<PAGE>
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q/A
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1998
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from __________________ to____________________
Commission File No. 1-10150
STARWOOD FINANCIAL TRUST
(Exact name of registrant as specified in its charter)
Maryland 95-6881527
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
1114 Avenue of the Americas 10036
27th Floor (Zip Code)
New York, NY 10036
(Address of principal executive
offices)
Registrant's telephone number, including area code: (212) 930-9400
Securities registered pursuant to Section 12(b) of the Act:
NAME OF EXCHANGE ON WHICH
TITLE OF EACH CLASS: REGISTERED:
-------------------- -------------------------
Class A Shares, $1.00 par value American Stock Exchange
Securities registered pursuant to Section 12(g) of None
the Act:
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
YES [ X ] NO [ _ ]
As of November 9, 1998, there were 52,407,718 Class A Shares of Starwood
Financial Trust, $1.00 par value, outstanding.
<PAGE>
STARWOOD FINANCIAL TRUST
INDEX TO FORM 10-Q
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
PART I. CONSOLIDATED FINANCIAL INFORMATION........................................................................3
ITEM 1. FINANCIAL STATEMENTS:
CONSOLIDATED BALANCE SHEETS AT SEPTEMBER 30, 1998 AND DECEMBER 31, 1997...................................3
CONSOLIDATED STATEMENTS OF OPERATIONS - FOR THE THREE AND NINE MONTH PERIODS ENDED
SEPTEMBER 30, 1998 AND 1997.......................................................................4
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS'EQUITY - FOR THE NINE MONTH PERIOD ENDED
SEPTEMBER 30, 1998................................................................................5
CONSOLIDATED STATEMENTS OF CASH FLOWS - FOR THE THREE AND NINE MONTH PERIODS ENDED
SEPTEMBER 30, 1998 AND 1997.......................................................................6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ...............................................................7
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS..............................................................16
Part II. OTHER INFORMATION........................................................................................22
ITEM 1. LEGAL PROCEEDINGS........................................................................................22
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS................................................................22
ITEM 3. DEFAULTS UPON SENIOR SECURITIES..........................................................................22
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS......................................................22
ITEM 5. OTHER INFORMATION........................................................................................22
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.........................................................................22
SIGNATURES...............................................................................................23
</TABLE>
2
<PAGE>
PART I - CONSOLIDATED FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
STARWOOD FINANCIAL TRUST
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 1997*
------------- ------------
(unaudited)
<S> <C> <C>
ASSETS
Loans and other investments, net (Note 5) .......................... $ 1,760,167 $ 90
Cash and cash equivalents .......................................... 6,291 296
Marketable securities .............................................. 6,117 11,085
Accrued interest and rent receivable ............................... 15,095 58
Deferred expenses and other assets ................................. 8,952 1,912
----------- ---------
Total assets .................................................. $ 1,796,622 $ 13,441
----------- ---------
----------- ---------
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Accounts payable, accrued expenses and other liabilities ........... $ 10,843 $ 1,915
Debt obligations (Note 6) .......................................... 1,014,672 --
----------- ---------
Total liabilities .................................................. 1,025,515 1,915
----------- ---------
Minority interest .................................................. -- 5,175
----------- ---------
Commitments and contingencies ...................................... -- --
Shareholders' equity:
Class A Shares, $1.00 par value, unlimited shares authorized,
52,407,718 (1) and 7,550,000 shares issued and outstanding
at September 30, 1998 and December 31, 1997, respectively ........ 52,408 7,550
Class B Shares, $0.01 par value, unlimited shares authorized,
26,203,859(1) and 3,775,000 shares issued and outstanding
at September 30, 1998 and December 31, 1997, respectively ........ 262 38
Net unrealized gains (losses) on "available-for-sale" investments .. (22) (162)
Additional paid in capital ......................................... 701,107 --
Retained earnings (deficit) ........................................ 17,352 (1,075)
----------- ---------
Total shareholders' equity .................................... 771,107 6,351
----------- ---------
Total liabilities and shareholders' equity .................... $ 1,796,622 $ 13,441
----------- ---------
----------- ---------
</TABLE>
*RECLASSIFIED TO CONFORM TO 1998 PRESENTATION.
(1) As adjusted for one-for-six reverse stock split effective June 19, 1998
(Note 1)
The accompanying notes are an integral part of the financial statements.
3
<PAGE>
STARWOOD FINANCIAL TRUST
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------- -------------------------
1998 1997 1998 1997
-------- -------- ------ -------
<S> <C> <C> <C> <C>
REVENUE:
Interest income $ 36,398 $ 246 $ 68,910 $ 704
Operating lease income 4,350 -- 8,624 --
Other income 1,329 -- 2,213 2
-------- ------ ------- -----
Total revenue 42,077 246 79,747 706
-------- ------ ------- -----
COSTS AND EXPENSES:
Interest expense 14,978 -- 25,472 --
Operating lease depreciation 1,374 -- 2,943 --
General and administrative 964 104 1,777 261
Advisory fees 2,826 -- 4,817 --
Provision for possible credit losses 1,000 -- 1,750 --
Stock option compensation expense (Note 9) -- -- 5,985 --
-------- ------ ------- -----
Total costs and expenses 21,142 104 42,744 261
-------- ------ ------- -----
Net income before minority interest 20,935 142 37,003 445
Minority interest -- (140) (54) (420)
-------- ------ ------- -----
Net income $ 20,935 $ 2 $ 36,949 $ 25
-------- ------ ------- -----
-------- ------ ------- -----
Basic earnings per Class A Share(1) $ 0.40 $ 0.00 $ 0.96 $ 0.02
-------- ------ ------- -----
-------- ------ ------- -----
Diluted earnings per Class A Share(1) $ 0.38 $ 0.00 $ 0.94 $ 0.01
-------- ------ ------- -----
-------- ------ ------- -----
</TABLE>
(1) As adjusted for one-for-six reverse stock split effective June 19, 1998
(Note 1)
The accompanying notes are an integral part of the financial statements.
4
<PAGE>
STARWOOD FINANCIAL TRUST
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(IN THOUSANDS)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998
(UNAUDITED)
<TABLE>
<CAPTION>
NET
PAR VALUE UNREALIZED
-------------------- GAINS ADDITIONAL RETAINED
CLASS A CLASS B (LOSSES) ON PAID-IN EARNINGS
SHARES SHARES INVESTMENTS CAPITAL (DEFICIT) TOTAL
------- --------- ----------- ---------- --------- -----
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1997* ............. $ 7,550 $ 38 $ (162) $ -- $ (1,075) $ 6,351
Recapitalization Transactions (Note 4) .... 306,796 1,534 -- 432,084 -- 740,414
Issuance of options to the Advisor (Note 9) -- -- -- 5,985 -- 5,985
Effective exercise of options ............. 18 -- -- 252 -- 270
Change in net unrealized gains (losses)
on investments .......................... -- -- 140 -- -- 140
Dividends paid ............................ -- -- -- -- (18,522) (18,522)
Effects of reorganization(1) (Note 1) ..... (261,956) (1,310) -- 262,786 -- (480)
Net income for the period ................. -- -- -- -- 36,949 36,949
--------- --------- --------- --------- --------- ---------
Balance as of September 30, 1998 .......... $ 52,408 $ 262 $ (22) $ 701,107 $ 17,352 $ 771,107
--------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- ---------
</TABLE>
* RECLASSIFIED TO CONFORM TO 1998 PRESENTATION.
(1) As adjusted for 1-for-six reverse stock split effective June 19, 1998
(Note 1)
The accompanying notes are an integral part of the financial statements.
5
<PAGE>
STARWOOD FINANCIAL TRUST
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
FOR THE FOR THE
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------- ------------------
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Cash flows from operating activities:
Net income ........................................................... $ 20,935 $ 2 $ 36,949 $ 25
Adjustments to reconcile net income to cash flows provided
by operating activities:
Minority interest ................................................ -- 140 54 420
Non-cash expense for options issued to Advisor (Note 9) .......... -- -- 5,985 --
Equity in earnings of unconsolidated joint
ventures and subsidiaries .................................... (690) -- (690) --
Depreciation and amortization .................................... 2,363 -- 4,870 --
Amortization of discount/premium and deferred interest ........... (5,837) -- (14,158) --
Provision for possible credit losses ............................. 1,000 -- 1,750 --
Changes in assets and liabilities:
Increase in accrued interest and rent receivable ......... (2,059) -- (7,586) --
Decrease in deferred expenses and other assets ........... 329 9 3,270 --
Increase in accounts payable, accrued
expenses and other liabilities ...................... 4,179 24 9,146 59
--------- -------- ----------- --------
Cash flows provided by operating activities .............. 20,220 175 39,590 504
--------- -------- ----------- --------
Cash flows from investing activities:
Net cash outflow for the Recapitalization
Transactions (Notes 3 & 4) ............................... -- -- (334,916) --
New loan originations/acquisitions ....................... (517,564) (10,249) (723,664) (16,255)
Principal fundings on existing loan commitments .......... (500) -- (10,500) --
Investment in unconsolidated joint venture (Note 5) ...... (47,252) -- (47,252) --
Repayments of and principal collections from loans and
other investments ...................................... 87,375 5,149 95,840 9,781
--------- -------- ----------- --------
Cash flows provided by (used in) investing activities .... (477,941) (5,100) (1,020,492) (6,474)
--------- -------- ----------- --------
Cash flows from financing activities:
Proceeds from issuance of Class B Shares ................. -- -- 1,534 --
Net borrowings under revolving credit facilities ......... 310,192 -- 605,814 --
Net borrowings under term loans .......................... 171,172 -- 374,936 --
Borrowings under repurchase agreements ................... (3,385) -- 33,921 --
Dividends paid ........................................... (18,522) -- (18,522) --
Payment for deferred financing costs ..................... (1,623) -- (10,310) --
Costs incurred in reorganization ......................... -- -- (480) --
Proceeds from exercise of options (Note 4) ............... -- -- 4 --
Proceeds from exercise of warrants (Note 4) .............. -- -- -- 4,924
--------- -------- ----------- --------
Cash flows provided by financing activities .............. 457,834 -- 986,897 4,924
--------- -------- ----------- --------
Increase (decrease) in cash and cash equivalents ..................... 113 (4,925) 5,995 (1,046)
Cash and cash equivalents at beginning of period ..................... 6,178 5,767 296 1,888
--------- -------- ----------- --------
Cash and cash equivalents at end of period ........................... $ 6,291 $ 842 $ 6,291 $ 842
--------- -------- ----------- --------
--------- -------- ----------- --------
Supplemental disclosure of cash flow information:
Cash paid during the period for interest ................. $ 12,644 $ -- $ 19,186 $ --
--------- -------- ----------- --------
--------- -------- ----------- --------
</TABLE>
The accompanying notes are an integral part of the financial statements.
6
<PAGE>
STARWOOD FINANCIAL TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - ORGANIZATION AND BUSINESS
ORGANIZATION - Starwood Financial Trust (the "Company") was formed for
the purpose of originating and acquiring various types of mortgage and other
real estate-related financial investments. Through a series of transactions
during 1994 and 1996, Starwood Mezzanine Investors, L.P. ("Starwood Mezzanine")
and certain affiliates of the general partner of Starwood Mezzanine (SAHI, Inc.
and SAHI Partners) acquired control of the Company.
On September 26, 1996, the Company became the sole general partner of
APMT Limited Partnership (the "Partnership") (see Note 4). As discussed in Note
4, on March 18, 1998, all the outstanding interests in the Partnership not held
by the Company were exchanged for additional $1.00 par value Class A Shares (the
"Class A Shares") of the Company, the Company became the sole partner of the
Partnership and the Partnership was terminated.
Also as more fully described in Note 4, on March 18, 1998, the Company
entered into a series of transactions approved by the Company's shareholders
with Starwood Mezzanine and Starwood Opportunity Fund IV, L.P. ("SOF IV") (an
affiliate of the general partners of Starwood Mezzanine), which, among other
things, substantially recapitalized the Company and modified its investment
policy (Starwood Mezzanine, SOF IV, SAHI, Inc. and SAHI Partners are
collectively referred to as the "Starwood Investors").
Effective June 18, 1998, the Company (which had previously been
organized under California law) changed its domicile to Maryland by merging
with a newly-formed subsidiary organized under Maryland Law and issued new
shares of the subsidiary to its shareholders in exchange for the previous
shares of the Company. Concurrently, the Company consummated a one-for-six
(1) reverse stock split.
During 1993 through 1997, the Company failed to qualify as a real estate
investment trust ("REIT") under the Internal Revenue Code of 1986, as amended
(the "Code"). However, pursuant to a Closing Agreement with the Internal Revenue
Service (the "IRS") obtained in March 1998, the Company will be eligible to and
intends to elect to be taxed as a REIT for the taxable year beginning January 1,
1998.
BUSINESS - The Company is a specialized finance company focused
exclusively on the commercial real estate industry and is a leading provider of
flexible mortgage, mezzanine and lease financing. The Company's mission is to
maximize risk-adjusted returns on equity by providing innovative and value-added
financing solutions to the real estate industry.
The Company originates and acquires investments in various types of
income-producing commercial real estate loans. The Company's investment program
emphasizes senior and junior commercial mortgage loans, including mezzanine
financing, higher-yielding senior mortgage loans and non-performing or
sub-performing loans. The Company anticipates that a portion of the investments
to be held in its portfolio on a long-term basis will be structured so that the
Company's investment is subordinate to third-party first mortgage debt but
senior to the real estate owner/operator's equity position.
NOTE 2 - BASIS OF PRESENTATION
The accompanying audited consolidated financial statements have been
prepared in conformity with the instructions to Form 10-Q and article 10, Rule
10-01 of Regulations S-X for interim financial statements. Accordingly, they do
not include all of the information and footnotes required by generally accepted
accounting principles ("GAAP") for complete financial statements. The
consolidated financial statements include the accounts of the Company and its
qualified REIT subsidiaries. Certain third-party mortgage servicing operations
are conducted through Starwood Operating, Inc. ("Starwood Operating"), a taxable
corporation, which is not consolidated with the Company for financial reporting
or income tax purposes. The Company owns all of the preferred stock and a 95%
economic interest in Starwood Operating, which is accounted for under the equity
method for financial reporting purposes.
In the opinion of management, the accompanying financial statements
contain all adjustments, consisting of normal and recurring accruals, necessary
for a fair presentation of the Company's financial condition at September 30,
1998 and the results of its operations, changes in shareholders' equity and its
cash flows for the three and nine month periods ended September 30, 1998 and
1997. Such operating results are not necessarily indicative of the results that
may be expected for any other interim periods or the entire year.
NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
LOANS AND OTHER INVESTMENTS, NET - As described in Note 5, loans and
other investments, net includes the following investments: senior mortgages,
junior mortgages, opportunistic mortgages, partnership loans, construction
loans, investments in real estate under operating leases, loan participations
and investments in certain real estate related marketable securities. In
general, management considers its loan and marketable real estate related
securities investments as held-to-maturity and, accordingly, reflects such items
at amortized historical cost.
- -------------
Explanatory note:
(1) All share information contained herein is presented as adjusted for effects
of one-for-six reverse stock split effective June 19, 1998.
7
<PAGE>
CASH AND CASH EQUIVALENTS - Cash and cash equivalents include cash held
in banks or invested in money market funds with original maturity terms of less
than 90 days.
NON-CASH ACTIVITY - During the nine month period ended September 30,
1998, the Company had significant non-cash activity including: (i) conversion of
units in the Partnership (shown as "minority interest" in the consolidated
financial statements) to Class A Shares (see Note 4); (ii) issuance of options
to the Advisor to acquire Class A Shares of the Company (see Note 9); and (iii)
issuance of new Class A Shares in exchange for a portion of the acquisition of
loans and related investments as part of the Recapitalization Transactions (see
Note 4).
The cash portion of the Recapitalization Transactions is summarized as
follows (in thousands):
<TABLE>
<CAPTION>
<S> <C>
Acquisition of loans and other investments ................... $ (1,061,006)
Acquired accrued interest and rent receivable ................ (7,451)
Par value of Class A Shares issued ........................... 302,223
Additional paid in capital on Class A Shares issued .......... 431,318
-------------
Net cash outflow for the Recapitalization Transactions ....... $ (334,916)
-------------
-------------
</TABLE>
MARKETABLE SECURITIES: The Company has certain investments in securities
which are insured or guaranteed by an agency of the U.S. Government, such as the
Government National Mortgage Association (GNMA), Federal National Mortgage
Association (FNMA), and Federal Home Loan Mortgage (FHLMC). Although the Company
generally intends to hold such investments for long-term investment purposes, it
may, from time to time, sell any of its investments in these securities as part
of its overall management of its balance sheet. Accordingly, the Company
considers such investments as "available-for-sale" and reflects such investments
at fair market value with changes in fair market value reflected as a component
of shareholder equity.
REVENUE RECOGNITION - Interest income, including amortization of loan
fees and premiums or discounts, is recognized using the effective interest
method. Income under equity participation features is recognized when earned and
payable. Income from prepayment penalties is recognized when received.
PROVISION FOR POSSIBLE CREDIT LOSSES - The Company's accounting policies
require that an allowance for estimated credit losses be maintained at a level
that management, based upon an evaluation of known and inherent risks in the
portfolio, considers adequate to provide for possible credit losses. Further,
specific valuation allowances are established for impaired loans in the amount
by which the carrying value, before allowance for estimated losses, exceeds the
fair value of collateral less disposition costs on an individual loan basis.
Management considers a loan to be impaired when, based upon current information
and events, it believes that it is probable that the Company will be unable to
collect all amounts due according to the contractual terms of the loan agreement
on a timely basis. Management measures these impaired loans at the fair value of
the loans' underlying collateral less estimated disposition costs. Impaired
loans may be left on accrual status during the period the Company is pursuing
repayment of the loan. These loans are placed on non-accrual status at such time
that the loans either: (i) become 90 days delinquent; or (ii) management
determines the borrower is incapable of, or has ceased efforts toward, curing
the cause of the impairment. Impairment losses are recognized as direct
write-downs of the related loan with a corresponding charge to the provision for
possible credit losses. Charge-offs occur when loans, or a portion thereof, are
considered uncollectible and of such little value that further pursuit of
collection is not warranted. Management's periodic evaluation of the allowance
for possible credit losses is based upon an analysis of the portfolio,
historical and industry loss experience, economic conditions and trends,
collateral values and quality and other relevant factors.
INCOME TAXES - The Company did not qualify as a REIT from 1993 through
1997; however, it did not incur any material tax liabilities as a result of its
operations. See Note 8 to the consolidated financial statements for more
information.
As confirmed in a Closing Agreement with the IRS obtained in March 1998,
the Company is eligible and intends to elect to be taxed as a REIT for its
taxable year beginning January 1, 1998. As a REIT, the Company will be subject
to income taxation at corporate rates on its REIT taxable income; however, the
Company is allowed a deduction for the amount of dividends paid to its
shareholders, thereby subjecting the distributed net income of the Company to
taxation at the shareholder level only. For income tax purposes, the Company
reports revenue and expenses on the accrual method. Starwood Operating is not
consolidated for federal income tax purposes and is taxed as a corporation. For
financial reporting purposes, current and deferred taxes are provided for in the
portion of earnings recognized by the Company with respect to its interest in
Starwood Operating.
EARNINGS (LOSS) PER CLASS A SHARE - In February 1997, the Financial
Accounting Standards Boards ("FASB") issued Statement of Financial Accounting
Standards No. 128, "Earnings per Share" ("SFAS No. 128") 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"). The Company adopted this
accounting standard effective December 31, 1997, as required. Prior periods have
been restated for comparative purposes in accordance with SFAS No. 128.
USE OF ESTIMATES - The preparation of financial statements in
conformity with generally accepted accounting principles requires management
to make estimates and assumptions that affect the reported amounts of assets
and liabilities and disclosure of contingent assets
8
<PAGE>
and liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. Actual results
could differ from those estimates.
NOTE 4 - TRANSACTIONS WITH AFFILIATES AND RECAPITALIZATION
TRANSACTIONS WITH AFFILIATES - The shares of the Company are of two
classes: Class A Shares (par value $1.00 per share) and Class B Shares (par
value $0.01 per share). There is no limit on the number of either Class A or
Class B Shares which the Company is authorized to issue. Class B Shares are
required to be issued by the Company in an amount equal to one-half of the
number of Class A Shares outstanding. Class A and Class B Shares are each
entitled to one vote per share with respect to the election of trustees and
other matters. Pursuant to the Company's Declaration of Trust, the Class B
Shares are convertible at the option of the Class B Shareholders into Class A
Shares on the basis of 49 Class B Shares for one Class A Share. However, the
current holder of Class B Shares has agreed with the Company that it will not
convert the Class B Shares into Class A Shares without the approval of a
majority of Trustees that are not affiliated with such holder. All distributions
of cash are made 99% to the Class A Shareholders and 1% to the Class B
Shareholders.
In November 1993, the Company was notified that SAHI, Inc. (one of the
Starwood Investors) had acquired all of the Company's 212,500 outstanding Class
B Shares. Subsequent to the acquisition of the Class B Shares, SAHI Partners
(another of the Starwood Investors) purchased the Class B Shares from SAHI, Inc.
and accumulated 40,683 Class A Shares, or 9.60% of the total then outstanding
Class A Shares.
On March 15, 1994, the Company announced that it had entered into an
agreement with SAHI and SAHI, Inc. for the sale of a warrant for the right to
purchase 833,333 Class A Shares at a price of $6.00 per share (the "Class A
Warrant") and 416,667 shares of Class B Shares at a price of $0.06 per share
(the "Class B Warrant"). SAHI and SAHI, Inc. purchased the warrants for
$101,000, which amount was applied against the purchase price for the initial
Class A and Class B Shares purchased pursuant to the warrants. On March 28,
1996, the Class A Warrant was assigned to Starwood Mezzanine.
On September 26, 1996, the Company became sole general partner of the
Partnership by contributing $400,000 in cash in exchange for an 8.05% interest
in the Partnership, which was evidenced by 66,667 partnership units. Starwood
Mezzanine became the 91.95% limited partner by contributing to the Partnership
its entire interest in the participation certificates in the Warwick Hotel
mortgage note, valued by the Company at approximately $4.6 million as of
September 30, 1996. Starwood Mezzanine's interest in the Partnership was
evidenced by 761,491 units, which were convertible into cash, Class A Shares or
a combination of both pursuant to an exchange rights agreement. In addition,
Starwood Mezzanine had the right to require the Company to register for public
sale, any or all of the Class A Shares in the Partnership issued to it upon the
exercise of the Class A Warrant or upon exchange of the units issued to Starwood
Mezzanine. As described below, the units were converted to Class A Shares in the
first quarter of 1998.
On January 22, 1997, Starwood Mezzanine exercised its rights under the
Class A Warrant to acquire 833,333 Class A Shares. After its exercise of the
Class A Warrant, Starwood Mezzanine beneficially owned 833,333 Class A Shares
and 761,491 units. In addition, SAHI, Inc. exercised its rights under the Class
B Warrant to acquire 416,667 Class B Shares. After its exercise of the Class B
Warrant, SAHI Inc. beneficially owned 1,009,911 Class B Shares and 40,683 Class
A Shares. Upon exercise of the Class A and Class B Warrant, SAHI, SAHI, Inc. and
Starwood Mezzanine jointly owned 70% of the outstanding Class A Shares and, with
the voting interest of the Class B Shares, controlled 80% of the voting interest
of the Company. The Company increased its capital by $5,025,000, and the
resulting funds were used to purchase qualified short-term government
securities.
During the quarter ended March 31, 1998, the Company consummated certain
transactions and entered into agreements which significantly recapitalized and
expanded the capital resources of the Company as well as modified future
operations including those described herein below in "Recapitalization
Transactions."
RECAPITALIZATION TRANSACTIONS - Prior to the consummation of the
Recapitalization Transactions: (i) Starwood Mezzanine and SAHI Inc. owned 70%
and 100% of the outstanding Class A Shares and Class B Shares of the Company,
respectively, through which they together controlled approximately 80% of the
voting interests in the Company; and (ii) Starwood Mezzanine owned 761,491 units
which represented the remaining 91.95% of the Partnership not held by the
Company that were convertible into either cash, an additional 761,491 Class A
Shares of the Company, or a combination of the two, as determined by the
Company.
On March 18, 1998, each outstanding unit held by Starwood Mezzanine was
exchanged for one Class A Share of the Company and, concurrently, the
Partnership was liquidated through a distribution of its net assets to the
Company, its then sole partner.
Simultaneously, Starwood Mezzanine and SOF IV consummated the
transactions contemplated by the contribution agreement ("Contribution
Agreement") among Starwood Mezzanine, SOF IV and the Company to substantially
recapitalize and increase the size of the Company's assets and operations
(collectively, the "Recapitalization Transactions"). Pursuant to the
Contribution Agreement, Starwood Mezzanine contributed various loans and other
investments to the Company in exchange for 9,191,333 Class A Shares and $25.5
million in cash, as adjusted. SOF IV contributed loans and other investments,
$17.9 million in cash and certain letters of intent in exchange for 41,179,133
Class A Shares of the Company and a cash payment of $324.3 million.
Concurrently, the holders of the Class B Shares who are affiliates of the
general partners of Starwood Mezzanine and SOF IV acquired 25,565,979 additional
Class B Shares sufficient to maintain existing voting preferences as required by
the Company's Amended and Restated Declaration of Trust (the "Declaration of
Trust"). Immediately after these transactions, the Starwood Investors owned an
aggregate of approximately 99.3% of the outstanding Class A Shares of the
Company and 100%
9
<PAGE>
of the Class B Shares. Assets acquired from Starwood Mezzanine have been
reflected using step acquisition accounting at predecessor basis adjusted to
fair market value to the extent of post-transaction third-party ownership.
Assets acquired from SOF IV have been reflected at their fair market value.
The following summary pro forma information includes the effects of the
following transactions consummated in March 1998: (i) the Recapitalization
Transactions; (ii) the exchange of each outstanding unit held by holders other
than the Company for one Class A Share; (iii) the liquidation and termination of
the Partnership; and (iv) the borrowings necessary to consummate the
aforementioned transactions. The pro forma operating data for the nine month
periods ended September 30, 1998 and 1997 are presented as if the transactions
had been completed on January 1, 1998 and 1997, respectively.
PRO FORMA
CONDENSED STATEMENT OF OPERATIONS
(IN THOUSANDS, EXCEPT FOR NET INCOME PER CLASS A SHARE)
<TABLE>
<CAPTION>
FOR THE NINE
MONTH PERIOD ENDED
SEPTEMBER 30,
----------------------
1998 1997
---- ----
(UNAUDITED)
<S> <C> <C>
REVENUE:
Interest income ................................................... $ 88,280 $ 43,721
Operating lease income ............................................ 11,850 11,561
Other income ...................................................... 2,489 16,905
--------- ---------
Total revenue ................................................... 102,619 72,187
--------- ---------
COSTS AND EXPENSES:
Interest expense .................................................. 31,333 -
Operating lease depreciation ...................................... 4,332 4,332
General and administrative ........................................ 2,223 2,776
Advisory fees ..................................................... 10,045 10,062
Provision for possible credit losses .............................. 1,750 1,750
--------- ---------
Total costs and expenses ..................................... 49,683 18,920
--------- ---------
Pro forma net income .............................................. $ 52,936 $ 53,267
--------- ---------
--------- ---------
Pro forma basic net income per Class A Share ...................... $ 1.00 $ 1.01
--------- ---------
--------- ---------
Weighted average number of Class A Shares outstanding ............. 52,408 52,344
--------- ---------
--------- ---------
</TABLE>
The pro forma operating data for the nine month period ended September
30, 1998 excludes a charge of approximately $6.0 million or $0.11 per Class A
Share, as adjusted, relating to the value of options to acquire Class A Shares
issued to the Advisor concurrently with the consummation of the Recapitalization
Transactions, as such charge is considered largely non-recurring in nature.
However, future charges may be taken to the extent of additional option grants,
which are at the discretion of the Board of Trustees.
While other real estate-related investments are assumed to have taken
place as of the beginning of each period, mortgage note receivable acquisitions
or originations are not reflected in these pro forma numbers until the actual
origination or acquisition date by Mezzanine or SOF IV. Consequently, since many
of the mortgage acquisitions or originations did not occur until after September
30, 1997, the revenue from these assets is not included in the 1997 pro forma
results. Pro forma other income for the nine months ended September 30, 1997
includes approximately $14.0 million related to the early repayment of an
improvement note held by Starwood Mezzanine. No interest expense has been
reflected in the pro forma operating data for the nine month period ended
September 30, 1997 since the aggregate capital contributed in the
Recapitalization Transactions exceeded the pro forma weighted average for the
real estate loans and related investments actually outstanding during the
period. The pro forma financial information is not necessarily indicative of
what the consolidated results of operations of the Company would have been as of
and for the periods indicated, nor does it purport to represent the results of
operations for future periods.
ADVISORY AGREEMENT - In connection with the Recapitalization
Transactions, the Company and Starwood Financial Advisors, L.L.C. (the
"Advisor") entered into an Advisory Agreement (the "Advisory Agreement")
pursuant to which the Advisor manages the investment affairs of the Company,
subject to the Company's purpose and investment policy, the investment
restrictions and the directives of the Board of Trustees. The services provided
by the Advisor include the following: identifying investment opportunities for
the Company; advising the Company with respect to and effecting acquisitions and
dispositions of the Company's investments; monitoring, managing and servicing
the Company's loan portfolio; and arranging debt financing for the Company. The
Advisor will not act in a manner that is inconsistent with the express direction
of the Board of Trustees and reports to the Board of Trustees and the officers
of the Company with respect to its activities.
Beginning on the 90th day after the consummation of the Recapitalization
Transactions, the Company commenced paying to the
10
<PAGE>
Advisor a quarterly base management fee of 0.3125% (1.25% per annum) of the
"Book Equity Value" of the Company (as defined in the Advisory Agreement),
determined as of the last day of each quarter, but estimated and paid in advance
subject to recomputation.
In addition, beginning on the 90th day after the consummation of the
Recapitalization Transactions, the Company commenced paying the Advisor a
quarterly incentive fee of 5.00% of the Company's "Adjusted Net Income" (as
defined in the Advisory Agreement) during each quarter that the Adjusted Net
Income for such quarter (restated and annualized as a rate of return on the
Company's Book Equity Value for such quarter) equals or exceeds a benchmark rate
defined in the Advisory Agreement. Approximately $1.1 million and $1.3 million
of incentive fees to the Advisor have been incurred in the three month and nine
month periods ended September 30, 1998, respectively. The Advisor may also be
reimbursed for certain expenses it incurs on behalf of the Company. No such
expenses have been incurred through September 30, 1998.
The Advisory Agreement has an initial term of three years, subject to
automatic renewal for one-year periods unless the Company has been liquidated or
a Termination Event (as defined in the Advisory Agreement and which generally
includes violations of the Advisory Agreement by the Advisor, a bankruptcy event
of the Advisor or the imposition of a material liability on the Company as a
result of the Advisor's bad faith, willful misconduct, gross negligence or
reckless disregard of duties) has occurred and is continuing. In addition, the
Advisor may terminate the Advisory Agreement on 60 days' notice to the Company
and the Company may terminate the Advisory Agreement upon 60 days' written
notice if a Termination Event has occurred or if the decision to terminate is
based on an affirmative vote of the holders of two thirds or more of the voting
shares of the Company at the time outstanding.
11
<PAGE>
NOTE 5 - LOANS AND OTHER INVESTMENTS - (IN THOUSANDS)
The following is a summary description of the Company's loans and other
investments:
<TABLE>
<CAPTION> Company's
Current Carrying Value as of
Number of Original Principal --------------------
Underlying Borrowers Commitment Balances September 30, December 31,
Type of Loan/Borrower Property Type In Class Amount Outstanding 1998 1997
- --------------------- ------------- -------- ------ ----------- ---- ----
<S> <C> <C> <C> <C> <C> <C>
Senior Mortgages Office/Hotel/ 12 $751,954 $657,543 $655,529 --
Mixed Use/
Apartment
Subordinated Mortgages Office/Hotel/ 15 542,172 501,581 516,379 --
Resort/
Residential/
Land
Opportunistic Mortgages Office/Hotel/ 3 166,644 125,402 82,986 --
Apartment
Partnership Office/Hotel 5 128,049 115,549 112,557 --
Loans/Unsecured Notes
Construction Loans Assisted 2 92,390 91,906 97,057 --
Living/Resorts
Real Estate Under
Operating Leases Hotels 1 N/A(3) N/A(3) 192,787 --
Loan Participations Various 2 15,841 15,841 11,700 --
Investments in Strategic Various 7 50,400 50,400 47,806 --
Origination Ventures (4)
Other Real Real estate N/A N/A N/A 45,116 $ 90
Estate-Related related securities
Investments
--------- -----
Subtotal Investments 1,761,917 90
Provision for Possible (1,750) --
Credit Losses --------- -----
Total Loans and
Other Investments, net $1,760,167 $ 90
--------- -----
--------- -----
</TABLE>
<TABLE>
<CAPTION>
Original Interest Interest
Maturity Accrual Payment Principal Participation
Dates Rates Rates Amortization Features
----- ----- ----- ------------ --------
<S> <C> <C> <C> <C> <C>
Senior Mortgages 1999 to 2010 Fixed: 7.28 to 16.00% Fixed: 7.28 to 10.82% Yes (1) Yes(2)
Variable: LIBOR+ Variable: LIBOR+
1.25 to 3.25% 1.25 to 3.25%
Subordinated Mortgages 1999 to 2007 9.53 to 17.00% 9.53 to 15.25% Yes(1) Yes(2)
Variable: LIBOR+ Variable: LIBOR+
4.00 to 5.80% 4.00 to 5.80%
Opportunistic Mortgages 1999 and 2007 6.00 to 7.00% 6.00 to 7.00% Yes (1) Yes(2)
Partnership 2002 to 2013 8.50 to 15.00% 8.50 to 15.00% No Yes (2)
Loans/Unsecured Notes Variable: LIBOR+ Variable: LIBOR+
5.37% 5.37%
Construction Loans 1999 and 2004 12.00 to 12.50% 10.00 to 12.50% No No
Real Estate Under
Operating Leases N/A(3) N/A(3) N/A(3) N/A(3) N/A(3)
Loan Participations 1999 Fixed: 7.13% Fixed: 5.45 to 6.40% No No
Variable: LIBOR+ Variable: LIBOR+
0.58 to 1.75% 0.58 to 1.75%
Investments in Strategic 1999 to 2018 Fixed: 8.14 to 9.45% Fixed: 8.14 to 9.45% Yes No
Origination Ventures (4) Variable: LIBOR+ Variable: LIBOR+
3.75 to 4.50% 3.75 to 4.50%
Other Real 2002 and 2007 12.00 to 12.75% 12.00 to 12.75% No No
Estate-Related
Investments
Subtotal Investments
Provision for Possible
Credit Losses
Total Loans and
Other Investments, net
</TABLE>
EXPLANATORY NOTES
- -----------------
(1) The loans require fixed payments of principal and interest resulting in
partial principal amortization over the term of the loan with the remaining
principal due at maturity. In addition, one of the loans permits additional
annual prepayments of principal of up to $1.3 million without penalty at
the borrower's option.
(2) Under some of these loans, the lender receives additional payments
representing additional interest for participation in available cash flow
from operations of the property and the proceeds, in excess of a base
amount, arising from a sale or refinancing of the property.
(3) The lease is a triple net operating lease covering 17 hotels under which
the lessee pays all costs associated with the operation of the hotels,
including real estate taxes, insurance, utilities, services and capital
expenditures. The initial term of the lease expires on December 31, 2020,
and can be extended for up to three five-year terms at the lessee's option.
Rent payments under the lease consist of base rent and additional rent
based on the amount by which the aggregate operating revenue for any given
year exceeds the aggregate operating revenue for the 12 months ended
September 30, 1996. The carrying amount is presented net of accumulated
depreciation.
(4) Information for this investment classification, except for the Company's
carrying value, represents terms of loans in an unconsolidated joint
venture. See narrative discussion of venture in this note.
12
<PAGE>
NOTE 5 - LOANS AND OTHER INVESTMENTS
During the three months ended September 30, 1998 and the period from
March 18, 1998 (the date of the consummation of the Recapitalization
Transaction) to September 30, 1998, the Company and its affiliated ventures
originated or acquired an aggregate of $517.6 million and $723.7 million in
loans and related investments, respectively, and received principal repayments
of $87.4 million and $95.8 million for those periods, respectively.
In addition, on July 24, 1998, the Company entered into a strategic
origination venture with a publicly traded finance company to originate loans
secured by specialty real estate. Under its terms, the venture is expected to be
ultimately capitalized 70.0% with third-party debt and 30.0% with capital
contributions from the Company and its venture partner. The Company will
contribute up to $72.0 million in preferred equity in exchange for a 12.00%
preferred return and 50% of the residual profits in excess of the aggregate of
its preferred return and a 12.00% return to the subordinate joint venture
partner. Pending the closing of third-party senior debt financing, the Company
plans to advance senior equity to the venture at a preferred return at a fixed
margin over LIBOR. Since July 24, 1998, the venture has funded approximately
$50.4 million of loans. Of the total loan amounts, the Company funded an
aggregate of $47.3 million, representing its interim funding of the venture's
senior debt and its share of the venture's preferred equity.
The Company has reflected provisions for possible credit losses of $1.0
and $1.75 million in its results of operations during the three month and nine
month periods ended September 30, 1998, respectively. There was no other
activity in the Company's reserve balances during these periods. These
provisions represent portfolio reserves based on management's evaluation of
general market conditions, the Company's and industry loss experience,
likelihood of delinquencies or defaults and the underlying collateral. No direct
impairment reserves on specific loans were considered necessary. Management may
transfer reserves between general and specific reserves as considered necessary.
NOTE 6 - DEBT OBLIGATIONS
The Company had no outstanding long term debt obligations as of December
31, 1997. As of September 30, 1998, the Company has obligations under various
arrangements with financial institutions as follows (in thousands):
<TABLE>
<CAPTION>
MAXIMUM PRINCIPAL
AMOUNT BALANCE AS OF INTEREST MATURITY
AVAILABLE SEPTEMBER 30, 1998 RATE DATE
--------- ------------------ ---- ----
<S> <C> <C> <C> <C>
REVOLVING CREDIT FACILITIES:
Line of credit $ 675,000 $ 605,814 LIBOR + 150bp March 2001
Line of credit 500,000 -- LIBOR + 100-125bp August 2000
------------
Total revolving credit facilities 605,814
------------
TERM LOANS:
Secured by real estate under operating leases 125,000 LIBOR + 150bp March 1999
Secured by senior mortgage investment 94,380 LIBOR + 100bp August 2000
Secured by senior and subordinate mortgage investments 114,791 LIBOR + 100bp August 2000
Secured by senior mortgage investment 40,765 LIBOR + 100bp May 1999
------------
Total term loans 374,936
------------
OTHER DEBT OBLIGATIONS: 33,922 Various Various
------------
TOTAL DEBT OBLIGATIONS $ 1,014,672
------------
------------
</TABLE>
Availability of amounts under the revolving credit facilities are based
on a percentage borrowing base calculation. An aggregate of $10.3 million in
loan fees were incurred under the Company's debt obligations.
These fees are amortized over the related loan terms.
NOTE 7 - RISK MANAGEMENT AND USE OF FINANCIAL INSTRUMENTS
RISK MANAGEMENT - In the normal course of its ongoing business operations,
the Company encounters economic risk. There are three main components of
economic risk: interest rate risk, credit risk and market risk. The Company is
subject to interest rate risk to the degree that its interest-bearing
liabilities mature or reprice at different speeds, or different bases, than its
interest earning assets. Credit risk is the risk of default on the Company's
loan portfolio that results from a property's or borrower's inability or
unwillingness to make contractually required payments. Market risk reflects
changes in the value of loans held for sale, securities available for sale and
purchased mortgage servicing rights due to changes in interest rates or other
market factors, including the rate of prepayments of principal and the value of
the collateral underlying loans and the valuation of real estate held by the
Company.
13
<PAGE>
USE OF DERIVATIVE FINANCIAL INSTRUMENTS - The Company's use of derivative
financial instruments is primarily limited to the utilization of interest rate
agreements or other instruments to manage interest rate exposure. The principal
objective of such arrangements is to minimize the risks and/or costs associated
with the Company's operating and financial structure as well as to hedge
specific anticipated transactions. The counter-parties to these contractual
arrangements are major financial institutions with which the Company and its
affiliates also have other financial relationships. The Company is potentially
exposed to credit loss in the event of nonperformance by these counter-parties.
However, because of their high credit ratings, the Company does not anticipate
that any of the counter-parties will fail to meet their obligations. Prior to
the Recapitalization Transactions, the Company did not significantly utilize
derivative financial instruments.
In anticipation of and since the completion of the Recapitalization
Transactions, the Company has entered into LIBOR interest rate caps struck at
9.00% in the notional amounts of $125.0 million and $300.0 million expiring in
March 1999 and 2001, respectively. The Company also entered into LIBOR interest
rate caps struck at 7.50% in the notional amounts of $40.4 million and $38.3
million expiring in January and June 2001, respectively, on amounts borrowed
under additional term loans. Further, the Company has also entered into
approximately $206.8 million of interest rate swaps to effectively fix the
interest rate on a portion of the Company's floating-rate obligations.
The Company is currently pursuing certain anticipated long-term fixed rate
borrowings and has entered into certain derivative instruments based on U.S.
Treasury securities to hedge the potential effects of interest rate movements on
these transactions. As of September 30, 1998, the Company had entered into an
aggregate notional amount of approximately $232.0 million under such agreements.
Under these agreements, the Company will generally receive additional cash flow
at settlement if interest rates rise and pay cash if interest rates fall. The
effects of such receipts or payments will be deferred and amortized over the
term of the specific related fixed rate borrowings. No settlements of such
contracts or the related forecasted borrowings have yet occurred. The currently
forecasted transactions are expected to occur in the first quarter of 1999. In
the event that, in the opinion of management, it is no longer probable that the
forecasted transactions will occur under terms substantially equivalent to those
projected, the Company will cease recognizing such transactions as hedges and
immediately recognize related gains or losses based on actual settlement or
estimated settlement value. No such gains or losses have been recognized by the
Company.
NOTE 8 - INCOME TAXES
Although originally formed to qualify as a REIT under the Code for the
purpose of making and acquiring various types of mortgage and other loans,
during 1993 through 1997, the Company failed to qualify as a REIT. As confirmed
by a Closing Agreement with the Internal Revenue Service (the "IRS") obtained in
March 1998, the Company will be eligible to and intends to elect to be taxed as
a REIT for the tax year commencing on January 1, 1998. The Company did not incur
any material tax liabilities as a result of its operations during such years.
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amount of assets and liabilities for financial reporting
purposes and income tax purposes as well as operating loss and tax credit carry
forwards. A valuation allowance is recorded if, based on the weight of available
evidence, it is more likely than not that some portion or all of the deferred
income tax asset will not be realized. Given the limited nature of the Company's
operations and assets and liabilities from 1993 through 1997, the only deferred
tax assets are net operating loss carry forwards ("NOL's") which arose during
such periods. Since the Company intends to elect to be treated as a REIT for its
tax year beginning January 1, 1998, it is anticipated that such NOL's will
expire unutilized. Accordingly, no net value, after consideration of a 100%
valuation allowance, has been reflected in these financial statements as of
September 30, 1998 and December 31, 1997.
NOTE 9 - 1996 SHARE INCENTIVE PLAN
The Company amended and restated its stock option plan to provide a means
of incentive compensation for officers, other key employees and trustees. Stock
options, restricted stock awards and other performance awards may be granted
under the Starwood Financial Trust 1996 Share Incentive Plan (the "Plan"). Under
the amended Plan, up to a maximum of 9.0% of the outstanding Class A Shares on a
fully-diluted basis, as adjusted for subsequent issuances of Class A Shares, are
reserved for issuance under the Plan. All grants of shares under the Plan, other
than automatic grants to non-employee trustees, will be at the sole discretion
of the Board of Trustees or a specifically designated sub-committee of such
trustees. Approximately 2,493,843 options to purchase Class A Shares at $15.00
per share that are immediately exercisable were granted to the Advisor under the
Plan upon consummation of the Recapitalization Transactions and additional
grants may be made to the Advisor or employees of the Company in the future.
During the first and second quarter of 1998, the Company issued options to
acquire an aggregate of 10,000 Class A Shares to certain trustees at exercise
prices equal to the market price at the date of grant.
The Company has elected to use the intrinsic method for accounting for
options issued to direct employees or trustees, as allowed under Statement of
Financial Accounting Standards No. 123 Accounting for Stock Based Compensation
("SFAS 123") and, accordingly, recognized no compensation charge in connection
with these options. The Company utilizes the option value method as required by
SFAS 123 to account for options issued to the Advisor. An independent financial
advisory firm estimated the value of these options at date of grant to be
approximately $2.40 per share using a Black-Scholes valuation model. In the
absence of comparable historical market information for the Company, the
advisory firm utilized assumptions consistent with activity of a comparable peer
group of companies including an estimated option life of five years, a 27.5%
volatility rate and an estimated annual
14
<PAGE>
dividend rate of 8.5%. The resulting charge to earnings was calculated as the
number of options allocated to the Advisor multiplied by the estimated value at
consummation. A charge of approximately $6.0 million has been reflected in the
Company's first quarter 1998 financial results. Future charges may be taken to
the extent of additional option grants, which are at the discretion of the Board
of Trustees.
NOTE 10 - EARNINGS PER SHARE
Basic EPS is computed based on the income applicable to Class A Shares
(which is net income reduced by 1% allocated to Class B Shares) divided by the
weighted-average number of Class A Shares outstanding during the period. Diluted
EPS is based on the net earnings applicable to Class A Shares plus dividends on
Class B Shares which are convertible into Class A Shares, divided by the
weighted average number of Class A Shares and dilutive potential Class A Shares
that were outstanding during the period. Dilutive potential Class A Shares
include the Class B Shares, which are convertible into Class A Shares at a rate
of 49 Class B Shares for one Class A Share, and potentially dilutive options to
purchase Class A Shares issued to the Advisor and the trustees of the Company.
Basic and diluted earnings per Class A Share are based upon the following
weighted average shares outstanding during each of the three and nine month
periods ended September 30, 1998 and 1997, respectively.
<TABLE>
<CAPTION>
(In thousands)
Three months ended Nine months ended
September 30, September 30,
-------------------- ----------------------
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Weighted average Class A Shares outstanding
for basic earnings per Class A Share 52,390 1,258 37,968 1,193
Add effect of assumed shares issued under
Treasury stock method for stock options 560 542 405 20
Add effects of conversion of Class B
Shares (1 for 49 ratio) 1,704 762 1,086 761
------ ------ ------- -----
Weighted average Class A Shares
outstanding for diluted earnings
per Class A Share 54,654 2,562 39,459 1,974
------ ------ ------- -----
------ ------ ------- -----
</TABLE>
As previously indicated, effective June 19, 1998, the Company consummated
a one-for-six reverse stock split for its Class A and Class B Shares. Historical
earnings per share have been retroactively restated to reflect the reverse split
for comparative purposes.
NOTE 11 - COMPREHENSIVE INCOME
In June 1997, the FASB issued Statement No. 130, "Reporting Comprehensive
Income" ("SFAS No. 130") effective for fiscal years beginning after December 15,
1997. The statement changes the reporting of certain items currently reported as
changes in the shareholder's equity section of the balance sheet and establishes
standards for the 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 its
components under generally accepted accounting principles. The Company has
adopted this standard effective January 1, 1998. Total comprehensive income was
$21.0 million and $13,000 for the three month periods ended September 30, 1998
and 1997 and $36.9 million and $31,000 for the nine month periods ended June 30,
1998 and 1997, respectively. The primary component of comprehensive income other
than net income was the change in value of certain investments in marketable
securities classified as available-for-sale.
NOTE 12 - DIVIDENDS
In order to maintain its election to qualify as a real estate investment
trust, the Company must distribute, at minimum, an amount equal to 95% of its
taxable income and must distribute 100% an amount equal to its taxable income to
not pay any corporate federal income taxes. Accordingly, the Company anticipates
it will distribute all of its taxable income to its shareholders. Because
taxable income differs from cash flow from operations due to non-cash revenues
or expenses, in certain circumstances, the Company may be required to borrow to
make sufficient dividend payments to meet this anticipated dividend threshold.
Total dividends declared by the Company aggregated $0.0 and $18.3 million
or $0.00 and $0.35 per Class A Share for the three month and nine month periods
ended September 30, 1998, respectively. On October 2, 1998, the Company declared
a dividend of approximately $20.1 million or $0.38 per Class A Share applicable
to the third quarter and payable to shareholders of record on October 15, 1998.
The exact amount of future quarterly dividends to Class A Shareholders will be
determined by the Board of Trustees based on the Company's actual and expected
operations for the fiscal year and the Company's overall liquidity position.
15
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
GENERAL
The Company is a specialized finance company focused exclusively on the
commercial real estate industry, and is a leading provider of flexible,
structured mortgage, mezzanine and lease financing.
Prior to the Recapitalization Transactions (described in Note 4 to the
Company's consolidated financial statements), the Company's primary source of
cash during 1997 was from income earned on its interest in the participation
certificates in the Warwick Hotel mortgage note and certain investments in
government or government-sponsored securities, as well as short term cash
investments. On October 1, 1997, the Warwick Hotel note was repaid and the $4.5
million of proceeds were invested in government securities.
On September 26, 1996, the Company became sole general partner of the
Partnership (see Notes 1 and 4 to the Company's consolidated financial
statements) by contributing $400,000 in cash in exchange for a 8.05% interest in
the Partnership evidenced by 66,667(1) units. Starwood Mezzanine became the
91.95% limited partner by contributing to the Partnership its entire interest in
the participation certificates in the Warwick Hotel mortgage note valued by the
Company at approximately $4.6 million at the time of contribution. Starwood
Mezzanine's units were converted into Class A Shares on March 18, 1998 on a
one-for-one basis and the Partnership was dissolved.
On January 22, 1997, Starwood Mezzanine exercised its rights under a
warrant (see Note 4) to acquire 833,333 Class A Shares. In addition, SAHI, Inc.
exercised its rights under the warrant (see Note 4) to acquire 416,667 Class B
Shares. As a result of the exercise of the warrants, the Company's capital
increased by $5,025,000, and the resulting funds were used to purchase
short-term government securities.
As more fully discussed in Note 4 to the Company's consolidated financial
statements, on March 18, 1998, the Company entered into a series of transactions
approved by the Company's shareholders which, among other things, substantially
recapitalized the Company and modified its investment policy. Effective June 18,
1998, the Company (which was organized under California law) changed its
domicile to Maryland by merging with a newly formed subsidiary organized under
Maryland Law and issued new shares of the subsidiary to its shareholders in
exchange for the previous shares of the Company. Concurrently, the Company
consummated a one-for-six reverse stock split.
As more fully discussed in Note 8 to the Company's consolidated financial
statements, for fiscal years 1993 to 1997 the Company did not qualify as a REIT;
however, the Company intends to elect to qualify as a REIT under the Code for
its 1998 taxable year and, as such, anticipates distributing annually
approximately 100% of its taxable income, subject to certain adjustments. Cash
for such distributions is expected to be generated from the Company's
operations. The Company's operations for any period may be affected by a number
of factors, including the investment assets held, the financial and operating
performance of the collateral underlying secured loans or the business of the
borrowers with respect to unsecured loans, or the economic or interest rate
environment generally.
RESULTS OF OPERATIONS
THREE MONTH PERIOD ENDED SEPTEMBER 30, 1998 COMPARED TO 1997
During the three months ended September 30, 1998, total revenue increased
by approximately $41.8 million as compared to total revenue for the three months
ended September 30, 1997. This increase is a result of the interest generated by
the loans and other investments contributed in the Recapitalization
Transactions, as well as approximately $517.6 million of other loan investments
newly originated or acquired by the Company during 1998 and an additional $0.5
million funded under existing loan commitments. The Company received principal
repayments of $87.4 million during the three months ended September 30, 1998.
Included in other income for the three month period ended September 30, 1998 are
fees associated with the repayment of two first mortgage loans aggregating
approximately $1.2 million.
The increase in the Company's total costs and expenses during the three
months ended September 30, 1998 compared to the three months ended September 30,
1997 is primarily due to interest expense on the borrowings under the revolving
credit facilities and other borrowings used to fund the Company's loan
origination/acquisition activities, as well as general and administrative costs
associated with the implementation of the Company's new business plan and
advisory fee expenses under the Advisory Agreement.
The Company believes that because of the significant expansion of the
scope of its operations as a result of the Recapitalization Transactions, which
occurred on March 18, 1998, prior periods are not necessarily indicative of the
Company's future operating results or financial condition.
- -------------
Explanatory note:
(1) All share information contained herein is presented as adjusted for effects
of one-for-six reverse stock split effective June 19, 1998.
16
<PAGE>
NINE MONTH PERIOD ENDED SEPTEMBER 30, 1998 COMPARED TO 1997
During the nine months ended September 30, 1998, total revenue increased
by approximately $79.0 million as compared to total revenue for the nine months
ended September 30, 1997. This increase is a result of the interest generated by
the loans and other investments contributed in the Recapitalization
Transactions, as well as approximately $723.7 million of other loan investments
newly originated or acquired by the Company during 1998 and an additional $10.5
million funded under existing loan commitments. The Company received principal
repayments of $95.8 million for the nine months ended September 30, 1998.
Included in other income for the nine month period ended September 30, 1998 are
fees associated with the repayment of two first mortgage loans of approximately
$1.2 million and a gain of approximately $0.9 million resulting from the
repayment of a $2.8 million loan participation which had been acquired at a
discount.
The increase in the Company's total costs and expenses during the nine
months ended September 30, 1998 compared to the nine months ended September 30,
1997 is primarily due to the expense associated with the issuance of
approximately 2,493,843 options to the Advisor (see Note 9 to the Company's
consolidated financial statements) as well as the interest expense on the
borrowings under the revolving credit facilities and other borrowings used to
fund the Company's new loan origination/acquisition activities, as well as
general and administrative costs associated with the implementation of the
Company's new business plan and advisory fee expenses under the Advisory
Agreement.
The minority interest expense represents Starwood Mezzanine's share of the
net income generated by the Partnership before the Partnership's dissolution on
March 18, 1998.
The Company believes that as a result of the Recapitalization
Transactions, which occurred on March 18, 1998, the nine month period ended
September 30, 1998 and the comparable prior periods are not necessarily
indicative of the Company's future operating results or financial condition.
INTEREST RATE RISK MANAGEMENT
As part of its business, the Company is exposed to interest rate risks.
Consistent with its expected election to qualify as a REIT, the Company has
implemented an interest rate risk management policy based on match funding, with
the objective that floating-rate assets be financed by floating-rate liabilities
and fixed-rate assets be financed by fixed-rate liabilities.
The Company's operating results will depend in part on the difference
between the interest and related income earned on its assets and the interest
expense incurred in connection with its interest-bearing liabilities.
Competition from other providers of mezzanine capital may lead to a decrease in
the interest rate earned on the Company's interest-bearing assets, which the
Company may not be able to offset by obtaining lower interest costs on its
borrowings. Changes in the general level of interest rates prevailing in the
financial markets may affect the spread between the Company's interest-earning
assets and interest-bearing liabilities. Any significant compression of the
spreads between interest-earning assets and interest-bearing liabilities could
have a material adverse effect on the Company. In addition, an increase in
interest rates could, among other things, reduce the value of the Company's
interest-bearing assets and its ability to realize gains from the sale of such
assets, and a decrease in the interest rates could reduce the average life of
the Company's interest-earning assets.
A substantial portion of the Company's loan investments are subject to
significant prepayment protection in the form of lock-outs, yield maintenance
provisions or other prepayment premiums which provide substantial yield
protection to the Company. Those assets not subject to prepayment penalties
include; (i) variable rate mortgages based on LIBOR, acquired at par, which
would not result in any gain or loss upon repayment; and (ii) opportunistic
loans/loan participations acquired at discounts to face values, which would
result in gains upon repayment. Further, while the Company generally seeks to
enter into loan investments which provide for substantial prepayment
protection, nonetheless, in the event of declining interest rates, the
Company could receive such prepayments and may not be able to reinvest such
proceeds at favorable returns. Such prepayments, if they occur, could have an
adverse effect on the spreads between interest-earning assets and
interest-bearing liabilities.
While the Company has not experienced any significant credit losses,
delinquencies or defaults, in the event of a significant rising interest rate
environment and/or economic downturn, defaults could increase and result in
credit losses to the Company which adversely affect its liquidity and
operating results. Such delinquencies or defaults, if they occur, could have
an adverse effect on the spreads between interest-earning assets and
interest-bearing liabilities.
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.
As more fully discussed in Note 7 to the Company's consolidated financial
statements, the Company employs match funding based hedging strategies to limit
the effects of changes in interest rates on its operations, including engaging
in interest rate caps, floors, swaps, futures and other interest rate related
derivative contracts. These strategies are specifically designed to reduce the
Company's exposure, on specific transactions or on a portfolio basis, to changes
in cash flows as a result of interest rate movements in the market. The Company
does not enter into derivative contracts for speculative purposes nor as a hedge
against changes in credit risk of its borrowers or of the Company itself.
Each interest rate cap or floor agreement is a legal contract between the
Company and a third party (the "counterparty"). When the Company purchases a cap
or floor contract, the Company makes an up-front payment to the counterparty
and the counterparty agrees to make payments to the Company in the future should
the reference rate (typically one- or three-month LIBOR) rise above (cap
agreements) or fall below (floor agreements) the "strike" rate specified in the
contract. Each contract has a "notional face amount". Should the reference rate
rise above the contractual strike rate in a cap, the Company will earn cap
income. Should the reference rate fall below the contractual strike rate in a
floor, the Company will earn floor income. Payments on an annualized basis will
equal the contractual notional face amount times the difference between actual
reference
17
<PAGE>
rates and the contracted strike rate. The cost of the up-front payment
is amortized over the term of the contract.
Interest rate swaps are agreements in which a series of interest rate
flows are exchanged over a prescribed period. The notional amount on which
interest payments is not exchanged. In general, the Company's swaps are "pay fix
swaps" involving the exchange of floating rate interest payments for fixed
interest payments.
Interest rate futures are contracts, generally settled in cash, in
which the seller agrees to deliver on a specified future date the cash
equivalent of the difference between the specified price or yield indicated
in the contract and the value of that of the specified instrument (e.g., U.S.
Treasury securities) upon settlement. The Company generally uses such
instruments to hedge forecasted fixed rate borrowings. Under these
agreements, the Company will generally receive additional cash flow at
settlement if interest rates rise and pay cash if interest rates fall. The
effects of such receipts or payments will be deferred and amortized over the
term of the specific related fixed rate borrowings. No settlements of such
contracts or the related forecasted borrowings have yet occurred. The
currently forecasted transactions are expected to occur in the first quarter
of 1999. In the event that, in the opinion of management, it is no longer
probable that the forecasted transactions will occur under terms
substantially equivalent to those projected, the Company will cease
recognizing such transactions as hedges and immediately recognize related
gains or losses based on actual settlement or estimated settlement value. No
such gains or losses have been recognized by the Company.
While a REIT may freely utilize the types of derivative instruments
discussed above to hedge interest rate risk on its liabilities, use of
derivatives for other purposes, including hedging asset related risks such as
credit, prepayment or interest rate exposure on the Company's loan assets, could
generate income which is not qualified income for purposes of maintaining REIT
status. As a consequence, the Company may only engage in such instruments to
hedge such risks on a limited basis.
There can be no assurance that the profitability of the Company will
not be adversely affected during any period as a result of changing interest
rates. In addition, hedging transactions using derivative instruments involve
certain additional risks such as counter-party credit risk, legal
enforceability of hedging contracts and the risk that unanticipated and
significant changes in interest rates will cause a significant loss of basis
in the contract. With regard to loss of basis in a hedging contract, indices
upon which contracts are priced may be more or less variable than the indices
upon which the hedged assets or liabilities are priced, thereby making the
hedge less effective. The counterparties to these contractual arrangements
are major financial institutions with which the Company and its affiliates may
also have other financial relationships. The Company is potentially exposed
to credit loss in the event of nonperformace by these counterparties.
However, because of their high credit ratings, the Company does not
anticipate that any of the counterparties will fail to meet their
obligations. There can be no assurance that the Company will be able to
adequately protect against the foregoing risks and that the Company will
ultimately realize an economic benefit from any hedging contract it enters
into which exceeds the related costs incurred in connection with engaging in
the hedges.
LIQUIDITY AND CAPITAL RESOURCES
The Company requires capital to fund its loan and other investment
origination/acquisition activities and operating expenses. The Company's capital
sources include cash flow from operations, borrowings under lines of credit,
additional term borrowings and reverse repurchase arrangements, long-term
financing secured by the Company's assets, unsecured financing and the issuance
of common, convertible and/or preferred equity securities.
Concurrently with the Recapitalization Transactions, the Company entered
into bank credit agreements under which the Company could borrow up to $625.0
million, with up to an additional $175.0 million available, subject to certain
conditions, to fund loan originations or acquisitions (including the cash
portion of the Recapitalization Transactions previously described) and for other
general corporate purposes. The credit agreements are comprised of: (i) a $500.0
million revolving credit facility, which bears interest at a fixed margin over
LIBOR and matures on March 13, 2001 and; (ii) a $125.0 million term loan secured
by the Company's operating lease properties, which bears interest at a fixed
margin over LIBOR and matures on March 15, 1999.
During the third quarter, the Company expanded its existing revolving
credit facility from $500.0 million to $675.0 million and entered into an
additional $500.0 million two-year secured credit facility bearing interest at
fixed margins over LIBOR. Availability of amounts to borrow under the revolving
credit facilities are subject to having sufficient assets included as security
under the facilities in accordance with a percentage borrowing base
calculations.
18
<PAGE>
In addition, since the completion of the Recapitalization Transactions,
the Company has entered into approximately $288.0 million in LIBOR based term
loans secured by certain first mortgage loans it acquired during this period of
which approximately $38.0 million had been repaid prior to September 30, 1998.
Further, the Company has borrowed amounts under reverse repurchase agreements
and other obligations, secured by its investments in government securities and
other marketable securities of real estate companies, under which approximately
$33.9 million was outstanding as of September 30, 1998.
An aggregate of $10.3 million in loan fees were incurred in connection
with these credit facilities and term loan agreements. These fees have been
deferred and are being amortized over the related credit facilities and loan
terms.
In anticipation of and since the completion of the Recapitalization
Transactions, the Company has entered into LIBOR interest rate caps struck at
9.00% in the notional amounts of $125.0 million and $300.0 million expiring in
March 1999 and 2001, respectively. The Company also entered into LIBOR interest
rate caps struck at 7.50% in the notional amounts of $40.4 million and $38.3
million expiring in January and June 2001, respectively, on amounts borrowed
under additional term loans. Further, the Company has also entered into
approximately $206.8 million of interest rate swaps to effectively fix the
interest rate on a portion of the Company's floating-rate obligations.
The Company is currently pursuing certain anticipated long-term fixed
rate borrowings and has entered into certain derivative instruments based on
U.S. Treasury securities to hedge the potential effects of interest rate
movements on these transactions. As of September 30, 1998, the Company had
entered into an aggregate notional amount of approximately $232.0 million
under such agreements. Approximately $136.0 million of these instruments were
entered into in May 1998 and represent fixed rates of approximately 5.8%. The
remaining portion or approximately $96.0 million of these instruments were
entered into in July 1998 and represent fixed rates of approximately 5.4%.
Under these agreements, the Company will generally receive additional cash
flow at settlement if interest rates rise and pay cash if interest rates
fall. The effects of such receipts or payments will be deferred and amortized
over the term of the specific related fixed rate borrowings. No settlements
of such contracts or the related forecasted borrowings have yet occurred. The
currently forecasted transactions are expected to occur in the first quarter
of 1999. In the event that, in the opinion of management, it is no longer
probable that the forecasted transactions will occur under terms
substantially equivalent to those projected, the Company will cease
recognizing such transactions as hedges and immediately recognize related
gains or losses based on actual settlement or estimated settlement value. No
such gains or losses have been recognized by the Company.
The distribution requirements under the REIT provisions of the Internal
Revenue Code restrict the Company's ability to retain earnings and thereby
replenish capital committed to its lending operations. However, the Company
believes that its significant capital resources and access to financing will
provide it with financial flexibility and market responsiveness at levels
sufficient to meet current and anticipated capital requirements, including
expected new investment transactions.
The Company's ability to meet its long-term (i.e. beyond one year)
liquidity requirements is subject to the renewal of its credit lines and
repurchase facilities and/or obtaining other sources of financing, including
issuing additional debt or equity from time to time. Any decision by the
Company's lenders and/or investors' to enter into such transaction with the
Company will depend upon a number of factors such as compliance with the terms
of its existing credit arrangements, the Company's financial performance,
industry or market trends, the general availability of and rates applicable to
financing investments, lenders'/investors' resources and policies concerning the
terms under which they would make such loans and the relative attractiveness of
alternative investment or lending opportunities. Through October 31, 1998, the
Company had not received nor expected to receive significant collateral calls on
its lines of credit or loan repurchase agreements.
Based on its monthly interest and other expenses, monthly cash
receipts, existing investment commitments and funding plans, the Company
believes that its existing sources of funds will be adequate for purposes of
meeting its short- and long-term liquidity needs. However, in light of recent
volatility in financial markets which may affect the Company's ability to
obtain additional capital resources, there can be no assurance that this will
in fact be the case. Material increases in monthly interest expense or other
capital needs or material decreases in monthly cash receipts, generally would
negatively impact the Company's liquidity. On the other hand, material
decreases in monthly interest expense or other capital needs generally would
positively affect the Company's liquidity.
YEAR 2000 ISSUES
Many computer systems were originally designed to recognize calendar years
by the last two digits in the date code field. Beginning in the Year 2000, these
date code fields will need to accept four-digit entries to distinguish
twenty-first century dates. As a result, in less than two years, the
computerized systems, which include information and non-information technology
systems and applications used by the Company will need to be reviewed, evaluated
and modified or replaced, if
19
<PAGE>
necessary, to ensure all such financial information and operating systems are
Year 2000 compliant.
STATE OF READINESS
The Company has adopted a plan and formed a team of internal and
external personnel to address Year 2000 issues. The Company has conducted the
discovery and assessment stages on all its in-house systems that could be
significantly affected by the Year 2000. The completed assessment indicated
that all of the Company's in-house systems are Year 2000 capable. The Company
has a 95% economic interest in Starwood Operating, which services third-party
mortgages. Starwood Operating has completed the assessment of its systems and
implemented all required upgrades and modifications. Starwood Operating is in
the process of testing all systems, which process is expected to be completed
by the first half of 1999. Year 2000 issues at Starwood Operating are being
addressed by the previous owner of the business, which has agreed to indemnify
Starwood Operating for any losses relating to Starwood Operating's systems
and is contractually obligated to ensure that all such systems are Year 2000
compliant by mid-1999.
The Company is in the process of communicating with its significant
depository institutions, lenders, custodians, vendors, tenants under
operating leases and borrowers with which it interfaces to evaluate their
Year 2000 readiness and compliance. Approximately 25% of these counterparties
have provided written responses to the Company's written questionnaires. To
date, the Company is not aware of any such counterparty with a Year 2000
issue that would materially impact the Company's results of operations,
liquidity, or capital resources. Other than communicating with its
counterparties, the Company has no means of ascertaining whether a given
counterparty will be Year 2000 ready. The inability of counterparties to
complete their Year 2000 resolution process in a timely manner could
materially impact the Company.
YEAR 2000 PROJECT COSTS
The Company estimates that total costs for the Year 2000 compliance
review, evaluation, assessment and remediation efforts should not exceed
$20,000, although there can be no assurance that actual costs will not exceed
this amount. This amount will be funded through cash flows from operations.
RISKS OF YEAR 2000
The Company believes that it has an effective program in place to resolve
the Year 2000 issue in a timely manner. Disruptions in the economy generally
resulting from Year 2000 issues could materially affect the Company. The amount
of potential liability and lost revenue cannot be reasonably estimated at this
time.
The Company has asked substantially all of its significant vendors and
service providers to provide reasonable assurances as to those parties' Year
2000 state of readiness. Approximately 25% of these vendors and service
providers have provided written responses to the Company's questionnaires.
Risks assessments and contingency plans, where required, will be finalized in
the first six months of 1999. To the extent that vendors and service
providers do not provide satisfactory evidence that their products and
services are Year 2000 compliant, the Company will seek to obtain the
necessary products and services from alternate sources. There can be no
assurance, however, that Year 2000 remediation by vendors and service
providers will be available, and any failure of such third parties' systems
could have a material adverse impact on the Company's operations. In
addition, the failure of borrowers to address Year 2000 issues fully could
have a material and adverse effect on their operations and financial
condition, which could impact their ability to service the outstanding
obligations to the Company, which, in turn, could have a material and adverse
effect on the Company's operations and financial position.
Based on the assessment to date, the Company believes it is prepared for
the most reasonable likely worst case scenarios regarding Year 2000 compliance.
NEW ACCOUNTING STANDARDS
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
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 financial
statement disclosures.
20
<PAGE>
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" ("SFAS No. 133"). SFAS No. 133 establishes accounting
and reporting standards for derivative financial instruments and hedging
activities. It requires that an entity recognize all derivatives as either
assets or liabilities in the statement of financial position and measure those
instruments at fair value. If certain conditions are met, a derivative may be
specifically designated as: (i) a hedge of the exposure to changes in the fair
value of a recognized asset or liability or an unrecognized firm commitment;
(ii) a hedge of the exposure to variable cash flows of a forecasted transaction;
or (iii) in certain circumstances, a hedge of a foreign currency exposure. This
statement becomes effective in fiscal year ending December 31, 2001. The
adoption of SFAS 133 is not expected to have a material impact on the financial
position or results of operations of the Company.
OTHER MATTERS
1940 ACT EXEMPTION
The Company at all times intends to conduct its business so as to not
become regulated as an investment company under the Investment Company Act of
1940. If the Company were to become regulated as an investment company, then the
Company's ability to use leverage would be substantially reduced. The Investment
Company Act exempts entities that are "primarily engaged in the business of
purchasing or otherwise acquiring mortgages and other liens on and interests in
real estate" (i.e., "Qualifying Interests"). Under the current interpretation of
the staff of the SEC, in order to qualify for this exemption, the Company must
maintain at least 55% of its assets directly in Qualifying Interests. As of
September 30, 1998, the Company calculates that it is in and has maintained
compliance with this requirement.
FORWARD LOOKING STATEMENTS
When used in this Form 10-Q, in future SEC filings or in press releases or
other written or oral communications, the words or phrases "will likely result",
"are expected to", "will continue", "is anticipated", "estimate", "project" or
similar expressions are intended to identify "forward looking statements" within
the meaning of the Private Securities Litigation Reform Act of 1995. The Company
cautions that such forward looking statements speak only as of the date made and
that various factors including regional and national economic conditions,
changes in levels of market interest rates, credit and other risks of lending
and investment activities, and competitive and regulatory factors could affect
the Company's financial performance and could cause actual results for future
periods to differ materially from those anticipated or projected.
The Company does not undertake and specifically disclaims any obligation
to update any forward-looking statements to reflect events or circumstances
after the date of such statements except as required by law.
21
<PAGE>
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
On September 29, 1998, the Company issued 18,000 Class A Shares upon exercise of
certain options previously issued to the Advisor with an exercise price of
$15.00 per share. These options were exercised by a consultant to the Advisor
who had received such options from the Advisor in connection with services
provided to the Advisor which do not affect the Company. The shares issued are
exempt from registration under the Securities Act of 1933, as amended pursuant
to Section (4)(2) thereof. As required by the Company's Declaration of Trust, on
the same day, 9,000 Class B Shares were issued to the current holders of the
Class B Shares for a price of $0.01 per share.
ITEM 3. DEFAULT UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM-8-K
A. EXHIBITS
None
B. REPORTS ON FORM 8-K
None
22
<PAGE>
SIGNATURES
Pursuant to the requirements of Securities Exchange Act of 1934,
the Company has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
STARWOOD FINANCIAL TRUST
--------------------------------------------
Registrant
Date February 23, 1999 /S/ JAY SUGARMAN
--------------------------------------------
Jay Sugarman
Chief Executive Officer and President
Date February 23, 1999 /S/ SPENCER B. HABER
--------------------------------------------
Spencer B. Haber
Chief Financial Officer
(Principal Financial and Accounting Officer)
23
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<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 6,291
<SECURITIES> 51,233
<RECEIVABLES> 15,095
<ALLOWANCES> 1,750
<INVENTORY> 0
<CURRENT-ASSETS> 70,869
<PP&E> 195,729
<DEPRECIATION> 2,943
<TOTAL-ASSETS> 1,796,622
<CURRENT-LIABILITIES> 10,843
<BONDS> 0
0
0
<COMMON> 52,670
<OTHER-SE> 718,437
<TOTAL-LIABILITY-AND-EQUITY> 1,796,622
<SALES> 0
<TOTAL-REVENUES> 79,747
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 15,576
<LOSS-PROVISION> 1,750
<INTEREST-EXPENSE> 25,472
<INCOME-PRETAX> 36,949
<INCOME-TAX> 0
<INCOME-CONTINUING> 36,949
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<EXTRAORDINARY> 0
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