company began to collect interest
on loans and investments made during this period. The decrease in 1996 was the
result of a lower amount of interest received due to the sale of certain
mortgage notes.
Rental revenues at the Company's commercial properties were $307,000, down
from $2,019,000 in 1996, which were down from $2,093,000 in 1995. The decrease
in 1997 from that received in 1996 was due to the sale of the properties during
1996 and 1997 which were generating the income. The decrease in rental revenues
reported in 1996 was attributable primarily to the absence of rent collected at
the two properties that were sold in the first half of 1996. No rental revenues
were generated by the Company's hotel property in 1996, which was foreclosed
upon after the Company suspended debt service payments.
Other interest income was $1,453,000 in 1997, up from $666,000 in 1996,
which was up from $248,000 in 1995. The increase in 1997 was a result of the
Company generating additional interest income from bank deposits due to
significant cash balances on hand from sale of Class A Preferred Shares in the
Investment and Class A Common Shares in the Offering. The increase in 1996 was
created by an increase in interest earned on cash accounts and marketable
securities, the additional cash balances generated from the sale of several
rental properties and notes receivable.
Total Expenses. Total expenses were $12,058,000, up from $2,895,000 in
1996, which was down from $3,098,000 in 1995. In 1997, total expenses were up
due primarily to a $7,960,000 increase in general and administrative expenses
from the implementation of the current business plan and the related hiring of
executive officers and employees, principally from the ranks of Victor Capital,
following the acquisition thereof. The reduction in expenses in 1996 was
primarily the result of the downsizing of the Company's portfolio, which reduced
depreciation, interest expense and associated property operating expenses.
Interest and related expense from loans and other investments was
$2,223,000, up from $86,000 in 1996, which was down from $370,000 in 1995. The
increase in 1997 was due to an increase in borrowing under the Company's Credit
Facility and repurchase agreements to fund new loans and investments made in the
second half of 1997. The decrease in 1996 was the result of a lower amount of
interest received due to the sale of certain mortgage notes offset by an
increase in interest earned on cash accounts and marketable securities.
Other interest expense was $156,000 in 1997, down from $461,000 in 1996,
which was consistent with the $445,000 amount in 1994. The decrease in 1997 from
the amounts in 1996 and 1995 resulted from the elimination of mortgage debt upon
sale of the Totem Square property.
General and administrative expenses were $9,463,000 in 1997, up
significantly from $1,503,000 in 1996. General and administrative expenses in
1996 were up from the $933,000 reported in 1995. The increase in general and
administrative costs in 1997 was due primarily to the addition of the new
executive officers and employees hired in 1997 whose salaries and benefits
totaled more than $5 million. The Company also incurred significant
non-recurring professional fees (an increase of more than $2 million over the
fees incurred in 1996) in conjunction with the reconstitution of the Company,
the termination of its REIT status and the implementation of its current
business plan. While the Company was able to lower a number of office expenses
in 1996, a net increase in general and administrative costs occurred due
primarily to an accelerated investigation of potential merger or acquisition
transactions plus related due diligence costs.
The 1997 non-cash depreciation charge was $92,000, an increase from $64,000
in 1996, which charge decreased in 1996 compared to the depreciation charge of
$662,000 in 1995. The increase in 1997 came as a result of the Company
purchasing additional equipment and leasehold improvements to its newly leased
office space in New York City. The decrease in 1996 reflected the sale of two
properties and the disposition of the hotel property. In addition, the Company's
two remaining properties were not depreciated in 1996 because they were being
held for sale.
Rental property expenses were relatively consistent when comparing 1995 to
1996 but decreased significantly, by $657,000, in 1997 when the remaining rental
properties were sold.
Net Loss. The net loss for the Company in 1997 was $4,557,000. The
significant increase in the loss was a result of the expenses associated with
the Company's hiring activity outpacing its income generation
17
<PAGE>
pursuant to the acquisition of Victor Capital and implementation of its business
plan. The net loss for the Company in 1996 was $414,000, a substantial decrease
over the net loss of $2,778,000 reported in 1995. This improvement was primarily
the result of sales proceeds received by the Company from property and mortgage
note dispositions offset by valuation losses discussed further below.
Net Gain or Loss on Sale of Investments. Net Gain or Loss on Foreclosure or
Sale of Investments was a loss of 432,000 in 1997, a gain of $1,069,000 in 1996
and a gain of $66,000 in 1995. The losses incurred in 1997 were due to the sales
of the two remaining rental properties during the first quarter of 1997.
The net gain recognized from the sale of a property in the first quarter of
1996 was $299,000. There was no gain or loss upon the foreclosure of the motel
property in the first quarter of 1996 as the net book value of the property was
equal to its debt.
During the second quarter of 1996, the Company incurred a net loss of
$164,000 from the sale of a storage facility property. Also during the second
quarter of 1996, the Company sold two of its seven mortgage notes. A gain of
$430,000 was recognized upon the sale of the Company's mortgage note which was
collateralized by a first deed of trust on an office/commercial building in
Phoenix, Arizona; and a gain of $30,000 was recognized upon the sale of the
Company's mortgage note which was collateralized by a second deed of trust on a
commercial building in Pacheco, California. During the third quarter of 1996,
the Company sold two more mortgage notes. A gain of $115,000 was recognized upon
the sale of the Company's mortgage note which was collateralized by a first deed
of trust on an office building in Scottsdale, Arizona; and a gain of $357,000
was recognized upon the sale of the Company's mortgage note which was
collateralized by a second deed of trust on an office/industrial building in
Sunnyvale, California.
In 1995, the Company recognized a deferred gain from the partial principal
payment received on one of its mortgage notes. During the first five months of
1994, the Company's hotel property experienced an average operating loss after
debt service of $107,000 per month. With the execution of a lease with the hotel
management company in 1994, this amount was reduced to approximately $8,600 per
month, the difference between the monthly lease payment of $20,000 and the
property's monthly debt service requirement of $28,600. The lease was
renegotiated in June 1995, reducing the monthly lease payments from $20,000 to
approximately $9,000, increasing the loss recorded by the Company. In 1994, the
Company experienced a gain of $114,000 on the sale of one property and the
recognition of a deferred gain from the partial principal payment on one of its
mortgage notes. This was offset by a $344,000 loss from the release of and
default on two of the Company's mortgage notes held at that time.
Provision for Possible Credit Losses. The provision for possible credit losses
is the charge to income to increase the reserve for possible credit losses to
the level that management estimates to be adequate considering delinquencies,
loss experience and collateral quality. Other factors considered relate to
geographic trends and product diversification, the size of the portfolio and
current economic conditions. Based upon these factors, the Company establishes
the provision for possible credit losses by category of asset. When it is
probable that the Company will be unable to collect all amounts contractually
due, the account is considered impaired. Where impairment is indicated, a
valuation write-down or write-off is measured based upon the excess of the
recorded investment amount over the net fair value of the collateral, as reduced
for selling costs. Any deficiency between the carrying amount of an asset and
the net sales price of repossessed collateral is charged to the reserve for
credit losses.
For the year ended December 31, 1997, the Company recorded a provision for
possible credit losses of $462,000. During 1997, the Company had no known assets
which were considered impaired and as such no significant additional provisions
were necessary. Management believes that the reserve for possible credit losses
is adequate based on the factors detailed above.
For the year ended December 31, 1996, the Company reported a provision for
possible credit losses of $1,743,000. By year end, the Company had reduced the
book value of its Sacramento, California shopping center to $1,215,000 and the
book value of its Kirkland, Washington retail property to $7,370,000. Since
these properties were no longer being held for investment, but rather for sale,
their book value was reduced to more accurately reflect the then-current market
value of the assets. The decline in the shopping center's value was the result
of the Company's relatively short lease term on the land underlying the center,
the physical condition of the property and changed market conditions in the
Sacramento area. Disposition efforts on behalf of retail property also indicated
the need to reduce this property's book value, as it was no
18
<PAGE>
longer being held for investment purposes but actively marketed for sale. Both
properties were sold during the first quarter of 1997.
In 1995, the provision for possible credit losses of $3,281,000 resulted
from the write-down in value of two commercial properties and five mortgage
notes. These credit losses were the result of a diminution in value of the
collateral underlying the Company's assets as a result of adverse economic
factors, particularly overbuilt real estate markets which caused a decline in
lease renewal rates.
Preferred Share Dividend and Dividend Requirement. The preferred share
dividend and dividend requirement arose in 1997 as a result of the Company
issuing $33 million of Class A Preferred Shares on July 15, 1997. Dividends
accrue on these shares at a rate of 9.5% per annum on a per share price of
$2.69.
Liquidity and Capital Resources
- -------------------------------
At December 31, 1997, the Company had $49,268,000 in cash. Liquidity in
1998 will be provided primarily by cash on hand, cash generated from operations,
principal and interest payments received on investments, loans and securities,
and additional borrowings under the Credit Facility. The Company believes these
sources of capital will adequately meet future cash requirements. Consistent
with its current business plan, the Company expects that during 1998 it will use
a significant amount of its available capital resources to originate and fund
loans and other investments. In connection with such investment and loan
transactions, the Company intends to employ significant leverage, up to a 5:1
debt-to-equity ratio, to enhance its return on equity.
The Company experienced a net increase in cash of approximately $44.6
million for the year ended December 31, 1997, compared to a net decrease in cash
of $80,000 for the year ended December 31, 1996. For the year ended December 31,
1997, cash provided by operating activities was $2,901,000, up approximately
$2.4 million from cash provided by operations of $449,000 during the same period
in 1996. Cash used in investing activities during this same period increased by
approximately $242.7 million to approximately $243.2 million, up from $452,000,
primarily as a result of the loans and other investments completed since June
30, 1997. Cash provided by financing activities increased approximately $284.9
million due primarily to the proceeds of repurchase obligations, borrowings
under the Credit Facility and net proceeds from the issuance of Class A
Preferred Shares and the Class A Common Shares.
The Company has two outstanding notes payable totaling $4,953,000 and
outstanding borrowings of $79,864,000 under the Credit Facility in addition to
the outstanding repurchase obligations of $82,173,000.
The Company's Credit Facility with a commercial lender provided for
borrowings up to $150 million. The Credit Facility has a term that expires on
September 30, 2000, including extensions, provided that the Company is in
compliance with the covenants and terms of the Credit Facility, there have been
no material adverse changes in the Company's financial position, and the Company
is not otherwise in material default of the terms of the Credit Facility. The
Credit Facility provides for advances to fund lender-approved investments
("Funded Portfolio Assets") made by the Company pursuant to its business plan.
The Company is currently negotiating with its commercial lender to the increase
the Credit Facility by $100 million thereby increasing liquidity.
The obligations of the Company under the Credit Facility are to be secured
by pledges of the Funded Portfolio Assets acquired with advances under the
Credit Facility. Borrowings under the Credit Facility bear interest at specified
rates over LIBOR, averaging approximately 8.2% for those borrowings outstanding
as of December 31, 1997, which rate may fluctuate based upon the credit quality
of the Funded Portfolio Assets. The Company incurred a commitment fee upon the
signing of the credit agreement and is obligated to pay an additional commitment
fee when total borrowings under the Credit Facility exceed $75 million. In
addition, each advance requires payment of a drawdown fee. Future repayments and
redrawdowns of amounts previously subject to the drawdown fee will not require
the Company to pay any additional fees. The Credit Facility provides for margin
calls on or collateral enhancement of asset-specific borrowings in the event of
asset quality and/or market value deterioration as determined under the Credit
Facility. The Credit Facility contains customary representations and warranties,
covenants and conditions and events of default. The Credit Facility also
contains a covenant obligating the Company to avoid undergoing an ownership
change that results in Craig M. Hatkoff, John R. Klopp or Samuel Zell no longer
retaining their senior offices with the Company and practical control of the
Company's business and operations.
19
<PAGE>
On December 31, 1997, the unused Credit Facility amounted to $70.1 million.
Impact of Inflation
- -------------------
The Company's operating results depend in part on the difference between
the interest income earned on its interest-earning assets and the interest
expense incurred in connection with its interest-bearing liabilities. Changes in
the general level of interest rates prevailing in the economy in response to
changes in the rate of inflation or otherwise can affect the Company's income by
affecting the spread between the Company's interest-earning assets and
interest-bearing liabilities, as well as, among other things, the value of the
Company's interest-earning assets and its ability to realize gains from the sale
of assets and the average life of the Company's interest-earning assets.
Interest rates are highly sensitive to many factors, including governmental
monetary and tax policies, domestic and international economic and political
considerations, and other factors beyond the control of the Company. The Company
employs the use of hedging strategies to limit the effects of changes in
interest rates on its operations, including engaging in interest rate swaps and
interest rate caps to minimize its exposure to changes in interest rates. There
can be no assurance that the Company will be able to adequately protect against
the foregoing risks or that the Company will ultimately realize an economic
benefit from any hedging contract into which it enters.
Year 2000 Information
- ---------------------
The Company has assessed the potential impact of the Year 2000 computer
systems issue in its operations. The Company believes that no significant
actions are required to be taken by the Company to address the issue and
therefore the impact of the issue will not materially affect the Company's
future operating results or financial condition.
20
<PAGE>
- ------------------------------------------------------------------------------
Item 8. Financial Statements and Supplementary Data
- ------------------------------------------------------------------------------
The financial statements required by this item and the reports of the
independent accountants thereon required by Item 14(a)(2) appear on pages F-2 to
F-1. See accompanying Index to the Consolidated Financial Statements on page
F-1. The supplementary financial data required by Item 302 of Regulation S-K
appears in Note 19 to the consolidated financial statements.
21
<PAGE>
------------------------------------------------------------------------------
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure
- ------------------------------------------------------------------------------
On April 14, 1997, the Board of Trustees adopted a resolution (i) not to
retain Coopers & Lybrand L.L.P. ("C&L") as the Company's auditors for the fiscal
year ending December 31, 1997 and (ii) to engage Ernst and Young LLP ("E&Y") as
the Company's independent auditors for the fiscal year ending December 31, 1997.
The reports of C&L on the Company's consolidated financial statements as of
and for the two years ended December 31, 1996 and 1995 did not contain an
adverse opinion or a disclaimer opinion nor were they qualified or modified as
to uncertainty, audit scope or accounting principles.
During the Company's fiscal years ended December 31, 1996 and 1995 and
through the date of their replacement on April 14, 1997, there were no
disagreements with C&L on any matter of accounting principals or practices,
financial statement disclosure, or auditing scope or procedure, which
disagreements, if not resolved to the satisfaction of C&L, would have caused
them to make reference thereto in their report(s) on the Company's financial
statements for such fiscal year(s), nor were there any "reportable events"
within the meaning of item 304(a)(1)(v) of regulation S-K promulgated under the
Securities Exchange Act of 1934, as amended (the "Exchange Act").
22
<PAGE>
SIGNATURES
----------
Pursuant to the requirements of Section 13 or Section 15(d) 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.
October 22, 1998 /s/ John R. Klopp
- ---------------- -----------------
Date John R. Klopp
Vice Chairman and Chief Executive Officer
23
<PAGE>
Index to Consolidated Financial Statements
<TABLE>
<S> <C>
Reports of Independent Auditors...................................................................F-2
Audited Financial Statements
Consolidated Balance Sheets as of December 31, 1997 and 1996......................................F-4
Consolidated Statements of Operations for the years ended December 31, 1997, 1996 and 1995........F-5
Consolidated Statements of Shareholders' Equity for the years
ended December 31, 1997, 1996 and 1995............................................................F-6
Consolidated Statements of Cash Flows for the years ended
December 31, 1997, 1996 and 1995..................................................................F-7
Notes to Consolidated Financial Statements........................................................F-8
</TABLE>
F-1
<PAGE>
Report of Independent Auditors
The Board of Trustees
Capital Trust and Subsidiaries
We have audited the consolidated balance sheet of Capital Trust and Subsidiaries
(the "Company") as of December 31, 1997 and the related consolidated statement
of operations, shareholders' equity and cash flows for the year then ended.
These consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, based on our audit, the financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
the Company at December 31, 1997, and the consolidated results of their
operations and their cash flows for the year then ended in conformity with
generally accepted accounting principles.
Ernst & Young LLP
New York, New York
January 23, 1998
F-2
<PAGE>
Report of Independent Auditors
The Board of Trustees of Capital Trust
(f/k/a California Real Estate Investment Trust):
We have audited the accompanying consolidated balance sheet of Capital
Trust (f/k/a California Real Estate Investment Trust and Subsidiary) (the
"Trust") as of December 31, 1996, and the related consolidated statements of
operations, cash flows, and changes in shareholders' equity for each of the two
years in the period ended December 31, 1996. These financial statements and
financial statement schedules are the responsibility of the Trust's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Capital Trust
(f/k/a California Real Estate Investment Trust and Subsidiary) as of December
31, 1996, and the consolidated results of their operations and their cash flows
for each of the two years in the period ended December 31, 1996, in conformity
with generally accepted accounting principles.
Coopers & Lybrand L.L.P.
San Francisco, California
February 14, 1997
F-3
<PAGE>
Capital Trust and Subsidiaries
Consolidated Balance Sheets
December 31, 1997 and 1996
(in thousands)
<TABLE>
1997 1996
------------------ ------------------
Assets
<S> <C> <C>
Cash and cash equivalents $ 49,268 $ 4,698
Available-for-sale securities 11,975 14,115
Commercial mortgage-backed securities 49,490 -
Loans receivable, net of $462 and $0 reserve for possible credit losses
in 1997 and 1996, respectively 202,322 1,576
Rental properties - 8,585
Excess of purchase price over net tangible assets acquired, net 331 -
Deposits and other receivables 284 707
Accrued interest receivable 818 -
Prepaid and other assets 2,878 355
------------------ ------------------
Total assets $ 317,366 $ 30,036
================== ==================
Liabilities and Shareholders' Equity
Liabilities:
Accounts payable and accrued expenses $ 5,718 $ 396
Notes payable 4,953 5,169
Credit facility 79,864 -
Repurchase obligations 82,173 -
Deferred origination fees and other revenue 1,369 -
------------------ ------------------
Total liabilities 174,077 5,565
------------------ ------------------
Commitments and contingencies
Shareholders' equity:
Class A Convertible Preferred Shares, $1.00 par value; $0.26 cumulative
annual dividend; 12,639 shares authorized, 12,268 shares issued and
outstanding at December 31, 1997 and no shares issued and outstanding
at December 31, 1996; (liquidation preference of $33,000) 12,268 -
Class A Common Shares, $1.00 par value; unlimited shares authorized, 18,157
shares issued and outstanding at December 31, 1997 and 9,157 shares issued
and outstanding at December 31, 1996 18,157 9,157
Additional paid-in capital 158,137 55,098
Unrealized gain (loss) on available-for-sale securities 387 (22)
Accumulated deficit (45,660) (39,762)
------------------ ------------------
Total Shareholders' equity 143,289 24,471
------------------ ------------------
Total liabilities and Shareholders' equity $ 317,366 $ 30,036
================== ==================
See accompanying notes to consolidated financial statements.
</TABLE>
F-4
<PAGE>
Capital Trust and Subsidiaries
Consolidated Statements of Operations
For the Years Ended December 31, 1997, 1996 and 1995
(in thousands, except per share data)
<TABLE>
1997 1996 1995
---------------- ----------------- -----------------
<S> <C> <C> <C>
Income from loans and other investments:
Interest and related income $ 4,992 $ 470 $ 1,148
Less: Interest and related expenses 2,223 86 370
---------------- ----------------- -----------------
Net income from loans and other investments 2,769 384 778
---------------- ----------------- -----------------
Other revenues:
Advisory and asset management fees 1,698 - -
Rental income 307 2,019 2,139
Other interest income 1,453 666 248
(Loss) gain on sale of rental properties and investments (432) 1,069 66
---------------- ----------------- -----------------
Total other revenues 3,026 3,754 2,453
---------------- ----------------- -----------------
Other expenses:
General and administrative 9,463 1,503 933
Other interest expense 156 461 445
Rental property expenses 124 781 688
Depreciation and amortization 92 64 662
Provision for possible credit losses 462 1,743 3,281
---------------- ----------------- -----------------
Total other expenses 10,297 4,552 6,009
---------------- ----------------- -----------------
Loss before income taxes (414) (2,778)
(4,502)
Provision for income taxes 55 - -
---------------- ----------------- -----------------
Net loss (4,557) (414) (2,778)
Less: Class A Preferred Share dividend (1,341) - -
Class A Preferred Share dividend requirement (130) - -
---------------- ----------------- -----------------
Net loss allocable to Class A Common Shares $ (6,028) $ (414) $ (2,778)
================ ================= =================
Per share information:
Net loss per Class A Common Share
Basic and Diluted $ (0.63) $ (0.05) $ (0.30)
================ ================= =================
Weighted average Class A Common Shares outstanding
Basic and Diluted 9,527,013 9,157,150 9,157,150
================ ================= =================
See accompanying notes to consolidated financial statements.
</TABLE>
F-5
<PAGE>
Capital Trust and Subsidiaries
Consolidated Statements of Shareholders' Equity
For the Years Ended December 31, 1997, 1996 and 1995
(in thousands)
<TABLE>
<CAPTION>
Class A Class A
Preferred Shares Common Shares Additional
------------------------------------------------ Paid-In Unrealized Accumulated
Number Amount Number Amount Capital Gain Deficit Total
-----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at January 1, 1995 - $ - 9,157 $ 9,157 $ 55,098 $ - $ (36,570) $ 27,685
Net Loss - - - - - - (2,778) (2,778)
----------------------------------------------------------------------------------------------------
Balance at December 31, 1995 - - 9,157 9,157 55,098 - (39,348) 24,907
Change in unrealized gain on
available-for-sale securities - - - - - (22) - (22)
Net Loss - - - - - - (414) (414)
----------------------------------------------------------------------------------------------------
Balance at December 31, 1996 - - 9,157 9,157 55,098 (22) (39,762) 24,471
Change in unrealized gain on
available-for-sale securities - - - - - 409 - 409
Issuance of preferred shares 12,268 12,268 - - 20,602 - - 32,870
Issuance of common shares - - 9,000 9,000 82,437 - - 91,437
Class A Preferred Share dividend - - - - - - (1,341) (1,341)
Net loss - - - - - - (4,557) (4,557)
----------------------------------------------------------------------------------------------------
Balance at December 31, 1997 12,268 $ 12,268 18,157 $ 18,157 $ 158,137 $ 387 $ (45,660) $ 143,289
====================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
F-6
<PAGE>
Capital Trust and Subsidiaries
Consolidated Statements of Cash Flows
For the Years Ended December 31, 1997, 1996 and 1995
(in thousands)
1997 1996 1995
<TABLE>
<CAPTION>
---------------- ----------------- -----------------
Cash flows from operating activities:
<S> <C> <C> <C>
Net loss $ (4,557) $ (414) $ (2,778)
Adjustments to reconcile net loss to net cash provided by
operating activities:
Depreciation and amortization 92 64 662
Loss (gain) on sale of rental properties and investments 432 (1,069) (66)
Provision for credit losses 462 1,743 3,281
Changes in assets and liabilities net of effects from
subsidiaries purchased:
Deposits and other receivables 2,707 (38) 294
Accrued interest receivable (818) - -
Prepaid and other assets (2,988) (61) (282)
Deferred revenue 1,369 - -
Accounts payable and accrued expenses 5,857 226 166
Other liabilities (64) (2) 11
---------------- ----------------- -----------------
Net cash provided by operating activities 2,492 449 1,288
---------------- ----------------- -----------------
Cash flows from investing activities:
Purchase of commercial mortgage-backed security (49,524) - -
Principal collections on commercial mortgage-backed
security 34 - -
Origination and purchase of loans receivable (211,709) - -
Principal collections on loans receivable 9,935 35 850
Purchases of equipment and leasehold improvements (479) - -
Proceeds from sale of rental properties 8,153 13,796 -
Improvements to rental properties - (146) (321)
Purchases of available-for-sale securities - (15,849) -
Principal collections on available-for-sale securities 4,947 1,712 -
Acquisition of Victor Capital Group, L.P., net of cash
acquired (4,066) - -
---------------- ----------------- -----------------
Net cash (used in) provided by investing activities (242,709) (452) 529
---------------- ----------------- -----------------
Cash flows from financing activities:
Proceeds from repurchase obligations 109,458 - -
Termination of repurchase obligations (27,285) - -
Proceeds from credit facility 81,864 - -
Repayment of credit facility (2,000) - -
Proceeds from notes payable 4,001 - -
Repayment of notes payable (4,217) (77) (405)
Dividends paid on preferred shares (1,341) - -
Net proceeds from issuance of Class A Common Shares 91,437 - -
Net proceeds from issuance of Class A Preferred Shares 32,870 - -
---------------- ----------------- -----------------
Net cash provided by (used in) financing activities 284,787 (77) (405)
---------------- ----------------- -----------------
Net increase (decrease) in cash and cash equivalents 44,570 (80) 1,412
Cash and cash equivalents at beginning of year 4,698 4,778 3,366
---------------- ----------------- -----------------
Cash and cash equivalents at end of year $ 49,268 $ 4,698 $ 4,778
================ ================= =================
See accompanying notes to consolidated financial statements.
</TABLE>
F-7
<PAGE>
Capital Trust and Subsidiaries
Notes to Consolidated Financial Statements
1. Organization
Capital Trust (the "Company") is a specialty finance company designed to take
advantage of high-yielding lending and investment opportunities in commercial
real estate and related assets. The Company makes investments in various types
of income producing commercial real estate, including senior and junior
commercial mortgage loans, preferred equity investments, direct equity
investments and subordinate interests in commercial mortgage-backed securities
("CMBS"). The Company also provides real estate investment banking, advisory and
asset management services through its wholly owned subsidiary, Victor Capital
Group, L.P. ("Victor Capital").
The Company, which was formerly known as California Real Estate Investment
Trust, was organized under the laws of the State of California pursuant to a
declaration of trust dated September 15, 1966. On December 31, 1996, 76% of the
Company's then-outstanding common shares of beneficial interest, $1.00 par value
("Common Shares") were held by the Company's former parent ("Former Parent"). On
January 3, 1997, the Former Parent sold its entire 76% ownership interest in the
Company (consisting of 6,959,593 Common Shares) to CalREIT Investors Limited
Partnership ("CRIL"), an affiliate of Equity Group Investments, Inc. ("EGI") and
Samuel Zell, the Company's current chairman of the board of trustees, for an
aggregate price of approximately $20.2 million. Prior to the purchase, which was
approved by the then-incumbent board of trustees, EGI and Victor Capital, a then
privately held company owned by two of the current trustees of the Company,
presented to the Company's then-incumbent board of trustees a proposed new
business plan in which the Company would cease to be a real estate investment
trust ("REIT") and instead become a specialty finance company as discussed
above. EGI and Victor Capital also proposed that they provide the Company with a
new management team to implement the business plan and invest, through an
affiliate, a minimum of $30 million in a new class of preferred shares to be
issued by the Company. In connection with the foregoing, the Company
subsequently agreed that, concurrently with the consummation of the proposed
preferred equity investment, it would acquire for $5 million Victor Capital's
real estate investment banking, advisory and asset management businesses,
including the services of its experienced management team. See Note 2.
On July 15, 1997, the proposed preferred share investment was consummated and
12,267,658 class A 9.5% cumulative convertible preferred shares of beneficial
interest, $1.00 par value ("Class A Preferred Shares"), in the Company were sold
to Veqtor Finance Company, LLC ("Veqtor"), an affiliate of Samuel Zell and the
principals of Victor Capital for an aggregate purchase price of $33.0 million.
See Note 13. Concurrently with the foregoing transaction, Veqtor purchased from
CRIL the 6,959,593 Common Shares held by it for an aggregate purchase price of
approximately $21.3 million (which shares were reclassified on that date as
class A common shares of beneficial interest, $1.00 par value ("Class A Common
Shares"), in the Company pursuant to the terms of an amended and restated
declaration of trust, dated July 15, 1997, adopted on that date (the "Amended
and Restated Declaration of Trust")).
As a result of these transactions, a change of control of the Company occurred
with Veqtor beneficially owning 19,227,251, or approximately 90% of the
outstanding voting shares of the Company. Pursuant to the Amended and Restated
Declaration of Trust, the Company's name was changed to "Capital Trust". As a
result of the aforementioned events, the Company, as intended, commenced full
implementation of the new business plan and thereby terminated its status as a
REIT.
F-8
<PAGE>
Capital Trust and Subsidiaries
Notes to Consolidated Financial Statements (continued)
2. Acquisition of Victor Capital
On July 15, 1997, the Company consummated the acquisition of the real estate
investment banking, advisory and asset management businesses of Victor Capital
and certain affiliated entities including the following wholly-owned
subsidiaries: VCG Montreal Management, Inc., Victor Asset Management Partners,
L.L.C., VP Metropolis Services, L.L.C., and 970 Management, LLC.
Victor Capital provides services to real estate investors, owners, developers
and financial institutions in connection with mortgage financings,
securitizations, joint ventures, debt and equity investments, mergers and
acquisitions, portfolio evaluations, restructurings and disposition programs.
Victor Capital's wholly owned subsidiaries provide asset management and advisory
services relating to various mortgage pools and real estate properties. In
addition, VCG Montreal Management, Inc. holds a nominal interest in a Canadian
real estate venture.
The purchase price in the Victor Capital acquisition was $5.0 million, which was
paid by the Company with the issuance of non-interest bearing acquisition notes,
payable in ten semi-annual equal installments of $500,000. The acquisition notes
have been discounted to approximately $3.9 million based on an imputed interest
rate of 9.5%. The acquisition has been accounted for under the purchase method
of accounting. The excess of the purchase price of the acquisition in excess of
net tangible assets acquired approximated $342,000.
During the period from July 15, 1997 to December 31, 1997, significant advisory
income collected as a result of the Company's acquisition of Victor Capital was
applied as a reduction of current accounts receivable and thereby not reflected
as revenue.
Had the acquisition occurred on January 1, 1997, pro forma revenues, net loss
(after giving effect to the Class A Preferred Share dividend and dividend
requirement) and net loss per common share (basic and diluted) would have been:
$11,271,000, $5,347,000 and $0.56, respectively.
3. Summary of Significant Accounting Policies
Principles of Consolidation
For the years ended December 31, 1996 and 1995, the Company owned commercial
rental property in Sacramento, California through a 59% limited partnership
interest in Totem Square L.P., a Washington limited partnership ("Totem"), and
an indirect 1% general partnership interest in Totem through its wholly-owned
subsidiary Cal-REIT Totem Square, Inc. An unrelated party held the remaining 40%
interest. This property was sold during the year ended December 31, 1997 and the
Totem Square L.P. and Totem Square, Inc. subsidiaries were liquidated and
dissolved.
The consolidated financial statements of the Company include the accounts of the
Company, Victor Capital and its wholly-owned subsidiaries (included in the
consolidated statement of operations since their acquisition on July 15, 1997)
and the results from the disposition of its rental property held by Totem, which
was sold on March 4, 1997 prior to commencement of the Company's new business
plan. See Note 1. All significant intercompany balances and transactions have
been eliminated in consolidation.
Revenue Recognition
Interest income for the Company's mortgage and other loans and investments is
recognized over the life of the investment using the interest method and
recognized on the accrual basis.
Fees received in connection with loan commitments, net of direct expenses, are
deferred until the loan is advanced and are then recognized over the term of the
loan as an adjustment to yield. Fees on commitments that expire unused are
recognized at expiration.
F-9
<PAGE>
Capital Trust and Subsidiaries
Notes to Consolidated Financial Statements (continued)
3. Summary of Significant Accounting Policies, continued
Income recognition is generally suspended for loans at the earlier of the date
at which payments become 90 days past due or when, in the opinion of management,
a full recovery of income and principal becomes doubtful. Income recognition is
resumed when the loan becomes contractually current and performance is
demonstrated to be resumed.
Fees from professional advisory services are generally recognized at the point
at which all Company services have been performed and no significant
contingencies exist with respect to entitlement to payment. Fees from asset
management services are recognized as services are rendered.
Reserve for Possible Credit Losses
The provision for possible credit losses is the charge to income to increase the
reserve for possible credit losses to the level that management estimates to be
adequate considering delinquencies, loss experience and collateral quality.
Other factors considered relate to geographic trends and product
diversification, the size of the portfolio and current economic conditions.
Based upon these factors, the Company establishes the provision for possible
credit losses by category of asset. When it is probable that the Company will be
unable to collect all amounts contractually due, the account is considered
impaired. Where impairment is indicated, a valuation write-down or write-off is
measured based upon the excess of the recorded investment amount over the net
fair value of the collateral, as reduced for selling costs. Any deficiency
between the carrying amount of an asset and the net sales price of repossessed
collateral is charged to the reserve for credit losses.
Cash and Cash Equivalents
The Company classifies highly liquid investments with original maturities of
three months or less from the date of purchase as cash equivalents. At December
31, 1997, cash equivalents of approximately $48.5 million consisted of an
investment in a money market fund that invests in Treasury bills. At December
31, 1996, the Company's cash was held in demand deposits with banks with strong
credit ratings. Bank balances in excess of federally insured amounts totaled
approximately $1.5 million and $4.3 million as of December 31, 1997 and 1996,
respectively. The Company has not experienced any losses on demand deposits or
money market investments.
Available-for-Sale Securities
Available-for-sale securities are reported on the consolidated balance sheet at
fair market value with any corresponding change in value reported as an
unrealized gain or loss (if assessed to be temporary), as a component of
shareholders' equity, after giving effect to taxes. See Note 5.
Commercial Mortgage-Backed Securities
The Company has the intent and ability to hold its subordinated investment in
CMBS until maturity. See Note 7. Consequently, this investment is classified as
held to maturity and is carried at amortized cost at December 31, 1997.
Income from CMBS is recognized based on the effective interest method using the
anticipated yield over the expected life of the investments. Changes in yield
resulting from prepayments are recognized over the remaining life of the
investment. The Company recognizes impairment on its CMBS whenever it determines
that the impact of expected future credit losses, as currently projected,
exceeds the impact of the expected future credit losses as originally projected.
Impairment losses are determined by comparing the current fair value of a CMBS
to its existing carrying amount, the difference being recognized as a loss in
the current period in the consolidated statements of operations. Reduced
estimates of credit losses are recognized as an adjustment to yield over the
remaining life of the portfolio.
F-10
<PAGE>
Capital Trust and Subsidiaries
Notes to Consolidated Financial Statements (continued)
3. Summary of Significant Accounting Policies, continued
Derivative Financial Instruments
The Company uses interest rate swaps to effectively convert fixed rate assets to
variable rate assets for proper matching with variable rate liabilities. The
differential to be paid or received on these agreements is recognized as an
adjustment to the interest income related to the earning asset.
The Company also uses interest rate caps to reduce its exposure to interest rate
changes on investments. The Company will receive payments on an interest rate
cap should the variable rate for which the cap was purchased exceeds a specified
threshold level and will be recorded as an adjustment to the interest income
related to the related earning asset.
Each derivative used as a hedge is matched with an asset or liability with which
it has a high correlation. The swap agreements are generally held to maturity
and the Company does not use derivative financial instruments for trading
purposes.
Rental Properties
Prior to December 31, 1996, rental properties were carried at cost, net of
accumulated depreciation and a valuation allowance for possible credit losses.
At December 31, 1996 all rental properties were classified as held for sale and
valued at net estimated sales prices.
Equipment and Leasehold Improvements, Net
Equipment and leasehold improvements, net, are stated at original cost less
accumulated depreciation and amortization. Depreciation is computed using the
straight-line method based on the estimated lives of the depreciable assets.
Amortization is computed over the remaining terms of the related leases.
Expenditures for maintenance and repairs are charged directly to expense at the
time incurred. Expenditures determined to represent additions and betterments
are capitalized. Cost of assets sold or retired and the related amounts of
accumulated depreciation are eliminated from the accounts in the year of sale or
retirement. Any resulting profit or loss is reflected in the consolidated
statements of operations.
Sales of Real Estate
The Company complies with the provisions of Statement of Financial Accounting
Standards No. 66, "Accounting for Sales of Real Estate." Accordingly, the
recognition of gains are deferred until such transactions have complied with the
criteria for full profit recognition under the Statement. The Company has
deferred gains of $239,000 at December 31, 1997 and 1996.
Deferred Debt Issuance Costs
The Company capitalizes costs incurred related to the issuance of long-term
debt. These costs are deferred and amortized on a straight-line basis over the
life of the related debt, which approximates the level-yield method, and
recognized as a component of interest expense.
F-11
<PAGE>
Capital Trust and Subsidiaries
Notes to Consolidated Financial Statements (continued)
3. Summary of Significant Accounting Policies, continued
Income Taxes
Prior to commencement of full implementation of the current business plan on
July 15, 1997, the Company had elected to be taxed as a REIT and, as such, was
not taxed on that portion of its taxable income which was distributed to
shareholders, provided that at least 95% of its real estate trust taxable income
was distributed and that the Company met certain other REIT requirements. At
July 15, 1997, the Company did not meet the requirements to continue to be taxed
as a REIT and will therefore not be considered a REIT retroactive to January 1,
1997.
Accordingly, the Company has adopted Financial Accounting Standards Board
Statement No. 109, "Accounting for Income Taxes" ("SFAS No. 109"). SFAS No. 109
utilizes the liability method for computing tax expenses. Under the liability
method, deferred income taxes are recognized for the tax consequences of
"temporary differences" by applying statutory tax rates to future years to
differences between the financial statement carrying amounts and the tax bases
of existing assets and liabilities. Deferred tax assets are recognized for
temporary differences that will result in deductible amounts in future years and
for carryforwards. A valuation allowance is recognized if it is more likely than
not that some portion of the deferred asset will not be recognized. When
evaluating whether a valuation allowance is appropriate, SFAS No. 109 requires a
company to consider such factors as previous operating results, future earning
potential, tax planning strategies and future reversals of existing temporary
differences. The valuation allowance is increased or decreased in future years
based on changes in these criteria.
Amortization of the Excess of Purchase Price Over Net Tangible Assets Acquired
The Company recognized the excess of purchase price over net tangible assets
acquired in a business combination accounted for as a purchase transaction and
is amortizing it on a straight-line basis over a period of 15 years. The
carrying value of the excess of purchase price over net tangible assets acquired
is analyzed quarterly by the Company based upon the expected revenue and
profitability levels of the acquired enterprise to determine whether the value
and future benefit may indicate a decline in value. If the Company determines
that there has been a decline in the value of the acquired enterprise, the
Company writes down the value of the excess of purchase price over net tangible
assets acquired to the revised fair value.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principals 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 consolidated financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
F-12
<PAGE>
Capital Trust and Subsidiaries
Notes to Consolidated Financial Statements (continued)
3. Summary of Significant Accounting Policies, continued
Earnings Per Class A Common Share
Earnings per Class A Common Share is presented based on the requirements of
Statement of Accounting Standards No. 128 ("SFAS No. 128") which is effective
for periods ending after December 15, 1997. SFAS No. 128 simplifies the standard
for computing earnings per share and makes them comparable with international
earnings per share standards. The statement replaces primary earnings per share
with basic earnings per share ("Basic EPS") and fully diluted earnings per share
with Diluted Earnings per Share ("Diluted EPS"). Basic EPS is computed based on
the income applicable to Class A Common Shares (which is net loss reduced by the
dividends on Class A Preferred Shares) divided by the weighted-average number of
Class A Common Shares outstanding during the period. Diluted EPS is based on the
net earnings applicable to Class A Common Shares plus dividends on Class A
Preferred Shares, divided by the weighted average number of Class A Common
Shares and dilutive potential Class A Common Shares that were outstanding during
the period. Dilutive potential Class A Common Shares include the convertible
Class A Preferred Shares and dilutive Class A Common Share options. At December
31, 1997, the Class A Preferred Share and Class A Common Share options were not
considered Class A Common Share equivalents for purposes of calculating Diluted
EPS as they were antidilutive. Accordingly, at December 31, 1997, there was no
difference between Basic EPS and Diluted EPS or weighted average Class A Common
Shares outstanding. The adoption of this accounting standard had no effect on
the reported December 31, 1997, 1996 or 1995 earnings per share amounts.
Reclassifications
Certain reclassifications have been made in the presentation of the 1996 and
1995 consolidated financial statements to conform to the 1997 presentation.
New Accounting Pronouncements
In June 1997, the FASB issued Statement No. 130, "Reporting Comprehensive
Income" ("SFAS No. 130") effective for fiscal years beginning after December 15,
1997, although earlier application is permitted. SFAS No. 130 establishes
standards for reporting and display of comprehensive income and its components
in a full set of general-purpose financial statements. SFAS No. 130 requires
that all components of comprehensive income shall be reported in the financial
statements in the period in which they are recognized. Furthermore, a total
amount for comprehensive income shall be displayed in the financial statement
where the components of other comprehensive income are reported. The Company was
not previously required to present comprehensive income or the components
therewith under generally accepted accounting principles. The Company intends to
adopt the requirements of this pronouncement in its financial statements for the
year ended December 31, 1998.
In June 1997, the FASB issued Statement No.131, "Disclosure about segments of an
Enterprise and Related Information" ("SFAS No. 131") effective for financial
statements issued for periods beginning after December 15, 1997. SFAS No. 131
requires disclosures about segments of an enterprise and related information
regarding the different types of business activities in which an enterprise
engages and the different economic environments in which it operates. The
Company intends to adopt the requirements of this pronouncement in its
consolidated financial statements for the year ended December 31, 1998. The
adoption of SFAS No. 131 is not expected to have a material impact on the
Company's consolidated financial statement disclosures.
F-13
<PAGE>
Capital Trust and Subsidiaries
Notes to Consolidated Financial Statements (continued)
4. Interest Rate Risk Management
The Company uses interest rate swaps and interest rate caps to hedge mismatches
in interest rate maturities, to reduce the Company's exposure to interest rate
fluctuations on certain loans and investments and to provide more stable spreads
between investment yields and the rates on their financing sources. The Company
has entered into interest rate swap agreements for notional amounts totaling
approximately $42.4 million with two investment grade financial institution
counterparties whereby the Company swapped fixed rate instruments, which
averaged approximately 6.22% at December 31, 1997 and 6.55% for the year then
ended, for floating rate instruments equal to the London Interbank Offered Rate
("LIBOR") which averaged approximately 5.94% at December 31, 1997 and 5.72% for
the year then ended. Amounts arising from the differential are recognized as an
adjustment to interest income related to the earning asset. The agreements
mature at varying times from December 1998 to April 2006.
The Company purchased an interest rate cap for a notional amount of $18.75
million at a cost of approximately $71,000. The interest rate cap provides for
payments to the Company should LIBOR exceed 11.25% during the period from
November 2003 to November 2007.
The Company is exposed to credit loss in the event of non-performance by the
counterparties (which are banks whose securities are rated investment grade) to
the interest rate swap and cap agreements, although it does not anticipate such
non-performance. The counterparties would bear the interest rate risk of such
transactions as market interest rates increase.
If an interest rate swap or interest rate cap is sold or terminated and cash is
received or paid, the gain or loss is deferred and recognized when the hedged
asset is sold or matures.
5. Available-for-Sale Securities
At December 31, 1997, the Company's available-for-sale securities consisted of
the following (in thousands):
<TABLE>
<CAPTION>
Gross
Unrealized Estimated
---------------------
Cost Gains Losses Fair Value
-----------------------------------------------
<S> <C> <C> <C> <C>
Federal National Mortgage Association, adjustable rate
interest currently at 7.845%, due April 1, 2024 $ 2,176 $ - $ (32) $ 2,144
Federal Home Loan Mortgage Association, adjustable rate
interest currently at 7.916%, due June 1, 2024 752 - (10) 742
Federal National Mortgage Association, adjustable rate
interest currently at 7.362%, due
May 1, 2025 440 - (9) 431
Federal National Mortgage Association, adjustable rate
interest currently at 7.965%, due
May 1, 2026 1,860 - (20) 1,840
Federal National Mortgage Association, adjustable rate
interest currently at 7.969%, due
June 1, 2026 4,545 29 - 4,574
Norwest Corp. Voting Common Stock, 630 shares 17 7 - 24
SL Green Realty Corp. Voting Common Stock,
85,600 shares 1,798 422 - 2,220
===============================================
$11,588 $ 458 $ (71) $ 11,975
===============================================
</TABLE>
F-14
<PAGE>
Capital Trust and Subsidiaries
Notes to Consolidated Financial Statements (continued)
5. Available-for-Sale Securities, continued
At December 31, 1996, the Company's available-for-sale securities consisted of
the following (in thousands):
<TABLE>
<CAPTION>
Gross
Unrealized Estimated
---------------------
Cost Gains Losses Fair Value
-----------------------------------------------
<S> <C> <C> <C> <C>
Federal National Mortgage Association, adjustable rate
interest at 7.783% at December 31, 1996, due
April 1, 2024 $ 2,879 $ - $ (34) $ 2,845
Federal Home Loan Mortgage Association, adjustable rate
interest at 7.625% at December 31, 1996, due
June 1, 2024 967 - (10) 957
Federal National Mortgage Association, adjustable rate
interest at 7.292% at December 31, 1996, due May 1, 2025 732 - (4) 728
Federal National Mortgage Association, adjustable rate
interest at 6.144% at December 31, 1996, due May 1, 2026 3,260 - (5) 3,255
Federal National Mortgage Association, adjustable rate
interest at 6.116% at December 31, 1996, due June 1, 2026 6,299 31 - 6,330
===============================================
$14,137 $ 31 $ (53) $ 14,115
===============================================
</TABLE>
The maturity dates of debt securities are not necessarily indicative of expected
maturities as principal is often prepaid on such instruments.
The 85,600 shares of SL Green Realty Corp. Common Stock were received as partial
payment for advisory services rendered by Victor Capital to SL Green Realty
Corp. These shares are restricted from sale by the Company for a period of one
year from the date of issuance, August 20, 1997.
The cost of securities sold is determined using the specific identification
method.
6. Rental Properties
At December 31, 1996, the Company's rental property portfolio included a retail
and mixed-use property carried at $8,585,000. These properties were sold during
1997.
The Company has established an allowance for valuation losses on rental
properties as follows (in thousands):
<TABLE>
<CAPTION>
1997 1996 1995
-------------- --------------- --------------
<S> <C> <C> <C>
Beginning balance $ - $ 6,898 $ 5,863
Provision for valuation losses - 1,743 1,035
Amounts charged against allowance for
valuation losses - (8,641) -
============== =============== ==============
Ending balance $ - $ - $ 6,898
============== =============== ==============
</TABLE>
F-15
<PAGE>
Capital Trust and Subsidiaries
Notes to Consolidated Financial Statements (continued)
7. Commercial Mortgage-Backed Securities
The Company pursues rated and unrated investments in public and private
subordinated interests ("Subordinated Interests") in commercial mortgage-backed
securities ("CMBS").
On June 30, 1997, the Company completed an investment for the entire junior
subordinated class of CMBS, known as the Class B Owner Trust Certificates, that
provides for both interest and principal repayments. The CMBS investment
consists of a security with a face value of $49.6 million purchased at a
discount for $49.2 million plus accrued fees. The investment was originally
collateralized by twenty short-term commercial notes receivable with original
maturities ranging from two to three years. At the time of acquisition, the
investment was subordinated to approximately $351.3 million of senior
securities. At December 31, 1997, the CMBS investment (including interest
receivable) was $49.5 million and had a yield of 8.96%.
In addition, the Company was named "special servicer" for the entire $413
million loan portfolio in which capacity the Company will earn fee income for
management of the collection process should any of the loans become
non-performing. At December 31, 1997, no fees relating to the special servicing
arrangement were earned.
8. Loans Receivable
The Company currently pursues lending opportunities designed to capitalize on
inefficiencies in the real estate capital, mortgage and finance markets. The
Company has classified its loans receivable into the following general
categories:
o Mortgage Loans. The Company originates and funds senior and junior
mortgage loans ("Mortgage Loans") to commercial real estate owners and
property developers who require interim financing until permanent
financing can be obtained. The Company's Mortgage Loans are generally
not intended to be permanent in nature, but rather are intended to be
of a relatively short-term duration, with extension options as deemed
appropriate, and typically require a balloon payment of principal at
maturity. The Company may also originate and fund permanent Mortgage
Loans in which the Company intends to sell the senior tranche, thereby
creating a Mezzanine Loan (as defined below).
o Mezzanine Loans. The Company originates high-yielding loans that are
subordinate to first lien mortgage loans on commercial real estate and
are secured either by a second lien mortgage or a pledge of the
ownership interests in the borrowing property owner. Alternatively,
the Company's mezzanine financings can take the form of a customized
preferred equity interest in the property owning limited liability
company or partnership entity with substantially similar terms
(collectively, "Mezzanine Loans"). Generally, the Company's Mezzanine
Loans have a longer anticipated duration than its Mortgage Loans and
are not intended to serve as transitional mortgage financing.
o Other Mortgage Loans Receivable. This classification includes loans
originated during the Company's prior operations as a REIT and other
loans and investments not meeting the above criteria.
F-16
<PAGE>
Capital Trust and Subsidiaries
Notes to Consolidated Financial Statements (continued)
8. Loans, continued
At December 31, 1997 and 1996, the Company's loans receivable consisted of the
following (in thousands):
1997 1996
---------------- ----------------
(1) Mortgage Loans $ 124,349 $ -
(2) Mezzanine Loans 76,373 -
(3) Other mortgage loans receivable 2,062 1,576
---------------- ----------------
202,784 1,576
Less: reserve for possible credit losses (462) -
================ ================
Total loans $ 202,322 $ 1,576
================ ================
The weighted average interest rate at December 31, 1997of the Company's loans
receivable was as follows:
(1) Mortgage Loans 11.47%
(2) Mezzanine Loans 11.44%
(3) Other mortgage loans receivable 8.41%
At December 31, 1997, $140.4 million of the aforementioned loans bear interest
at floating rates ranging from LIBOR plus 375 basis points to LIBOR plus 600
basis points. The remaining $62.4 million of loans were financed at fixed rates
ranging from 8.50% to 12.00%. At December 31, 1997, the average earning rate in
effect, before giving effect to interest rate swaps (See Note 4) but including
amortization of fees and premiums, was 11.43%.
(1) The Company has five Mortgage Loans in its portfolio as described below:
(A) On August 4, 1997, the Company originated, and funded in part, a $35.0
million commitment for a subordinated mortgage loan for improvements
to a mixed-use property in Chicago, Illinois. The loan is subordinate
to senior indebtedness and is secured by the mixed-use property and
two mortgage notes aggregating $9.6 million on nearby development
sites. The loan has a two-year initial term with a one-year extension
option available to the borrower, subject to certain conditions, and
is payable upon the sale of the property unless the Company approves
the assumption of the debt by an institutional investor. On August 4,
1997, the Company funded $19.0 million against the aforementioned
commitment and, subsequently, on August 19, 1997, the Company entered
into a participation agreement with a third party (the "Participant")
pursuant to which the Company assigned a 42.9% (or $15.0 million)
interest in the loan. In connection with the participation agreement,
the Participant paid to the Company approximately $8.2 million or
42.9% of the $19.0 million previously funded by the Company. During
the period to December 31, 1997, the Company and the Participant
funded additional amounts aggregating $4.3 million, of which $1.8
million was funded by the Participant.
On December 31, 1997, the Company reacquired two-thirds (or $10.0
million) of the $15.0 million participation previously assigned to a
third party on August 19, 1997 at par or $6.6 million.
Through December 31, 1997, the Company's portion of the funding
provided under the mortgage loan aggregated $19.9 million and the
Company's remaining share of the commitment amounts to $10.1 million.
F-17
<PAGE>
Capital Trust and Subsidiaries
Notes to Consolidated Financial Statements (continued)
8. Loans, continued
(B) On November 7, 1997, the Company originated and funded a $50.3 million
second mortgage loan on an office building in New York City.
Simultaneous with the loan funding, the Company entered into a pari
passu participation agreement to which it sold a 50% (or $25.1
million) participation interest in the loan to EOP Operating Limited
Partnership, whose general partner is Equity Office Properties Trust,
an affiliate of the Company. The loan is subordinate to senior
indebtedness and is further secured by various additional collateral
owned by a principal of the borrower as well as a limited personal
guarantee of a principal of the borrower. Collection under the
personal guarantee and the other collateral is limited to $10.0
million. The loan has a two-year initial term with a one-year
extension option available to the borrower and bears interest at a
specified rate over LIBOR, which such rate increases during the
extension period. Under certain circumstances, the borrower may defer
a portion of the interest accrued on the loan during the initial
two-year term subject to a specified minimum rate. The loan is
interest only during the initial two-year term with excess cash flow
after determined reserves being applied to amortization during the
extension term.
On December 30, 1997, the Company reacquired $20.1 million of the
$25.1 million participation previously assigned to EOP Operating
Limited Partnership on November 7, 1997 at par. At December 31, 1997,
the Company's share of the second mortgage loan aggregated $45.3
million.
The following is a summary of the financial information for the year
ended December 31, 1997 of the aforementioned property related to the
Company's mortgage loan:
Revenues (primarily rent) $ 33,237,000
Expenses (primarily utilities, operating and taxes) 10,162,000
(C) On December 17, 1997, the Company funded a $6.0 million first mortgage
acquisition loan secured by a first mortgage on an office building and
movie theatre in St. Louis, Missouri. The loan is further secured by a
pledge of all the partnership interests in the borrower. The loan is
for one year and bears interest at a fixed rate. The loan is
non-amortizing and features a conversion option which gives the
borrower the option of converting the loan into a long-term, fixed
rate mortgage, subject to certain covenants.
(D) On December 18, 1997, the Company originated, and funded in part, a
$6.0 million subordinated participation in a $20.5 million first
mortgage acquisition loan on a retail/office building in Boston,
Massachusetts. The Company funded $4.5 million of its participation at
the closing and the other participant has fully funded its commitment.
Additional fundings will be made for approved costs incurred in
conjunction with leases executed in accordance with pre-determined
guidelines. The entire loan is secured by a first mortgage on the
building and a pledge of the ownership interests in the borrower. The
loan has a term of two years and bears interest at a specified rate
above LIBOR. The loan is non-amortizing, and provides for a conversion
option that gives the borrower the option of converting the loan into
a long-term, fixed rate mortgage, subject to certain covenants.
(E) On December 23, 1997, the Company purchased a $62.6 million mortgage
loan obligation from a financial institution at a premium of
approximately $1.4 million. The loan is secured by a first mortgage on
an office and retail property in New York City. With the acquisition
of the mortgage loan obligation, the Company acquired an existing loan
of approximately $47.3 million and assumed an obligation to make
additional advances of approximately $15.3 million. The loan, which
matures in January 2001, bears interest at a fixed rate over LIBOR for
its term. Prepayment of the loan is permitted during the entire term,
but is subject to a prepayment penalty during the first two years.
There is no prepayment penalty during the final year of the loan. A
specified fee is due from the borrower to the Company upon
satisfaction of the loan.
F-18
<PAGE>
Capital Trust and Subsidiaries
Notes to Consolidated Financial Statements (continued)
8. Loans, continued
The following is a summary of the financial information for the year
ended December 31, 1997 of the aforementioned property related to the
Company's mortgage loan:
Revenues (primarily rent) $ 7,396,000
Expenses (primarily utilities, operating and taxes) 5,802,000
(2) The Company has entered into five Mezzanine Loans as detailed below:
(A) On September 19, 1997 the Company completed a fixed rate investment in
the form of a $15.0 million portion of a ten year $80.0 million
mezzanine loan secured by a pledge of the ownership interests in the
entities that own an office building in New York City. Additionally,
the investment is secured by a full payment guarantee by the principal
owner of the property owning entities, in the event of certain
circumstances, including bankruptcy. The investment was purchased at a
premium for approximately $15.6 million. In the event that excess cash
flow available, as defined, is insufficient to pay the loan's interest
currently, up to 2% can be accrued and added to principal. Scheduled
maturity of the Note is April 2007, with prepayment prohibited for the
first five years but permitted during the following four years with
yield maintenance. The loan is fully prepayable with no premium or
penalty in the tenth year.
(B) On October 31, 1997 the Company completed a five year, fixed rate
investment in the form of a $10.0 million second mortgage loan secured
by a mortgage on the interests of a 64% tenancy-in-common interest in
an office building in New York City. Additionally, the loan is further
secured by a pledge by 100% of the membership interests in the
borrower. The loan is non-amortizing and may be prepaid with yield
maintenance at any time. The borrower established an interest reserve
at closing.
(C) On December 5, 1997, the Company originated a $3.0 million second
mortgage loan on an assisted living facility in Great Neck, New York.
The fixed rate loan has a term of five years and is secured by a
second mortgage on the property and limited personal guarantees of the
principals of the borrower, which decrease as the occupancy of the
property increases. Amortization is dependent on excess cash flow
being generated. A fee is due from the borrower to the Company upon
satisfaction of the loan that will provide the Company with a stated
internal rate of return, which increases over the term of the loan.
(D) On December 29, 1997, the Company purchased a $25.0 million fixed rate
mezzanine loan, which matures in September 2007, for $25.8 million.
The loan is secured by a pledge of the ownership interests in the
entities that own the office and retail property in New York City. The
loan is further secured by a full payment guaranty by the principals
that own the property in the event of certain occurrences, including
bankruptcy. Prepayment of the loan is permitted during the entire loan
period subject to yield maintenance during the first six years of the
loan and without prepayment premium or penalty for the remainder of
the loan term.
(E) On December 31, 1997, the Company completed a $22.0 million preferred
equity financing in the form of a customized interest in the limited
liability company that owns an office/retail property in Santa Monica,
California. The preferred equity interest has a remaining term of 34
months and pays distributions at a specified rate over LIBOR until
redemption. Early redemption of the preferred equity interest is not
permitted during the first four months following the closing of the
acquisition transaction. The preferred equity interest is subject to
early redemption penalties for the period from the fifth through the
twenty-second months of the Company's ownership and is not subject to
any penalties during the last year proceeding the mandatory redemption
date.
F-19
<PAGE>
Capital Trust and Subsidiaries
Notes to Consolidated Financial Statements (continued)
8. Loans, continued
(3) The other mortgage loan receivables are collateralized by real estate
properties in California and Arizona that arose from the sale of real
estate. These mortgage loans receivable mature at varying dates
between February 11, 1999 and March 31, 2012.
As of December 31, 1996, the Company was in the process of monetizing
its assets and accordingly, wrote down such assets to current market
value, less estimated selling costs. The Company has established an
allowance for valuation losses on loans receivable as follows (in
thousands):
<TABLE>
<CAPTION>
1997 1996 1995
-------------- --------------- --------------
<S> <C> <C> <C>
Beginning balance $ - $ 9,151 $ 7,182
Provision for valuation losses 462 - 2,246
Deferred gains on notes and other, net - - (66)
Amounts charged against allowance for
valuation losses - (9,151) (211)
============== =============== ==============
Ending balance $ 462 $ - $ 9,151
============== =============== ==============
</TABLE>
9. Risk Factors
The Company's assets are subject to various risks that can affect results,
including the level and volatility of prevailing interest rates, adverse changes
in general economic conditions and real estate markets, the deterioration of
credit quality of borrowers and the risks associated with the ownership and
operation of real estate. Any significant compression of the spreads of the
interest rates earned on interest-earning assets over the interest rates paid on
interest-bearing liabilities could have a material adverse effect on the
Company's operating results. Adverse changes in national and regional economic
conditions can have an effect on real estate values increasing the risk of
undercollateralization to the extent that the fair market value of properties
serving as collateral security for the Company's assets are reduced. Numerous
factors, such as adverse changes in local market conditions, competition,
increases in operating expenses and uninsured losses, can affect a property
owner's ability to maintain or increase revenues to cover operating expenses and
the debt service on the property's financing and, consequently, lead to a
deterioration in credit quality or a loan default and reduce the value of the
Company's asset. In addition, the yield to maturity on the Company's CMBS assets
are subject to the default and loss experience on the underlying mortgage loans,
as well as by the rate and timing of payments of principal. If there are
realized losses on the underlying loans, the company may not recover the full
amount, or possibly, any of its initial investment in the affected CMBS asset.
To the extent there are prepayments on the underlying mortgage loans as a result
of refinancing at lower rates, the Company's CMBS assets may be retired
substantially earlier than their stated maturities leading to reinvestment in
lower yielding assets. There can be no assurance that the Company's assets will
not experience any of the foregoing risks or that, as a result of any such
experience, the Company will not suffer a reduced return on investment or an
investment loss.
F-20
<PAGE>
Capital Trust and Subsidiaries
Notes to Consolidated Financial Statements (continued)
10. Equipment and Leasehold Improvements
At December 31, 1997 and 1996, equipment and leasehold improvements, net, are
summarized as follows (in thousands):
<TABLE>
Period of
Depreciation or
Amortization 1997 1996
------------------------- -------------- ----------------
<S> <C> <C> <C>
Office equipment 3 to 7 years $ 307 $ 80
Leasehold improvements Term of leases 143 -
-------------- ----------------
450 80
Less: accumulated depreciation (93) (29)
============== ================
$ 357 $ 51
============== ================
</TABLE>
Depreciation and amortization expense on equipment and leasehold improvements
totaled $64,000, $19,000 and $10,000 for the years ended December 31, 1997, 1996
and 1995, respectively. Equipment and leasehold improvements are included in
prepaid and other assets in the consolidated balance sheets.
11. Notes Payable
At December 31, 1997, the Company has notes payable aggregating $5.0 million.
In connection with the acquisition of Victor Capital and affiliated entities,
the Company issued $5.0 million of non-interest bearing unsecured notes
("Acquisition Notes") to the sellers, payable in ten semi-annual payments of
$500,000. The Acquisition Notes have been discounted to $3.9 million based on an
imputed interest rate of 9.5%. At December 31, 1997, the net present value of
the Acquisition Notes (including interest payable) amounted to approximately
$4.1 million.
The Company is also indebted under a note payable due to a life insurance
company. This note is secured by the property that was sold in 1997. The note
bears interest at 9.50% per annum with principal and interest payable monthly
until August 7, 2017 when the entire unpaid principal balance and any unpaid
interest is due. The life insurance company has the right to call the entire
note due and payable upon ninety days prior written notice. At December 31,
1997, the balance of the note payable amounted to approximately $859,000.
As of December 31, 1996, the Company had long-term notes payable of $5,169,000,
most of which were collateralized by deeds of trust on rental properties with an
aggregate book value of $8,585,000. These notes were due in installments to the
year 2014 and had interest rates ranging from 8% to 10.75%. Except for the note
payable described in the preceding paragraph, these notes were repaid during
1997.
F-21
<PAGE>
Capital Trust and Subsidiaries
Notes to Consolidated Financial Statements (continued)
12. Long-Term Debt
Credit Facility
Effective September 30, 1997, the Company entered into a credit agreement with a
commercial lender that provides for a three-year $150 million line of credit
(the "Credit Facility"). The Credit Facility provides for advances to fund
lender-approved loans and investments made by the Company ("Funded Portfolio
Assets").
The obligations of the Company under the Credit Facility are secured by pledges
of the Funded Portfolio Assets acquired with advances under the Credit Facility.
Borrowings under the Credit Facility bear interest at specified rates over LIBOR
(averaging approximately 8.2% for the borrowing outstanding at December 31,
1997) which rates may fluctuate based upon the credit quality of the Funded
Portfolio Assets. The Company incurred an initial commitment fee upon the
signing of the credit agreement and is obligated to pay an additional commitment
fee when the total borrowing under the Credit Facility exceeds $75 million.
Future repayments and redrawdowns of amounts previously subject to the drawdown
fee will not require the Company to pay any additional fees. The Credit Facility
provides for margin calls on asset-specific borrowings in the event of asset
quality and/or market value deterioration as determined under the Credit
Facility. The Credit Facility contains customary representations and warranties,
covenants and conditions and events of default. The Credit Facility also
contains a covenant obligating the Company to avoid undergoing an ownership
change that results in Craig M. Hatkoff, John R. Klopp or Samuel Zell no longer
retaining their senior offices and trusteeships with the Company and practical
control of the Company's business and operations.
On December 31, 1997, the unused Credit Facility amounted to $70.1 million.
Repurchase Obligations
The Company has entered into four repurchase agreements.
Three of the repurchase agreements with CS First Boston arose in connection with
the purchase of a mezzanine loan, the CMBS investment and the preferred equity
investment described in Note 7. At December 31, 1997, the Company has sold such
assets totaling $97.3 million, which approximates market value, and has a
liability to repurchase these assets for $72.7 million. The liability balance of
$72.7 million bears interest at specified rates over LIBOR (weighted average of
6.75% at December 31, 1997), and generally have a one year term with extensions
available by mutual consent. These agreements mature in late December 1998.
The Company also has entered into a repurchase agreement with Paine Webber in
conjunction with the financing of all of its FNMA and FHLMC securities. At
December 31, 1997, the Company has sold such securities with a book value
totaling $9.8 million (market value $9.7 million) and has a liability to
repurchase these assets for $9.5 million. The liability balance of $9.5 million
bears interest at 6.40%, and matures on January 29, 1998.
F-22
<PAGE>
Capital Trust and Subsidiaries
Notes to Consolidated Financial Statements (continued)
13. Shareholders' Equity
Authorized Capital
Pursuant to the Company's Amended and Restated Declaration of Trust, all of the
Company's previously issued common shares of beneficial interest, $1.00 par
value, were reclassified as Class A Common Shares on July 15, 1997. The total
number of authorized capital shares of the Company is unlimited and currently
consists of (i) Class A Preferred Shares, (ii) class B 9.5% cumulative
convertible non-voting preferred shares of beneficial interest, $1.00 par value,
in the Company ("Class B Preferred Shares"), (iii) Class A Common Shares, and
(iv) class B common shares of beneficial interest, $1.00 par value, in the
Company ("Class B Common Shares"). As of December 31, 1997, there were
12,267,658 Class A Preferred Shares issued and outstanding, no Class B Preferred
Shares issued and outstanding, 18,157,150 Class A Common Shares issued and
outstanding and no Class B Common Shares issued and outstanding. The board of
trustees is authorized, with certain exceptions, to provide for the issuance of
additional preferred shares of beneficial interest in one or more classes or
series.
Common Shares
Except as described herein or as required by law, all Class A Common Shares and
Class B Common Shares are identical and entitled to the same dividend,
liquidation and other rights. The Class A Common Shares are voting shares
entitled to vote on all matters presented to a vote of shareholders, except as
provided by law or subject to the voting rights of any outstanding preferred
shares. The Class B Common Shares do not have voting rights and are not counted
in determining the presence of a quorum for the transaction of business at any
meeting of the shareholders. Holders of record of Class A Common Shares and
Class B Common Shares on the record date fixed by the Company's board of
trustees are entitled to receive such dividends as may be declared by the board
of trustees subject to the rights of the holders of any series of preferred
shares.
Each Class A Common Share is convertible at the option of the holder thereof
into one Class B Common Share and, subject to certain conditions, each Class B
Common Share is convertible at the option of the holder thereof into Class A
Common Share.
The Company is restricted from declaring or paying any dividends on its Class A
Common Shares or Class B Common Shares unless all accrued and unpaid dividends
with respect to the Class A Preferred Shares have been paid in full.
Preferred Shares
In connection with the adoption of the Amended and Restated Designation of
Trust, the Company created two classes of preferred shares, the Class A
Preferred Shares and the Class B Preferred Shares (collectively, the "Preferred
Shares"). Each class of Preferred Shares consists of 12,639,405 authorized
shares, as specified in the certificate of designation, preferences and rights
with respect thereto adopted on July 15, 1997 (the "Certificate of
Designation"). On July 15, 1997, Veqtor purchased from the Company 12,267,658
Class A Preferred Shares for an aggregate purchase price of approximately $33
million.
F-23
<PAGE>
Capital Trust and Subsidiaries
Notes to Consolidated Financial Statements (continued)
13. Shareholders' Equity, continued
Except as described herein or as required by law, both classes of Preferred
Shares are identical and entitled to the same dividend, liquidation and other
rights as provided in the Certificate of Designation and the Restated
Declaration. The Class A Preferred Shares are entitled to vote together with the
holders of the Class A Common Shares as a single class on all matters submitted
to a vote of shareholders. Each Class A Preferred Share entitles the holder
thereof to a number of votes per share equal to the number of Class A Common
Shares into which such Class A Preferred Share is then convertible. Except as
described herein, the Class B Preferred Shares do not have voting rights and are
not counted in determining the presence of a quorum for the transaction of
business at a shareholders' meeting. The affirmative vote of the shareholders of
a majority of the outstanding Preferred Shares, voting together as a separate
single class, except in certain circumstances, have the right to approve any
merger, consolidation or transfer of all or substantially all of the assets of
the Company. Holders of the Preferred Shares are entitled to receive, when and
as declared by the board of trustees, cash dividends per share at the rate of
9.5% per annum on a per share price of $2.69. Such dividends shall accrue
(whether or not declared) and, to the extent not paid for any dividend period,
will be cumulative. Dividends on the Preferred Shares are payable, when and as
declared, semi-annually, in arrears, on December 26 and June 25 of each year
commencing December 26, 1997.
Each Class A Preferred Share is convertible at the option of the holder thereof
into an equal number of Class B Preferred Shares, or into a number of Class A
Common Shares equal to the ratio of (x) $2.69 plus an amount equal to all
dividends per share accrued and unpaid thereon as of the date of such conversion
to (y) the Conversion Price in effect as of the date of such conversion. Each
Class B Preferred Share is convertible at the option of the holder thereof,
subject to certain conditions, into an equal number of Class A Preferred Shares
or into a number of Class B Common Shares equal to the ratio of (x) $2.69 plus
an amount equal to all dividends per share accrued and unpaid thereon as of the
date of such conversion to (y) the Conversion Price in effect as of the date of
such conversion. The Conversion Price as of December 31, 1997 is $2.69.
14. General and Administrative Expenses
General and administrative expenses for the years ended December 31, 1997, 1996
and 1995 consist of (in thousands):
<TABLE>
1997 1996 1995
------------------ ------------------ ------------------
<S> <C> <C> <C>
Salaries and Benefits $ 5,035 $ - $ 19
Professional services 2,311 295 212
Other 2,117 1,208 702
================== ================== ==================
Total $ 9,463 $ 1,503 $ 933
================== ================== ==================
</TABLE>
The Company incurred significant non-recurring fees for professional services in
1997 (an increase of more than $2,000,000 over 1996) in conjunction with the
reconstitution of the Company, the termination of its REIT status and the
implementation of its current business plan.
F-24
<PAGE>
Capital Trust and Subsidiaries
Notes to Consolidated Financial Statements (continued)
15. Income Taxes
The Company and its subsidiaries will elect to file a consolidated federal
income tax return for the year ending December 31, 1997. The provision for
income taxes for the year ended December 31, 1997 is comprised of the following:
Current
Federal -
State -
Local 55
Deferred
Federal -
State -
Local -
==============
Provision for income taxes $ 55
==============
The Company has federal net operating loss carryforwards ("NOLs") as of December
31, 1997 of approximately $20.2 million. Such NOLs expire through 2012. The
Company also had a federal capital loss carryover of approximately $1.6 million
that can be used to offset future capital gains. Due to CRIL's purchase of
6,959,593 Class A Common Shares from the Company's Former Parent in January 1997
and another prior ownership change, a substantial portion of the NOLs are
limited for federal income tax purposes to approximately $1.5 million annually.
Any unused portion of such annual limitation can be carried forward to future
periods.
The reconciliation of income tax computed at the U.S. federal statutory tax rate
to the effective income tax rate for the year ended December 31, 1997 is as
follows (in thousands):
Federal income tax at statutory rate (34%) $ (1,531) (34.0)%
State and local taxes, net of federal tax benefit 36 0.1%
Tax benefit of net operating loss not currently recognized 1,536 34.0 %
Other 14 0.0 %
====================
$ 55 0.1%
====================
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for tax reporting purposes.
The components of the net deferred tax assets recorded under SFAS No. 109 as of
December 31, 1997 is as follows (in thousands):
Net operating loss carryforward $ 9,090
Reserves on other assets and for possible credit losses 3,326
Deferred revenue 616
Reserve for uncollectible accounts 208
-----------
Deferred tax assets $ 13,240
Valuation allowance (13,240)
-----------
$ -
===========
The Company recorded a valuation allowance to fully reserve its net deferred
assets. Under SFAS No. 109, this valuation allowance will be adjusted in future
years, as appropriate. However, the timing and extent of such future adjustments
can not presently be determined.
F-25
<PAGE>
Capital Trust and Subsidiaries
Notes to Consolidated Financial Statements (continued)
16. Employee Benefit Plans
1997 Long-Term Incentive Share Plan
On May 23, 1997, the board of trustees adopted the 1997 Long-Term Incentive Plan
(the "Incentive Share Plan"), which became effective upon shareholder approval
on July 15, 1997 at the 1997 annual meeting of shareholders (the "1997 Annual
Meeting"). The Incentive Share Plan permits the grant of nonqualified share
option ("NQSO"), incentive share option ("ISO"), restricted share, share
appreciation right ("SAR"), performance unit, performance share and share unit
awards. The Company has reserved an aggregate of 2,000,000 Class A Common Shares
for issuance pursuant to awards under the Incentive Share Plan and the Trustee
Share Plan (as defined below). The maximum number of shares that may be subject
of awards to any employee during the term of the plan may not exceed 500,000
shares and the maximum amount payable in cash to any employee with respect to
any performance period pursuant to any performance unit or performance share
award is $1.0 million. Through December 31, 1997, the Company had outstanding
ISOs and NQSOs (the "Grants") pursuant to the Incentive Share Plan to purchase
an aggregate of 607,000 Class A Common Shares with an exercise price of $6.00
per share (the closing Class A Common Share price on the date of the grant).
None of the options are exercisable at December 31, 1997 and they have a
remaining contractual life of 9-1/2 years.
The ISOs shall be exercisable no more than ten years after their date of grant
and five years after the grant in the case of a 10% shareholder and vest over a
period of three years with one-third vesting at each anniversary date. Payment
of an option may be made with cash, with previously owned Class A Common Shares,
by foregoing compensation in accordance with performance compensation committee
or compensation committee rules or by a combination of these.
Restricted shares may be granted under the Incentive Share Plan with performance
goals and periods of restriction as the board of trustees may designate. The
performance goals may be based on the attainment of certain objective and/or
subjective measures. The Incentive Share Plan also authorizes the grant of share
units at any time and from time to time on such terms as shall be determined by
the board of trustees or administering compensation committee. Share units shall
be payable in Class A Common Shares upon the occurrence of certain trigger
events. The terms and conditions of the trigger events may vary by share unit
award, by the participant, or both.
SFAS No. 123, "Accounting for Stock-Based Compensation" was issued by the FASB
in October 1995. SFAS No. 123 encourages the adoption of a new fair-value based
accounting method for employee stock-based compensation plans. SFAS No. 123 also
permits companies to continue accounting for stock-based compensation plans as
prescribed by APB Opinion No. 25. However, companies electing to continue
accounting for stock-based compensation plans under the APB Opinion No. 25, must
make pro forma disclosures as if the company adopted the cost recognition
requirements under SFAS No. 123. The Company has continued to account for
stock-based compensation under the APB Opinion No. 25. Accordingly, no
compensation cost has been recognized for the Incentive Share Plan or the
Trustee Share Plan in the accompanying consolidated statement of operations as
the exercise price of the share options granted thereunder equaled the market
price of the underlying shares on the date of the Grant.
The fair value of each option grant is estimated on the date of grant using the
Black-Scholes option-pricing model with the following weighted average
assumptions used for grants in 1997, respectively: (1) dividend yield of zero;
(2) expected volatility of 40%; (3) risk-free interest rate of 5.71% and (4) an
expected life of five years. The weighted average fair value of each share
option granted during the year ended December 31, 1997 was $2.63.
The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options that have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions including the expected share price volatility. Because
F-26
<PAGE>
Capital Trust and Subsidiaries
Notes to Consolidated Financial Statements (continued)
16. Employee Benefit Plans, continued
the Company's employee share options have characteristics significantly
different from those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its employee share options.
For purposes of pro forma disclosures, the estimated fair value of the options
is amortized to expense over the options' vesting period. For the year ended
December 31, 1997, pro forma net loss, after giving effect to the Class A
Preferred Share dividend requirement, and basic and diluted loss per share,
after giving effect to the fair value of the grants would be $6.2 million and
$0.65, respectively.
The pro forma information presented above is not representative of the effect
share options will have on pro forma net income or earnings per share for future
years.
1997 Non-Employee Trustee Share Plan
On May 23, 1997, the board of trustees adopted the 1997 Non-Employee Trustee
Share Plan (the "Trustee Share Plan"), which became effective upon shareholder
approval on July 15, 1997 at the 1997 Annual Meeting. The Trustee Share Plan
permits the grant of NQSO, restricted shares, SAR, performance unit, share and
share unit awards. The Company has reserved an aggregate of 2,000,000 Class A
Common Shares for issuance pursuant to awards under the Trustee Share Plan and
the Incentive Share Plan. Through December 31, 1997, the Company issued to each
of two trustees pursuant to the Trustee Share Plan NQSOs to purchase 25,000
Class A Common Shares with an exercise price of $6.00 per share (the closing
Class A Common Share price on the date of grant).
The board of trustees shall determine the purchase price per Class A Common
Share covered by a NQSO granted under the Trustee Share Plan. Payment of a NQSO
may be made with cash, with previously owned Class A Common Shares, by foregoing
compensation in accordance with board rules or by a combination of these. SARs
may be granted under the plan in lieu of NQSOS, in addition to NQSOS,
independent of NQSOs or as a combination of the foregoing. A holder of a SAR is
entitled upon exercise to receive Class A Common Shares, or cash or a
combination of both, as the board of trustees may determine, equal in value on
the date of exercise to the amount by which the fair market value of one Class A
Common Share on the date of exercise exceeds the exercise price fixed by the
board on the date of grant (which price shall not be less than 100% of the
market price of a Class A Common Share on the date of grant) multiplied by the
number of shares in respect of which the SARs are exercised.
Restricted shares may be granted under the Trustee Share Plan with performance
goals and periods of restriction as the board of trustees may designate. The
performance goals may be based on the attainment of certain objective and/or
subjective measures. The Trustee Share Plan also authorizes the grant of share
units at any time and from time to time on such terms as shall be determined by
the board of trustees. Share units shall be payable in Class A Common Shares
upon the occurrence of certain trigger events. The terms and conditions of the
trigger events may vary by share unit award, by the participant, or both.
F-27
<PAGE>
Capital Trust and Subsidiaries
Notes to Consolidated Financial Statements (continued)
17. Fair Values of Financial Instruments
SFAS No. 107, "Disclosures about Fair Value of Financial Instruments," requires
disclosure of fair value information about financial instruments, whether or not
recognized in the statement of financial condition, for which it is practicable
to estimate that value. In cases where quoted market prices are not available,
fair values are based upon estimates using present value or other valuation
techniques. Those techniques are significantly affected by the assumptions used,
including the discount rate and the estimated future cash flows. In that regard,
the derived fair value estimates cannot be substantiated by comparison to
independent markets and, in many cases, could not be realized in immediate
settlement of the instrument. SFAS No. 107 excludes certain financial
instruments and all non-financial instruments from its disclosure requirements.
Accordingly, the aggregate fair value amounts do not represent the underlying
value of the Company.
The following methods and assumptions were used to estimate the fair value of
each class financial instruments for which it is practicable to estimate that
value:
Cash and cash equivalents: The carrying amount of cash on hand and money
market funds is considered to be a reasonable estimate of fair value.
Available-for-sale securities: The fair value was determined based upon the
market value of the securities.
Commercial mortgage-backed security: The fair value was obtained by
obtaining a quote for the sale of the security. The fair value of the
commercial mortgage-backed security was $49.5 million at December 31, 1997.
Loans receivable, net: The fair values were estimated by using current
institutional purchaser yield requirements. The fair value of the investing
and lending transactions totaled $203.2 million at December 31, 1997.
Interest rate swap agreement: The fair value was estimated based upon the
amount at which similar financial instruments would be valued. At December
31, 1997, the fair value of the interest rate swaps approximated
($874,000).
Interest rate cap agreement: The fair value was estimated based upon the
amount at which similar financial instruments would be valued. At December
31, 1997, the fair value of the interest rate cap approximated $70,000.
Credit Facility: The Credit Facility was entered into effective September
30, 1997 at floating rates of interest, and therefore, the carrying value
is a reasonable estimate of fair value.
Repurchase obligation: The repurchase obligations bear interest at a
floating rate and the book value is a reasonable estimate of fair value.
The notes included above reflect fair values where appropriate for the financial
instruments of the Company, utilizing the assumptions and methodologies as
defined.
F-28
<PAGE>
Capital Trust and Subsidiaries
Notes to Consolidated Financial Statements (continued)
18. Supplemental Schedule of Non-Cash and Financing Activities
The following is a summary of the significant non-cash investing and financing
activities during the year ended December 31, 1997:
Stock received as partial compensation for advisory services $ 1,798
In connection with the sale of properties and notes receivable, the Company
entered into various non-cash transactions as follows during the year ended
December 31, 1997 (in thousands):
Sales price less selling costs $ 8,396
Amount due from buyer (1,090)
-------------
Net cash received $ 7,306
=============
Interest paid on the Company's outstanding debt for 1997, 1996 and 1995 was
$1,877,000, $550,000 and $730,000, respectively.
19. Transactions with Related Parties
The Company entered into a consulting agreement, dated as of July 15, 1997, with
a trustee of the Company. The consulting agreement has a term of one year.
Pursuant to the agreement, the Trustee provides consulting services for the
Company including strategic planning, identifying and negotiating mergers,
acquisitions, joint ventures and strategic alliances, and advising as to capital
structure matters. During the year ended December 31, 1997 the Company has
incurred an expense of $300,000 in connection with this agreement.
The Company pays EGI, an affiliate under common control of the Chairman of the
board of trustees, for certain corporate services provided to the Company. These
services include consulting on legal matters, tax matters, risk management,
investor relations and investment banking. During the year ended December 31,
1997, the Company has incurred $134,000 of expenses in connection with these
services.
During 1996 and 1995, the Company shared certain personnel and other costs with
Former Parent. The Company reimbursed Former Parent pursuant to a cost
allocation agreement based on each Company's respective asset values (real
property and notes receivable) that was subject to annual negotiation. During
1996 and 1995, reimbursable costs charged to the Company by Former Owner
approximated $258,000 and $435,000, respectively. The 1995 amount was partially
offset against $202,000 (net of valuation allowances of $141,000) which was
recorded as due from Former Parent at December 31, 1994.
At December 31, 1996, the Company owed $31,000 to the Former Parent pursuant to
the cost allocation agreement. The cost allocation agreement between the Company
and the Former Parent was terminated on January 7, 1997. At December 31, 1997,
the Company had no amounts due to the Former Parent pursuant to the cost
allocation arrangement.
During the year ended December 31, 1997, the Company, through two of its
acquired subsidiaries, earned asset management fees pursuant to agreements with
entities in which two of the executive officers and trustees of the Company have
an equity interest and serve as officers, members or as a general partner
thereof. During the year ended December 31, 1997, the Company earned $327,000
from such agreements, which has been included in the consolidated statement of
operations.
F-29
<PAGE>
Capital Trust and Subsidiaries
Notes to Consolidated Financial Statements (continued)
20. Commitments and Contingencies
Leases
The Company leases premises and equipment under operating leases with various
expiration dates. Minimum annual rental payments at December 31, 1997 are as
follows (in thousands):
Years ending December 31:
1998 $ 508
1999 515
2000 197
2001 23
2002 23
------------
$ 1,266
============
Rent expense for office space and equipment amounted to $310,000, $40,000 and
$30,000 for the years ended December 31, 1997, 1996 and 1995, respectively.
Litigation
In the normal course of business, the Company is subject to various legal
proceedings and claims, the resolution of which, in management's opinion, will
not have a material adverse effect on the consolidated financial position or the
results of operations of the company.
Employment Agreements
The Company has employment agreements with three of its executive officers.
The employment agreements with two of the executive officers provide for
five-year terms of employment commencing as of July 15, 1997. Such agreements
contain extension options that extend such agreements automatically unless
terminated by notice, as defined, by either party. The employment agreements
provide for base annual salaries of $500,000, which will be increased each
calendar year to reflect increases in the cost of living and will otherwise be
subject to increase in the discretion of the board of trustees. Such executive
officers are also entitled to annual incentive cash bonuses to be determined by
the board of trustees based on individual performance and the profitability of
the Company and are participants in the Incentive Share Plan and other employee
benefit plans of the Company.
The employment agreement with another executive officer provides for a two-year
employment term. Such agreement contains extension options that extend the
agreement automatically unless terminated by notice by either party. The
employment agreement provides for base annual salary of $300,000, annual
bonuses, as specified, at the end of 1997 and 1998, and participation in the
Incentive Share Plan and other employee benefit plans of the Company. Such
executive officer is also entitled to an annual incentive cash bonus to be
determined by the board of trustees based on individual performance and the
profitability of the Company.
F-30
<PAGE>
Capital Trust and Subsidiaries
Notes to Consolidated Financial Statements (continued)
21. Summary of Quarterly Results of Operations (Unaudited)
The following is a summary of the unaudited quarterly results of operations for
the years ended December 31, 1997, 1996 and 1995:
<TABLE>
<CAPTION>
March 31 June 30 September 30 December 31
--------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C>
1997
Revenues $ 613 $ 371 $ 2,729 $ 4,737
Net income (loss) $ (508) $ (352) $ (1,593) $ (2,104)
Class A Preferred Share dividends and
dividend requirement $ - $ - $ 679 $ 792
Net income (loss) per Class A
Common Share $ (0.06) $ (0.04) $ (0.25) $ (0.27)
1996
Revenues $ 871 $ 780 $ 771 $ 733
Net income (loss) $ 440 $ (213) $ (514) $ (127)
Net income (loss) per share $ 0.05 $ (0.02) $ (0.06) $ (0.02)
1995
Revenues $ 879 $ 836 $ 942 $ 878
Net income (loss) $ 242 $ 44 $ 100 $ (3,164)
Net income (loss) per share $ 0.03 $ 0.00 $ 0.01 $ (0.34)
</TABLE>
The 1996 and first three quarters of 1997 earnings per share amounts have been
restated to comply with Statement of Financial Accounting Standards No. 128,
"Earnings per Share".
F-31
