<PAGE>
UNITED STATES SECURITIES AND
EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1998
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to __________
Commission File Number 1-13355
SECURITY CAPITAL GROUP INCORPORATED
(Exact name of registrant as specified in its charter)
Maryland 36-3692698
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
125 Lincoln Avenue, Santa Fe, New Mexico 87501
(Address of principal executive offices) (Zip Code)
(505) 982-9292
(Registrant's telephone number, including area code)
(Former name, former address and former fiscal year,
if changed since last report)
Indicated 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 for the past 90 days.
Yes X No____
The number of shares outstanding of the Registrant's common stock as
of October 31, 1998 was:
Class A Common Shares, $.01 par value - 1,508,877 shares
Class B Common Shares, $.01 par value - 46,351,534 shares
<PAGE>
SECURITY CAPITAL GROUP INCORPORATED
INDEX
Page
Number(s)
PART I. Financial Information
Item 1. Consolidated Financial Statements
Consolidated Balance Sheets - September 30, 1998 (unaudited)
and December 31, 1997................................... 1
Consolidated Statements of Operations - Three and Nine months
ended September 30, 1998 and 1997 (unaudited)........... 2-3
Consolidated Statement of Shareholders' Equity -Nine months
ended September 30, 1998 (unaudited).................... 4
Consolidated Statements of Cash Flows - Nine months ended
September 30, 1998 and 1997 (unaudited)................. 5-6
Notes to Consolidated Financial Statements (unaudited)...... 7-20
Report of Independent Public Accountants.................... 21
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations........................... 22-34
PART II. Other Information
Item 6. Exhibits and Reports on Form 8-K............................ 35
<PAGE>
SECURITY CAPITAL GROUP INCORPORATED
and Subsidiaries
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
------------- -------------
(unaudited)
<S> <C> <C>
ASSETS
------
Investments, at equity:
ProLogis Trust $ 631,830 $ 660,078
Archstone Communities Trust 823,935 831,574
Security Capital U.S. Realty 783,771 909,581
Security Capital European Realty 336,083 --
Strategic Hotel Capital Incorporated 369,292 196,694
Security Capital Preferred Growth Incorporated 79,464 60,821
------------- -------------
3,024,375 2,658,748
Real estate, less accumulated depreciation 1,107,897 709,229
Investments in publicly traded real estate securities, at market value 148,528 129,334
------------- -------------
Total real estate investments 4,280,800 3,497,311
Cash and cash equivalents 16,710 11,454
Other assets 152,619 105,474
------------- -------------
Total assets $ 4,450,129 $ 3,614,239
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
Liabilities:
Lines of credit $ 558,080 $ 172,808
Mortgage notes payable 343,362 301,606
Convertible debt 322,774 323,024
Long-term debt 499,613 --
Accounts payable and accrued expenses 140,752 73,543
Deferred income taxes 32,009 87,250
------------- -------------
Total liabilities 1,896,590 958,231
Minority interests 134,342 107,135
Shareholders' Equity:
Class A Shares, $.01 par value; 20,000,000 shares authorized; 1,509,731
and 2,045,601 shares issued and outstanding in
1998 and 1997, respectively 15 20
Class B Shares, $.01 par value; 229,537,385 shares authorized;
46,307,626 and 22,627,541 shares issued and outstanding in
1998 and 1997, respectively 463 226
Series A Preferred Shares, $.01 par value; 139,000 shares
issued and outstanding in 1997; stated liquidation
preference of $1,000 per share -- 139,000
Series B Preferred Shares, $.01 par value; 257,642 shares
issued and outstanding in 1998; stated liquidation
preference of $1,000 per share 257,642
--
Additional paid-in capital 2,413,735 2,509,175
Accumulated deficit (252,658) (99,548)
------------- -------------
Total shareholders' equity 2,419,197 2,548,873
------------- -------------
Total liabilities and shareholders' equity $ 4,450,129 $ 3,614,239
============= =============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
1
<PAGE>
SECURITY CAPITAL GROUP INCORPORATED
and Subsidiaries
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------------- -----------------------------
1998 1997 1998 1997
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
INCOME:
Equity in earnings (loss) of:
ProLogis Trust $ (3,588) $ (24,164) $ 17,744 $ (6,505)
Archstone Communities Trust 16,273 (7,915) 51,672 29,375
Security Capital U.S. Realty (109,359) 55,683 (163,294) 90,781
Security Capital European Realty 574 -- (785) --
Strategic Hotel Capital Incorporated (3,319) (1,423) (2,403) (1,423)
Security Capital Preferred Growth Incorporated (4,589) 4,843 (3,959) 4,843
Financial Services Division revenues from
related parties 22,375 31,725 70,684 89,668
Homestead Village room revenue 39,741 15,922 100,979 40,421
Realized capital gains (losses) (13,922) 1,226 (11,447) 1,206
Increase (decrease) in market value of investments (8,024) 15,388 (17,403) 18,749
Other income, net 7,640 1,908 18,041 4,789
------------- ------------- ------------- -------------
(56,198) 93,193 59,829 271,904
------------- ------------- ------------- -------------
EXPENSES:
Financial Services Division expenses 18,841 27,091 50,487 83,239
Homestead Village rental expenses 17,158 6,991 43,456 17,369
Interest expense 23,947 31,407 54,038 88,655
General, administrative and other 14,195 10,197 40,858 33,814
Depreciation and amortization 9,239 4,488 24,087 10,631
------------ ------------- ------------- -------------
83,380 80,174 212,926 233,708
------------ ------------- ------------- -------------
Earnings (loss) from operations (139,578) 13,019 (153,097) 38,196
Gain on sale of management companies -- 93,395 -- 93,395
------------ ------------- ------------- -------------
Earnings (loss) before income taxes, minority
interest and extraordinary charge (139,578) 106,414 (153,097) 131,591
------------ ------------- ------------- -------------
Provision for income tax expense (benefit):
Current (1,525) -- 5,859 --
Deferred (45,259) 54,656 (55,241) 70,879
------------ ------------- ------------- -------------
Total income tax expense (benefit) (46,784) 54,656 (49,382) 70,879
Minority interests in net earnings (loss)
of subsidiaries 107 1,226 1,159 2,599
------------ ------------- ------------- -------------
Earnings (loss) before extraordinary charge (92,901) 50,532 (104,874) 58,113
Less Preferred Share dividends 4,509 2,606 30,579 7,819
------------ ------------- ------------- -------------
Earnings (loss) attributable to common shares (97,410) 47,926 (135,453) 50,294
Extraordinary charge - loss on early extinguish-
ment of debt, net of minority interests 17,657 -- 17,657 --
------------ ------------- ------------- -------------
Net earnings (loss) attributable to
common shares $ (115,067) $ 47,926 $ (153,110) $ 50,294
============ ============= ============= =============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
2
<PAGE>
SECURITY CAPITAL GROUP INCORPORATED
and Subsidiaries
CONSOLIDATED STATEMENTS OF OPERATIONS - (Continued)
(In thousands, except per share data)
(Unaudited)
<TABLE>
<CAPTION>
----------------------------- -----------------------------
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------------- -----------------------------
1998 1997 1998 1997
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Weighted-average Class B Shares outstanding:
Basic 120,184 67,463 121,706 64,575
============= ============= ============= =============
Diluted 120,184 125,889 121,706 69,369
============= ============= ============= =============
Earnings (loss) per share:
Basic earnings (loss) before extraordinary
charge $ (0.81) $ 0.71 $ (1.11) $ 0.78
Extraordinary charge-loss on early
extinguishment of debt (0.15) -- (0.15) --
------------- ------------- ------------- -------------
Basic net earnings (loss) attributable to
common shares $ (0.96) $ 0.71 $ (1.26) $ 0.78
============= ============= ============= =============
Diluted earnings (loss) before extraordinary
charge $ (0.81) $ 0.55 $ (1.11) $ 0.73
Extraordinary charge-loss on early
extinguishment of debt (0.15) -- (0.15) --
------------- ------------- ------------- -------------
Diluted net earnings (loss) attributable to
common shares $ (0.96) $ 0.55 $ (1.26) $ 0.73
============= ============= ============= =============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
3
<PAGE>
SECURITY CAPITAL GROUP INCORPORATED
and Subsidiaries
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
Nine Months Ended September 30, 1998
(In thousands, except shares)
(Unaudited)
<TABLE>
<CAPTION>
Common Stock
-------------------------------------------
Class A Class B Preferred Stock at
--------------------- --------------------- Liquidation Value Additional Total
Shares Shares at Shares Shares at ------------------ Paid-in Accumulated Shareholders'
Outstanding Par Value Outstanding Par Value Series A Series B Capital Deficit Equity
----------- --------- ----------- --------- --------- -------- ---------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balances at December 31, 1997 2,045,601 $20.455 22,627,541 $226.275 $ 139,000 $ -- $2,509,175 $ (99,548) $2,548,873
Conversion of Class A Shares
to Class B Shares (538,649) (5.386) 26,932,245 269.323 -- -- (264) -- --
Exercise of stock options 1,394 0.014 33,648 0.336 -- -- 1,884 -- 1,885
and warrants
Issuance of Series B Preferred -- -- (3,296,640) (32.966) (139,000) 257,642 (98,766) (19,843) --
Conversion of 2016 debentures
to Class B Shares -- -- 10,832 0.108 -- -- 250 -- 250
Repurchase of Class A Shares (495) (0.005) -- -- -- -- (641) -- (641)
Issuance of Class A Shares 1,880 0.019 -- -- -- -- 2,498 -- 2,498
Cost of raising capital -- -- -- -- -- -- (401) -- (401)
Net loss -- -- -- -- -- -- -- (122,531) (122,531)
Preferred Share dividends -- -- -- -- -- -- -- (10,736) (10,736)
--------- -------- ---------- -------- --------- -------- ---------- --------- ----------
Balances at September 30, 1998 1,509,731 $15.097 46,307,626 $463.076 $ -- $257,642 $2,413,735 $(252,658) $2,419,197
========= ======= ========== ======== ========= ======== ========== ========= ==========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
4
<PAGE>
SECURITY CAPITAL GROUP INCORPORATED
and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
-----------------------------
1998 1997
------------- -------------
<S> <C> <C>
Operating Activities:
Net earnings (loss) $ (122,531) $ 58,113
Adjustments to reconcile net earnings (loss) to cash flows
provided by operating activities:
Deferred income tax expense (benefit) (55,241) 70,879
Minority interests 1,159 2,599
Extraordinary charge - loss on early extinguishment of debt,
net of minority interest 17,657 --
Equity in (earnings) loss of unconsolidated investees 101,025 (117,073)
Distributions from unconsolidated investees 107,702 78,090
(Increase) decrease in market value of investments 17,403 (18,749)
Depreciation and amortization 24,087 10,631
Gain on sale of management companies -- (93,395)
Other 4,340 7,731
Increase in other assets (60,761) (4,549)
Increase in accrued interest on convertible debt 5,245 40,595
Increase in accounts payable and accrued expenses 66,860 5,367
------------- -------------
Net cash flows provided by operating activities 106,945 40,239
------------- -------------
Investing Activities:
Real estate investments (393,185) (255,081)
Investment in shares of:
Security Capital U.S. Realty (37,484) (149,040)
Security Capital European Realty (266,096) --
Strategic Hotel Capital Incorporated (87,500) (94,594)
Security Capital Preferred Growth Incorporated (25,000) (15,000)
Purchases of publicly traded real estate securities, net (36,595) (101,510)
Purchase of Strategic Hotel Capital Incorporated
convertible debt (87,500) --
Purchase of Homestead Village Incorporated warrants -- (23,859)
Advances on notes receivable from affiliate (70,300) --
Other (3,907) (21,017)
------------- -------------
Net cash flows used in investing activities $ (1,007,567) $ (660,101)
------------- -------------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
5
<PAGE>
SECURITY CAPITAL GROUP INCORPORATED
and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS-(Continued)
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
Nine months ended
September 30,
-----------------------------
1998 1997
------------- -------------
<S> <C> <C>
Financing Activities:
Proceeds from lines of credit $ 1,111,772 $ 386,908
Payments on lines of credit (726,500) (393,500)
Proceeds from long-term debt offering, net 499,613 --
Proceeds from mortgage notes payable 163,041 158,250
Payments on mortgage notes payable (122,028) --
Proceeds from issuance of convertible debt -- 98,729
Proceeds from issuance of common shares, net of expenses 3,341 691,627
Proceeds from issuance of common shares to minority interest
holders 32,205 2,174
Preferred dividends paid (10,736) (7,819)
Debt issuance costs (19,252) (1,519)
Homestead payment to extinguish debt (25,344) --
Other (234) (987)
------------- -------------
Net cash flows provided by financing activities 905,878 933,863
------------- -------------
Net increase in cash and cash equivalents 5,256 314,001
Cash and cash equivalents, beginning of period 11,454 19,323
------------- -------------
Cash and cash equivalents, end of period $ 16,710 $ 333,324
============= =============
Non-Cash Investing and Financing Activities:
Receipt of Security Capital European Realty
shares in satisfaction of indebtedness $ 70,772 $ --
============= =============
Issuance of Series B Preferred Shares:
Series B Preferred Shares issued $ 257,642 $ --
Series A Preferred Shares retired (139,000) --
Fair value of Class B Common Shares retired (98,799) --
Series A Preferred dividend recorded (19,843) --
------------- -------------
$ -- $ --
============= =============
Shares issued to acquire SCGPB Incorporated $ -- $ (6,600)
============= =============
Shares received from ARCHSTONE in exchange for
management companies $ -- $ 75,838
============= =============
Shares received from PROLOGIS in exchange for
management companies $ -- $ 81,871
============= =============
Issuance of warrants to ATLANTIC shareholders $ -- $ 11,530
============= =============
Issuance of common stock under debenture interest
reinvestment plans $ -- $ 4,624
============= =============
Increase in property and equipment and development cost payable $ -- $ 14,488
============= =============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
6
<PAGE>
SECURITY CAPITAL GROUP INCORPORATED
and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(1) GENERAL
Security Capital Group Incorporated (Security Capital) is a real estate
research, investment and operating management company. Its strategy is to create
the optimal organization to lead and profit from global real estate
securitization. Security Capital has invested in various companies (the Capital
Division) (see note 2) and provides various capital management and financial
services through a Financial Services Division (see note 3). The Capital
Division invests in real estate investment trusts and other real estate-related
companies. Its objective is to create increasing cash flow at the investee level
by generating capital appreciation and growing dividends. The Financial Services
Division provides research, operational and capital deployment oversight,
capital management, capital markets, accounting and administrative services for
third party customers and for the companies in which Security Capital and its
affiliates have invested.
The consolidated financial statements of Security Capital as of September 30,
1998, are unaudited and, pursuant to the rules of the Securities and Exchange
Commission (SEC), certain information and footnote disclosures normally included
in financial statements have been omitted. While management of Security Capital
believes that the disclosures presented are adequate, these interim consolidated
financial statements should be read in conjunction with Security Capital's 1997
audited consolidated financial statements contained in Security Capital's 1997
Annual Report on Form 10-K.
In the opinion of management, the accompanying unaudited financial statements
contain all adjustments, consisting only of normal recurring adjustments,
necessary for a fair presentation of Security Capital's consolidated financial
statements for the interim periods presented. Certain reclassifications have
been made in the 1997 consolidated financial statements and notes to
consolidated financial statements for the interim periods presented in order to
conform to the 1998 presentation. The results of operations for the nine-month
period ended September 30, 1998, are not necessarily indicative of the results
to be expected for the entire year.
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 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.
7
<PAGE>
SECURITY CAPITAL GROUP INCORPORATED
and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(2) REAL ESTATE INVESTMENTS
Security Capital holds investments at September 30, 1998, through its
wholly-owned subsidiary, SC Realty Incorporated (SC Realty), as follows:
<TABLE>
<CAPTION>
% Ownership as of Security Capital's
------------------------------- Investments for the
September 30, December 31, Nine Months Ended
Investment Type of Entity 1998 1997 September 30, 1998
- -------------------------------------- ------------------ -------------- --------------- -------------------
<S> <C> <C> <C> <C>
ProLogis Trust - formerly Security Industrial REIT 40.5% 42.5% $ --
Capital Industrial Trust (PROLOGIS)
Archstone Communities Trust - Multi-family REIT 38.1% 33.1%(a) --
formerly Security Capital Pacific Trust
(ARCHSTONE)
Security Capital U.S. Realty U.S. real estate 34.5% 32.9% 37,484,000
(SC-USREALTY) investments
Security Capital European Realty Global real estate 34.6% -- (b) 336,868,000
formerly Security Capital investments
Global Realty (SC-ER)
Homestead Village Incorporated Extended-stay lodging 69.8% 65.0% 129,108,000
(Homestead)
Strategic Hotel Capital Incorporated Upscale hotels 30.4% 39.5% 175,000,000
(SHC)
Security Capital U.S. Real Estate U.S. real estate 91.7% 98.3% --
Shares (SC-US) securities fund
Security Capital Preferred Growth Preferred stock 10.7% 12.9% 25,000,000
Incorporated (SC-PG) investments in real
estate companies
Security Capital European Real Estate European real 99.9% 100.0% 5,000,000
Shares (SC-E) estate securities fund
Security Capital Real Estate Arbitrage Arbitrage real estate
Shares (SC-ARBITRAGE) securities fund 99.9% -- (c) 25,000,000
</TABLE>
(a) In July 1998 ARCHSTONE and Security Capital Atlantic Incorporated
(ATLANTIC) consummated their merger. Pursuant to the merger transaction,
ATLANTIC was merged into ARCHSTONE, which continues its existence under the
name "Archstone Communities Trust" and is traded on the NYSE under the
symbol "ASN". In accordance with the terms of the merger, each outstanding
ATLANTIC common share was converted into one ARCHSTONE common share and
each outstanding ATLANTIC Series A preferred share was converted into one
comparable ARCHSTONE Series C preferred share. Upon consummation of the
merger, Security Capital owned approximately 38.2% of ARCHSTONE's common
shares and continues to be ARCHSTONE's largest shareholder.
(b) SC-ER (formerly known as Security Capital Global Realty) is a newly formed
European based company that will own strategic control positions in fully
integrated real estate operating companies mainly in Europe or the
Asia-Pacific region. In April 1998 SC-ER completed a $1,500,000,000 equity
subscription offering, of which Security Capital and its subsidiaries
subscribed for $518,258,000 of common shares.
8
<PAGE>
SECURITY CAPITAL GROUP INCORPORATED
and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(c) SC-ARBITRAGE is a newly formed investment fund that engages in various
arbitrage transactions of real estate securities in the United States.
Security Capital received dividends from its investees for the three and nine
months ended September 30, 1998 and 1997 as follows:
<TABLE>
<CAPTION>
Dividends Received (In thousands)
-------------------------------------------------------------
Three months ended Nine months ended
September 30, September 30,
----------------------------- -----------------------------
1998 1997 1998 1997
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Gross Dividends:
PROLOGIS $ 15,885 $ 11,526 $ 45,991 $ 34,577
ARCHSTONE 19,361 8,902 40,229 26,706
ATLANTIC -- 8,403 19,083 25,209
SC-US 965 1,087 5,693 3,575
SC-PG 984 -- 2,397 --
------------- ------------- ------------- -------------
$ 37,195 $ 29,918 $ 113,393 $ 90,067
============= ============= ============= =============
</TABLE>
<TABLE>
<CAPTION>
Dividend Amount Per Investee Share
-------------------------------------------------------------
Three months ended Nine months ended
September 30, September 30,
----------------------------- -----------------------------
1998 1997 1998 1997
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
PROLOGIS $ 0.3183 $ 0.2675 $ 0.9216 $ 0.8025
============= ============= ============= =============
ARCHSTONE $ 0.3550 $ 0.3250 $ 1.0350 $ 0.9750
============= ============= ============= =============
ATLANTIC $ -- $ 0.3900 $ 0.8000 $ 1.1700
============= ============= ============= =============
SC-US $ 0.1000 $ 0.1127 $ 0.5902 $ 0.3709
============= ============== ============= =============
SC-PG $ 0.2500 $ -- $ 0.6400 $ --
============= ============== ============= =============
</TABLE>
9
<PAGE>
SECURITY CAPITAL GROUP INCORPORATED
and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Presented below is the summary earnings information for Security Capital's
equity investees for the nine months ended September 30, 1998 and 1997 (in
thousands):
<TABLE>
<CAPTION>
PROLOGIS ARCHSTONE ATLANTIC SHC
--------------------- --------------------- --------------------- -------
1998 1997 1998 1997 1998 1997 1998
--------- --------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
Rental, room revenue and other
income, net $ 271,425 $ 222,042 $ 352,832 $ 260,550 $ 101,532 $ 126,383 $ 384,907
--------- --------- --------- --------- --------- --------- ---------
Expenses:
Operating, general and
administrative and other 193,971 139,522 259,021 192,359 75,357 91,661 385,235
Costs incurred in acquiring
management companies from
Security Capital -- 75,376 -- 71,707 -- -- --
--------- --------- --------- --------- --------- --------- ---------
193,971 214,898 259,021 264,066 75,357 91,661 385,235
--------- --------- --------- --------- --------- --------- ---------
Net earnings before minority
interest 77,454 7,144 93,811 (3,516) 26,175 34,722 (328)
Minority interest share of
net earnings 3,101 2,763 -- -- -- -- 6,820
--------- --------- --------- --------- --------- --------- ---------
Net earnings (loss) from operations 74,353 4,381 93,811 (3,516) 26,175 34,722 (7,148)
Gain on disposition of
depreciated real estate 4,278 6,529 36,688 47,930 -- 259 --
--------- --------- --------- --------- --------- --------- ---------
Net earnings (loss) 78,631 10,910 130,499 44,414 26,175 34,981 (7,148)
Less Preferred Share dividends 35,543 26,488 15,192 14,625 2,156 491 --
--------- --------- --------- --------- --------- --------- ---------
Net earnings (loss) attributable
to common shares $ 43,088 $ (15,578) $ 115,307 $ 29,789 $ 24,019 $ 34,490 $ (7,148)
Security Capital share of net
earnings (loss) $ 17,744 $ (6,505) $ 39,674 $ 10,996 $ 11,998 $ 18,379 $ (2,403)
========= ========= ========= ========= ========= ========= =========
</TABLE>
<TABLE>
<CAPTION>
SC-USREALTY SC-ER SC-PG
------------------------ ----------- -------------------------
1998 1997 1998 1998 1997
----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Net investment income (loss) $ 59,652 $ 41,860 $ (9,709) $ 24,174 $ (51)
Realized gains on publicly traded investments 32,763 22,416 -- -- --
Increase (decrease) in appreciation of investments (601,047) 213,395 7,432 (56,139) 40,274
Elimination of a related party transaction 26,808 -- -- --
----------- ----------- ----------- ----------- -----------
Adjusted net earnings (loss) $ (481,824) 277,671 $ (2,277) $ (31,965) $ 40,223
=========== =========== =========== =========== ===========
Security Capital share of adjusted net earnings (loss) $ (163,294) $ 90,781 $ (785) $ (3,959) $ 4,843
=========== =========== =========== =========== ===========
</TABLE>
10
<PAGE>
SECURITY CAPITAL GROUP INCORPORATED
and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
A condensed consolidating balance sheet of Security Capital as of September 30,
1998, follows (in thousands):
<TABLE>
<CAPTION>
Investment
Security Capital(a) Homestead(b) Funds(b)(c) Consolidated(d)
<S> <C> <C> <C> <C>
Investments, at equity $ 3,517,526 $ -- $ -- $ 3,024,375
Net real estate investments 29,309 1,084,856 -- 1,107,897
Investments in publicly traded real estate
securities, at market value -- -- 148,528 148,528
Cash and other assets 115,687 86,721 15,132 169,329
------------------- ------------ ----------- ---------------
Total assets $ 3,662,522 $ 1,171,577 $ 163,660 $ 4,450,129
=================== ============ =========== ===============
Lines of credit $ 265,500 $ 292,580 $ -- $ 558,080
Long-term debt 822,387 343,362 -- 1,165,749
Other liabilities 130,890 66,877 21,860 172,761
------------------- ------------ ----------- ---------------
Total liabilities 1,218,777 702,819 21,860 1,896,590
Minority interests 20,160 -- -- 134,342
Shareholders' equity 2,423,585 468,758 141,800 2,419,197
------------------- ------------ ----------- ---------------
Total liabilities and
shareholders' equity $ 3,662,522 $ 1,171,577 $ 163,660 $ 4,450,129
=================== ============ =========== ===============
</TABLE>
(a) Includes Homestead and the Investment Funds on the equity method.
(b) Reflects the carrying amount prior to elimination entries.
(c) The Investment Funds, which invest in securities of real estate
companies, include SC-US, SC-E and SC-ARBITRAGE.
(d) Consolidated amounts include effect of
elimination entries.
11
<PAGE>
SECURITY CAPITAL GROUP INCORPORATED
and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
A condensed consolidating statement of operations for Security Capital for the
nine months ended September 30, 1998, follows (in thousands):
<TABLE>
<CAPTION>
Security Investment
Capital(a) Homestead(b) Funds(b)(c) Consolidated(d)
<S> <C> <C> <C> <C>
Equity in earnings (loss) of investees $ (137,533) $ -- $ -- $ (101,025)
Financial Services Division revenues from
related parties 75,037 -- -- 70,684
Room revenue -- 100,979 -- 100,979
Other income 12,181 1,786 (22,975) (10,809)
---------- ------------ ----------- ---------------
(50,315) 102,765 (22,975) 59,829
---------- ------------ ----------- ---------------
Financial Services Division expenses 50,487 -- -- 50,487
Rental expenses -- 43,456 -- 43,456
Interest expense 40,362 13,798 -- 54,038
General, administrative and other 26,554 16,368 1,400 40,858
Depreciation and amortization 3,661 22,227 -- 24,087
---------- ------------ ----------- ----------------
121,064 95,849 1,400 212,926
---------- ------------ ----------- ----------------
Earnings (loss) before income taxes,
minority interests, and extraordinary charge (171,379) 6,916 (24,375) (153,097)
Income tax benefit (49,382) -- -- (49,382)
Minority interests -- -- -- 1,159
---------- ------------ ----------- ---------------
Net earnings (loss) before extraordinary
charge (121,997) 6,916 (24,375) (104,874)
Less Preferred Share dividends 30,579 -- -- 30,579
---------- ------------ ----------- ---------------
Earnings (loss) attributable to common shares (152,576) 6,916 (24,375) (135,453)
Extraordinary loss on early extinguishment
of debt, net -- (25,344) -- (17,657)
---------- ------------- ----------- ---------------
Net loss attributable to
common share $ (152,576) $ (18,428) $ (24,375) $ (153,110)
========== ============ =========== ===============
</TABLE>
(a) Includes Homestead and the Investment Funds on the equity method.
(b) Reflects the carrying amount prior to elimination entries.
(c) The Investment Funds, which invest in securities of real estate companies,
include SC-US, SC-E and SC-ARBITRAGE.
(d) Consolidated amounts include effect of elimination entries.
12
<PAGE>
SECURITY CAPITAL GROUP INCORPORATED
and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(3) FINANCIAL SERVICES DIVISION REVENUES FROM RELATED PARTIES
Financial Services Division fees for the three and nine months ended September
30, 1998 and 1997, were earned from the following sources (in thousands):
<TABLE>
<CAPTION>
Three Months Ended Nine Months ended
September 30, September 30,
----------------------------- ------------------------
1998 1997 1998 1997
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
REIT management fees $ -- $ 10,993 $ -- $ 39,379
Property management fees -- 7,421 -- 23,846
Global Capital Management Group fees 13,420 7,424 35,001 17,978
Global Capital Markets Group fees 5,153 5,097 26,336 7,707
Corporate Services fees 4,950 1,624 12,776 2,496
Real Estate Research fees 352 114 924 290
------------- ------------- ------------- -------------
Total Financial Services Division
revenues 23,875 32,673 75,037 91,696
Less amounts eliminated in
Consolidation (1,500) (948) (4,353) (2,028)
------------- ------------- ------------- -------------
Consolidated Financial Services
Division revenues $ 22,375 $ 31,725 $ 70,684 $ 89,668
============= ============= ============= =============
</TABLE>
(4) INDEBTEDNESS
Lines of Credit:
Borrowings outstanding on Security Capital's and Homestead's revolving bank
lines of credit at September 30, 1998, totaled $265,500,000 and $292,580,000,
respectively.
Security Capital has a $650,000,000 unsecured revolving line of credit with
Wells Fargo Bank, National Association (Wells Fargo), as agent for a group of
lenders. The agreement is effective through April 6, 2000, with an option to
renew for successive one-year periods with the approval of lenders. Borrowings
bear interest at LIBOR plus a margin (1.00% as of September 30, 1998) based upon
Security Capital's credit rating or a Base Rate (defined as the higher of Wells
Fargo prime rate or the Federal Funds rate plus .50%).
Commitment fees range from 0.125% to 0.20% per annum based on the average
unfunded line of credit balance. The line is guaranteed by SC Realty which is a
wholly owned subsidiary of Security Capital.
During a non-monetary default, no payments other than dividends paid on Security
Capital's Series B Preferred Shares shall be permitted. Distributions and
dividends paid on Security Capital's Series B Preferred Shares cannot exceed 50%
of the cash flow available for distributions, provided no event of default has
occurred and is continuing. In the event of a monetary default, all
distributions are prohibited.
13
<PAGE>
SECURITY CAPITAL GROUP INCORPORATED
and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Homestead's lines of credit as of September 30, 1998, are summarized as follows:
<TABLE>
<CAPTION>
Fee on average
Amount Maturity Interest rate range unfunded balances Collateral
- --------------- ----------------- ------------------------- ----------------- --------------------------
<S> <C> <C> <C> <C>
$ 150,000,000 April 24, 1999 Eurodollar rate plus 1.5% 0.375% Real estate
to 2.5% or the higher
of prime plus 0.5% to
1.5% or the federal funds
rate plus 1% to 2%
$ 50,000,000 April 24, 1999 Eurodollar rate plus 2.75% 0.5% $50,000,000 subject to
or the higher of prime collateral requirements
plus 1.75% or the Federal
Funds rate plus 2.25%
$ 200,000,000 February 23, 1999 Eurodollar rate plus 1% 0.25% Subscription receivable
to 1.25% or prime to prime from Security Capital
plus 0.25% for $200,000,000 of
Homestead convertible
subordinated debentures,
which Homestead may
convert to Homestead
common stock if it is
not in default
</TABLE>
Each line of credit requires maintenance of certain financial covenants.
Security Capital, SC Realty and Homestead were in compliance with all such
covenants at September 30, 1998.
Senior Unsecured Notes:
On June 23, 1998, Security Capital issued the following long-term debt, all of
which was outstanding as of September 30, 1998 (in thousands):
<TABLE>
<CAPTION>
<S> <C> <C>
6.95% Senior Unsecured Notes, due June 15, 2005, original principal of
$200,000,000, net of original issue discount. Interest is payable on June
15 and December 15 of each
year, commencing December 15, 1998. $ 199,794
7.15% Senior Unsecured Notes, due June 15, 2007, original principal of
$100,000,000, net of original issue discount. Interest is payable on June
15 and December 15 of each
year, commencing December 15, 1998. 99,819
7.70% Senior Unsecured Notes, due June 15, 2028, original principal of
$200,000,000. Interest is payable on June 15
and December 15 of each year, commencing December 15, 1998. 200,000
------------
$ 499,613
============
</TABLE>
14
<PAGE>
SECURITY CAPITAL GROUP INCORPORATED
and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
All of the Senior Unsecured Notes are redeemable at any time at the option of
Security Capital, in whole or in part, at a redemption price equal to the sum of
the principal amount of the Senior Unsecured Notes being redeemed plus accrued
interest thereon to the redemption date plus an adjustment, if any, based on the
yield to maturity relative to market yields available at redemption.
Under the terms of the indenture, Security Capital may incur additional debt
only if, after giving effect to the debt being incurred, (i) the ratio of debt
to adjusted total assets, as defined in the indenture, does not exceed 50%, and
(ii) the fixed charge coverage ratio, as defined in the indenture, for the four
preceding fiscal quarters is not less than 1.5 to 1.0. In addition, Security
Capital may not at any time permit its consolidated tangible net worth, as
defined in the indenture, to be less than $1,500,000,000. At September 30, 1998,
Security Capital was in compliance with all debt covenants contained in the
indenture.
Convertible Debt:
Security Capital's 6.50% convertible subordinated debentures due 2016 (2016
Convertible Debentures) are convertible into Class A Shares at $1,153.90 per
share, at the option of the holders. The principal amount outstanding totaled
$322,774,000 and $323,024,000 at September 30, 1998, and December 31, 1997,
respectively.
Homestead Convertible Mortgage Notes Payable:
On July 6, 1998, Homestead entered into a mortgage loan purchase agreement with
ARCHSTONE (through its merger with ATLANTIC) and Merrill Lynch Mortgage Capital
Inc. (MLMC) whereby $98,000,000 of Homestead convertible mortgage notes held by
ARCHSTONE were modified to, among other things, eliminate their convertibility
feature in exchange for a payment of $21,400,000 from Homestead to ARCHSTONE.
The amount paid to ARCHSTONE was based on trailing market prices of Homestead
common stock at the time the agreement was entered into, which exceeded the
conversion price of the convertible mortgage notes at that date. Homestead
funded the payment with the proceeds received from the sale of $24,000,000 of
7.5% convertible subordinated debentures. Also pursuant to the mortgage loan
purchase agreement ARCHSTONE sold the modified notes to MLMC for $98,000,000. On
August 7, 1998, Homestead converted the $98,000,000 of mortgage notes and the
$24,000,000 of 7.5% convertible subordinated debentures into a $122,000,000
mortgage of a newly formed special purpose subsidiary of Homestead. The mortgage
note is collateralized by 26 Homestead properties (totaling $227,000,000 of
historical cost at September 30, 1998) which were formerly collateral for the
ARCHSTONE mortgage notes. The $122,000,000 mortgage note matures June 30, 1999,
and provides for interest-only monthly payments of LIBOR plus 1.70% through
September 30, 1998, LIBOR plus 2.0% through November 30, 1998, and LIBOR plus
2.25% thereafter, with options to extend.
The transaction resulted in an early extinguishment of debt measured as the
difference between the $98,000,000 carrying amount of the original mortgage
notes to ARCHSTONE and the amount paid to extinguish the debt, including
transaction costs. Such loss on extinguishment of debt and transaction costs
amounted to $25,344,000 and was recorded as an extraordinary item in the third
quarter of 1998.
15
<PAGE>
SECURITY CAPITAL GROUP INCORPORATED
and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Interest:
Presented below are the interest costs incurred by Security Capital and its
consolidated subsidiaries for the three and nine months ended September 30, 1998
and 1997 (in thousands).
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
1998 1997 1998 1997
--------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C>
Total interest incurred $ 31,001 $ 38,516 $ 75,249 $ 148,214
=============== =============== =============== ===============
Capitalized interest included in total
interest incurred $ 7,054 $ 7,109 $ 21,211 $ 59,559
=============== =============== =============== ===============
Interest paid in cash $ 11,302 $ 2,606 $ 45,367 $ 53,123
=============== =============== ============== ===============
Amortization of deferred financing costs
included in interest expense $ 2,334 $ 1,252 $ 5,133 $ 2,677
=============== =============== =============== ===============
</TABLE>
(5) SHAREHOLDERS' EQUITY
Each share of Class A common stock, par value $.01 per share (Class A Common
Shares), is convertible into 50 shares of Class B common stock, par value $.01
per share (Class B Common Shares). Class B Common Shares are not convertible
into Class A Common Shares.
Warrants:
Security Capital issued registered warrants to acquire $250,000,000 of Class B
Common Shares (8,928,572 warrants) to the common and convertible preferred
shareholders of PROLOGIS, ARCHSTONE and ATLANTIC, and limited partnership unit
holders of PROLOGIS as of September 16, 1997. The exercise price of a warrant
was $28 per Class B Common Share, and the warrants expired on September 18,
1998. As of the expiration date 91,479 warrants had been exercised.
Series B Preferred Shares:
On May 12, 1998, Security Capital issued 257,642 shares of Series B Preferred
Shares, par value $.01 per share, to Commerzbank Aktiengesellshaft
(Commerzbank), in exchange for 139,000 Series A Preferred Shares and 3,293,288
Class B Common Shares held by Commerzbank. Security Capital also paid a cash
dividend to Commerzbank on the Series A Preferred Shares for the period from
April 1, 1998, to May 12, 1998, of $1,216,250.
16
<PAGE>
SECURITY CAPITAL GROUP INCORPORATED
and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
The Series B Preferred Shares have a liquidation preference of $1,000 per share
for an aggregate preference of $257,642,000 plus any accrued and unpaid
dividends. Subject to certain adjustments, each Series B Preferred Share is
convertible, at the option of the holder at any time, into 25.641026 Class B
Common Shares (a conversion price of $39.00 per share). The Series B Preferred
Shares are initially convertible into a total of 6,606,205 Class B Common
Shares. The Series B Preferred Shares are entitled to receive cumulative
preferential cash distributions at the rate of 7.0% per annum. The Series B
Preferred Shares are redeemable, at the option of Security Capital, after May
12, 2003, at a redemption price equal to $1,000 per share plus any accrued and
unpaid dividends.
The exchange of the Series B Preferred Shares for the Series A Preferred Shares
and 3,293,288 Class B Common Shares was based on the fair value of those
securities at the date of the Exchange Agreement. For financial accounting
purposes, the fair value of the Series B Preferred Shares issued ($257,642,000)
less the sum of (a) the carrying value of the Series A Preferred Shares
($139,000,000) and (b) the fair value of the Class B Shares ($98,799,000) was
recorded as a dividend ($19,843,000).
Shelf Registration:
On September 30, 1998, Security Capital filed a $1,000,000,000 shelf
registration statement with the Securities and Exchange Commission which was
declared effective on October 13, 1998. These securities can be issued in the
form of Class A Common Shares, Class B Common Shares, unsecured debt securities,
preferred shares or warrants to purchase any of the above securities. They will
be issued on an as-needed basis, subject to Security Capital's ability to effect
any offering on satisfactory terms.
17
<PAGE>
SECURITY CAPITAL GROUP INCORPORATED
and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Per Share Data:
Security Capital adopted SFAS No. 128, Earnings per Share, effective December
15, 1997. Previously reported earnings per share data have been restated to
conform to SFAS No. 128.
The following is a reconciliation of the numerators and denominators used to
calculate basic and diluted earnings per Class B Common Share under SFAS No. 128
for the periods indicated (in thousands, except per common share amounts):
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30, September 30,
----------------------------- -----------------------------
1998 1997 1998 1997
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Net income (loss) attributable to common shares $ (115,067) $ 47,926 $ (153,110) $ 50,294
Debenture interest expense, net of tax -- 18,377 -- --
Preferred share dividends -- 2,606 -- --
------------- ------------- ------------- -------------
Net income (loss) attributable to common shares
and assumed conversions $ (115,067) $ 68,909 $ (153,110) $ 50,294
============= ============= ============= =============
Weighted-average Class B common shares
outstanding - Basic 120,184 67,463 121,706 64,575
Increase in shares which would result from:
Exercise of options -- 4,794 -- 4,794
Exercise of warrants -- 144 -- --
Conversion of debentures -- 48,193 -- --
Conversion of preferred shares -- 5,295 -- --
------------- ------------- ------------- -------------
Adjusted weighted-average Class B common shares
outstanding - Diluted 120,184 125,889 121,706 69,369
============= ============= ============= =============
Per share net earnings (loss) attributable to Class B
common shares:
Basic $ (0.96) $ 0.71 $ (1.26) $ 0.78
============= ============= ============= =============
Diluted $ (0.96) $ 0.55 $ (1.26) $ 0.73
============= ============= ============= =============
</TABLE>
For all periods (except the three months ended September 30, 1997), the
Convertible Debentures and the Preferred Shares are not assumed converted for
the purpose of calculating diluted earnings per Class B Common Share as the
effects are anti-dilutive, and for loss periods the conversion of options and
warrants is not assumed as the effect is anti-dilutive.
18
<PAGE>
SECURITY CAPITAL GROUP INCORPORATED
and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(6) DERIVATIVE FINANCIAL INSTRUMENTS
Security Capital uses derivatives to manage well-defined risks associated with
interest rate fluctuations on anticipated transactions. In May 1998, in
anticipation of the June 1998 debt offering (see Note 4), Security Capital
entered into the following forward treasury lock transactions:
<TABLE>
<CAPTION>
Trade Date Reference Treasury Notional Amount
------------ ------------------- ---------------
<S> <C> <C> <C>
May 22, 1998 6.125% of Nov. 2027 $ 187,500,000
May 22, 1998 6.5% of May 2005 75,000,000
May 26, 1998 5.625% of May 2008 112,500,000
---------------
$ 375,000,000
</TABLE>
These contracts were terminated on June 18, 1998, resulting in deferred losses
totaling $9,500,000. These losses are being amortized into interest expense over
the life of the related Senior Unsecured Notes which have a weighted average
maturity of 16.6 years. As of September 30, 1998, Security Capital has no
interest rate hedge contracts outstanding.
(7) COMMITMENTS AND CONTINGENCIES
Security Capital and its affiliates have committed to invest up to $518,258,000
in equity securities of SC-ER (see Note 2). As of September 30, 1998,
$336,868,000 had been funded by Security Capital and its affiliates.
At September 30, 1998, Homestead had approximately $113,000,000 of unfunded
commitments for developments under construction.
In connection with a line of credit agreement entered into by Homestead in June
1998, Security Capital committed, during the eight month term of the line of
credit, to retain its ownership of Homestead common shares and to purchase up to
$200,000,000 of subordinated convertible debentures of Homestead under certain
circumstances (which amount may be reduced if Security Capital purchases other
Homestead securities or if Homestead obtains other qualifying equity investments
from third parties). Homestead may convert these debentures to common stock if
it is not in default under its credit agreements. Homestead has pledged this
investment obligation of Security Capital as security under Homestead's June
1998 line of credit.
(8) RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998 the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, Accounting for Derivative Instruments
and Hedging Activities. Statement 133 is effective for fiscal years beginning
after June 15, 1999, but may be implemented for fiscal quarters beginning after
June 15, 1998. The Statement establishes accounting and reporting standards
19
<PAGE>
SECURITY CAPITAL GROUP INCORPORATED
and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
requiring that every derivative instrument (including certain derivative
instruments embedded in other contracts) be recorded in the balance sheet as
either an asset or liability measured at its fair value. The Statement requires
that changes in the derivative's fair value be recognized currently in earnings
unless specific hedge accounting criteria are met. Security Capital has not yet
quantified the impacts of adopting Statement 133 on its financial statements and
has not determined the timing of or method of its adoption of Statement 133.
In April 1998 the Accounting Standards Executive Committee issued Statement of
Position 98-5 (SOP 98-5) "Reporting on the Costs of Start-Up Activities"
establishing accounting standards requiring the expensing of organizational,
pre-opening, and start-up costs. SOP 98-5 is effective for fiscal years
beginning after December 15, 1998. Restatement of financial statements for
earlier periods is prohibited. Upon adoption, any material unamortized
organizational, pre-opening and start-up costs will be required to be written
off and charged to 1999 operations as a cumulative effect of adoption of an
accounting standard. Security Capital and its subsidiaries are in the process of
evaluating SOP 98-5 and will adopt the standard in the first quarter of its 1999
fiscal year. The impact of adoption of SOP 98-5 on Security Capital's results of
operation and financial position has not been quantified.
(9) HOMESTEAD SUBSEQUENT EVENT
In the fourth quarter of 1998, in light of the difficult environment in the
capital markets and the resulting limited availability of new financing for
additional commitments for developments, Homestead reorganized its internal
development department and terminated approximately 40 full-time persons. In
addition, Homestead is reviewing its land sites owned and contracts for
purchases of development sites and is aligning its decision to develop and/or
acquire sites for development with its ability to obtain specific financings or
its ability to use cash flow from operations. In conjunction with the severance
of development personnel and changed expectations to pursue development of
certain sites owned or under contract for acquisition, Homestead anticipates
recording an accrual for expenses of severance and abandoned pursuits totaling
$6,000,000 to $7,000,000. As a result of the reorganization expenses, Homestead
anticipates it will not meet its bank lines of credit debt service coverage
ratio covenant for the fourth quarter of 1998. Homestead has initiated
discussions with the banks to seek a waiver of this covenant for the fourth
quarter of 1998.
20
<PAGE>
To the Board of Directors and Shareholders of
Security Capital Group Incorporated:
We have reviewed the accompanying consolidated balance sheet of Security Capital
Group Incorporated and subsidiaries (see note 1) as of September 30, 1998, and
the related consolidated statements of operations for the three and nine-month
periods ended September 30, 1998 and 1997, the consolidated statement of
shareholders' equity for the nine-month period ended September 30, 1998 and the
consolidated statements of cash flows for the nine-month periods ended September
30, 1998 and 1997. These financial statements are the responsibility of the
Management of the Company. We were furnished with the reports of other
accountants on their reviews of the financial statements of Archstone
Communities Trust and Homestead Village Incorporated (September 30, 1997), whose
total assets represent 18.5% of the total assets of Security Capital Group
Incorporated and subsidiaries as of September 30, 1998, and whose income
represent 22.4% and 47.1% of the total income in the consolidated statements of
operations of Security Capital Group Incorporated and subsidiaries for the
nine-month periods ended September 30, 1998 and 1997, respectively.
We conducted our review in accordance with standards established by the American
Institute of Certified Public Accountants. A review of interim financial
information consists principally of applying analytical procedures to financial
data and making inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted in accordance
with generally accepted auditing standards, the objective of which is the
expression of an opinion regarding the financial statements taken as a whole.
Accordingly, we do not express such an opinion.
Based on our review and the reports of other accountants, we are not aware of
any material modifications that should be made to the financial statements
referred to above for them to be in conformity with generally accepted
accounting principles.
We have previously audited, in accordance with generally accepted auditing
standards, the consolidated balance sheet of Security Capital Group Incorporated
and subsidiaries as of December 31, 1997, and, in our report dated March 18,
1998, we expressed an unqualified opinion on that statement based on our audit
and reports of other auditors. In our opinion, the information set forth in the
accompanying consolidated balance sheet as of December 31, 1997, is fairly
stated, in all material respects, in relation to the balance sheet from which it
has been derived.
ARTHUR ANDERSEN LLP
Chicago, Illinois
November 12, 1998
21
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion should be read in conjunction with Security Capital's
consolidated financial statements and the notes thereto in Item 1 of this
report. See Security Capital's 1997 Form 10-K for a discussion of various risk
factors associated with forward looking statements made in this document.
Overview
Security Capital is a real estate research, investment and operating management
company. Security Capital obtains income from five sources: (1) the Capital
Division's share of earnings from its investees; (2) Global Capital Management
Group revenues; (3) Global Capital Markets Group revenues; (4) Corporate
Services revenues for information technology, accounting and administrative
services; and (5) Real Estate Research Group revenues. Revenues from the Global
Capital Management Group, the Global Capital Markets Group, the Corporate
Services Group and the Real Estate Research Group are all included in the
Financial Services Division and are only reflected in Security Capital's
consolidated financial statements if they were earned from investees not
consolidated in the financial statements. Financial Services Division revenues
earned from consolidated investees (Homestead, Security Capital U.S. Real Estate
Shares, Security Capital European Real Estate Shares and Security Capital Real
Estate Arbitrage Shares) are eliminated in Security Capital's consolidated
financial statements.
Results of Operations
Three and Nine Months Ended September 30, 1998 Compared to the Three and Nine
Months Ended September 30, 1997
Sale of REIT and Property Managers
Prior to September 1997, certain Security Capital Financial Services Division
subsidiaries managed the operations (REIT Managers) of and provided property
management services (Property Managers) to various REITs (PROLOGIS, ARCHSTONE
and ATLANTIC) in which the Capital Division was a significant owner. Effective
September 9, 1997, Security Capital exchanged the REIT and Property Managers for
additional shares of PROLOGIS (3,692,024 shares), ARCHSTONE (3,295,533 shares)
and ATLANTIC (2,306,591 shares).
ARCHSTONE and ATLANTIC Merger
In July 1998 ARCHSTONE and ATLANTIC consummated their merger. Pursuant to the
merger transaction, ATLANTIC was merged into ARCHSTONE, which continues its
existence under the name "Archstone Communities Trust" and is traded on the NYSE
under the symbol "ASN". In accordance with the terms of the merger, each
outstanding ATLANTIC common share was converted into one ARCHSTONE common share
and each outstanding ATLANTIC Series A preferred share was converted into one
comparable ARCHSTONE Series C preferred share. As of September 30, 1998,
Security Capital owned approximately 38.1% of ARCHSTONE's common shares and
continues to be ARCHSTONE's largest shareholder.
22
<PAGE>
Capital Division Investments
Dividends Received
Security Capital's dividends received increased from $29.9 million to $37.2
million, a 24% increase for the three months ended September 30, 1998, compared
to the same period in 1997 and increased from $90.1 million to $113.4 million, a
26% increase for the nine months ended September 30, 1998, compared to the same
period in 1997. The increase results primarily from (a) the purchase of
additional shares in PROLOGIS and SC-US; (b) additional shares received from
PROLOGIS, ARCHSTONE and ATLANTIC in the internalization of their managements in
September 1997; (c) additional investments in SC-PG and (d) increases in the per
share dividend rates of most of its investees (see "dividends per investee
share" chart in Note 2 to the consolidated financial statements).
Equity in Earnings of Investees
Security Capital includes in its earnings its share of the earnings of its
unconsolidated investees. SC-USREALTY, SC-US, SC-E and SC-ARBITRAGE, in
accordance with generally accepted accounting principles, include unrealized
gains or losses on their investments in their earnings. This component of
earnings or loss fluctuates with changes in the prevailing market prices for the
shares of the real estate companies in which they invest. The fluctuation in
market prices does not have an impact on cash flow, but the general decline in
real estate equity security prices during 1998 has had a significant adverse
impact on Security Capital's equity in earnings of these investees.
Presented below is Security Capital's equity in earnings (loss) of affiliates
for the three and nine months ended September 30, 1998 and 1997, and Security
Capital's common share ownership interest in affiliates as of September 30, 1998
and 1997 ($'s in millions):
<TABLE>
<CAPTION>
Equity in Earnings (Loss) % Ownership
------------------------------------------------- -----------------------
Three Months Ended Nine Months Ended
September 30, September 30, September 30,
----------------------- ----------------------- -----------------------
1998 1997 1998 1997 1998 1997
---------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
PROLOGIS $ (3.6) $ (24.2) $ 17.7 $ (6.5) 40.5% 43.0%
ARCHSTONE 16.3 (7.9) 51.7 29.4 38.1% 33.2%
SC-USREALTY (109.4) 55.7 (163.3) 90.8 34.5% 31.3%
SC-ER 0.6 -- (0.8) -- 34.6% --
SHC (3.3) (1.4) (2.4) (1.4) 30.4% 49.4%
SC-PG (4.6) 4.8 (4.0) 4.8 10.7% 12.0%
---------- ---------- ---------- ----------
$ (104.0) $ 27.0 $ (101.1) $ 117.1
========== ========== ========== ==========
</TABLE>
The increase in Security Capital's equity in PROLOGIS' earnings for the three
and nine months ended September 30, 1998, is primarily due the one-time non-cash
expense of $75.4 million, in September 1997, related to PROLOGIS' acquisition of
its REIT and property management companies from Security Capital; partially
offset by interest rate hedge expense, increases in depreciation expense,
preferred share dividends and increased weighted average common shares
outstanding in 1998. Additionally there was an increased number of distribution
properties in operation in 1998 as compared to 1997 and increased rental rates
on renewal leases for previously occupied space and an overall decrease in
operating and general and administrative expenses.
The increase in Security Capital's equity in ARCHSTONE's earnings, for the three
and nine months ended September 30, 1998, compared to the same periods in 1997,
23
<PAGE>
is primarily due to a one-time non-cash expense of $71.7 million, in September
1997, related to ARCHSTONE's acquisition of its REIT and property management
companies from Security Capital, the merger of ATLANTIC into ARCHSTONE in July
1998, and for the three months ended September 30, 1998, an increase in gains on
dispositions of real estate.
The decrease in Security Capital's share of SC-USREALTY's earnings for the three
and nine months ended September 30, 1998, compared to the same periods in 1997,
is primarily due to a decrease in unrealized appreciation of investments ($388.1
million for the third quarter and $601.0 million for the first nine months of
1998) due to the decline in the market value of REIT stocks generally, including
those owned by SC-USREALTY. SC-USREALTY's realized gains on its non-strategic
real estate portfolio investments decreased by $6.6 million for the third
quarter of 1998 and increased by $10.3 million for the first nine months of 1998
compared to the same periods in 1997. SC-USREALTY's net investment income
(defined as dividends and other investment income net of administrative
expenses, advisor fees, taxes and interest) increased by $3.0 million for the
quarter and $17.8 million for the first nine months of 1998 as compared to the
same periods in 1997.
The decline in the real estate equity markets in 1998 may impact the ability of
operating affiliates of Security Capital to access the equity and debt markets,
which could adversely impact their ability to maintain their historical growth
rates. However, this should be partially mitigated by the affiliates' ability to
maximize the performance of their portfolio of operating properties.
Room Revenue and Rental Expenses from Homestead
Homestead's room revenue increased from $15.9 million to $39.7 million, a 150%
increase for the three months ended September 30, 1998, compared to the same
period in 1997 and increased from $40.4 million to $101.0 million, a 150%
increase for the nine months ended September 30, 1998, compared to the same
period in 1997. Homestead's rental expenses increased from $7.0 million to $17.2
million, a 146% increase for the three months ended September 30, 1998, compared
to the same period in 1997 and increased from $17.4 million to $43.5 million, a
150% increase for the nine months ended September 30, 1998, compared to the same
period in 1997. Homestead's 61 property openings from the end of the third
quarter of 1997 through the end of the third quarter of 1998 was the primary
reason for both the increase in room revenue and rental expenses. The slight
decrease in property operating income margin to 57.0% is due to the lease up
phase associated with property openings.
24
<PAGE>
Financial Services Division Revenues
The components of Financial Services Division revenues were as follows (in
millions):
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------- -------------------------
1998 1997 1998 1997
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Global Capital Management $ 13.4 $ 7.4 $ 35.0 $ 18.0
Global Capital Markets 5.2 5.1 26.3 7.7
Corporate Services 4.9 1.7 12.8 2.5
REIT and property management fees -- 18.4 -- 63.2
Real Estate Research 0.4 0.1 0.9 0.3
----------- ----------- ----------- -----------
Total Financial Services Division revenues 23.9 32.7 75.0 91.7
Less amounts eliminated in consolidation (1.5) (1.0) (4.3) (2.0)
----------- ----------- ----------- -----------
Consolidated Financial Services
Division revenues $ 22.4 $ 31.7 $ 70.7 $ 89.7
=========== =========== =========== ===========
</TABLE>
The decrease in Financial Services Division revenues for the three and nine
months ended September 30, 1998, compared to the same periods in 1997 was
primarily attributable to the September 9, 1997, sale of the PROLOGIS, ATLANTIC
and ARCHSTONE REIT Managers and Property Managers substantially offset by: (i)
the growth in assets managed by Global Capital Management (shown in the
following table), which generated increased advisory and management fees; (ii)
an increase in corporate services and real estate research services revenue; and
(iii) for the nine months ended September 30, 1998, as compared to the same
period in 1997, an increase in global capital markets fees generated by
transactions related to new affiliates.
The following table reflects the assets under management by the Global Capital
Management Group as of September 30, 1998 and 1997 (in millions):
<TABLE>
<CAPTION>
September 30,
---------------------------
1998 1997
------------- --------------
<S> <C> <C>
SC-USREALTY $ 2,922 $ 2,466
SC-ER 1,014 --
SC-PG 736 139
Investment Funds 142 133
------------- --------------
$ 4,814 $ 2,738
============= ==============
</TABLE>
Growth in Financial Services Division revenues is expected to come primarily
from management and advisory revenues earned by the Global Capital Management
Group and fees earned by the Corporate Services Group and the Real Estate
Research Group. The decline in real estate security stock prices may make it
more difficult to attract assets to the company's investment funds and investees
which could, in turn, impact future revenue growth for the Global Capital
Management Group or the Global Capital Markets Group. Additionally, the decline
in real estate securities prices has reduced the value of assets under
management in closed-end managed entities, thereby decreasing fee income to
Security Capital for managing such entities. Any reduced growth could be
partially offset by increases in other Financial Services revenues as Security
Capital continues to expand in this area, although no assurance of this growth
can be given.
25
<PAGE>
Realized capital gains (losses)
Realized capital gains decreased from net capital gains of $1.2 million to net
capital losses of $13.9 million ($14.6 million adjusted for reclassification and
minority interest) for the three months ended September 30, 1998, compared to
the same period in 1997 and decreased from net capital gains of $1.2 million to
net capital losses of $11.4 million for the nine months ended September 30,
1998, compared to the same period in 1997. This decrease is due to the decrease
in the market value of SC-US's, SC-ARBITRAGE's and SC-E's investments.
Increase (decrease) in Market Value of investments
Market value of investments decreased from an increase of $15.4 million to a
decrease of $8.0 million for the three months ended September 30, 1998, compared
to the same period in 1997 and decreased from an increase of $18.7 million to a
decrease of $17.4 million for the nine months ended September 30, 1998 compared
to the same period in 1997. This decrease is due to the decrease in the market
value of SC-US's, SC-ARBITRAGE's and SC-E's investments.
At September 30, 1998, SC-US had investments at cost and fair market value of
approximately $108.7 million and $105.5 million, respectively. At September 30,
1998, SC-ARBITRAGE had investments at cost and fair market value of
approximately $21.9 million and $21.1 million, respectively. At September 30,
1998, SC-E had investments at cost and fair market value of approximately $21.7
million and $20.9 million, respectively.
Other Income, net
Other income increased from $1.9 million to $7.6 million for the three months
ended September 30, 1998, compared to the same period in 1997 and increased from
$4.8 million to $18.0 million for the nine months ended September 30, 1998,
compared to the same period in 1997. The increase is primarily due to interest
income on SHC debentures and additional dividend income earned by the investment
funds.
Financial Services Division Expenses
Financial Services Division expenses decreased from $27.1 million to $18.8
million, a 31% decrease for the three months ended September 30, 1998, compared
to the same period in 1997, and decreased from $83.2 million to $50.5 million, a
39% decrease for the nine months ended September 30, 1998, compared to the same
period in 1997. These decreases primarily resulted from the sale of the REIT and
property management companies which incurred $20.4 million and $59.7 million of
expenses for the three and nine months ended September 30, 1997, respectively.
This decrease was partially offset by increased personnel expenses related to
the Financial Services Division activity.
General, Administrative and Other
General, administrative and other expenses increased from $10.2 million to $14.2
million, a 39% increase for the three months ended September 30, 1998, compared
to the same period in 1997, and increased from $33.8 million to $40.9 million, a
21% increase for the nine months ended September 30, 1998, compared to the same
period in 1997. These increases result primarily from additional personnel and
related costs.
26
<PAGE>
Interest Expense
Interest expense for the three months ended September 30, 1998 and 1997, is
summarized as follows (in millions):
<TABLE>
<CAPTION>
Security Capital Homestead Total
-------------------- -------------------- --------------------
1998 1997 1998 1997 1998 1997
--------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
Convertible debentures $ 5.2 $ 28.2 $ -- $ -- $ 5.2 $ 28.2
Lines of credit 3.5 3.2 4.9 -- 8.4 3.2
Senior unsecured notes 9.1 -- -- -- 9.1 --
Mortgage notes payable -- -- 8.3 7.1 8.3 7.1
Capitalized interest (0.5) -- (6.6) (7.1) (7.1) (7.1)
--------- --------- --------- --------- --------- ---------
Total $ 17.3 $ 31.4 $ 6.6 $ -- $ 23.9 $ 31.4
========= ========= ========= ========= ========= =========
</TABLE>
Interest expense for the nine months ended September 30, 1998 and 1997, is
summarized as follows (in millions):
<TABLE>
<CAPTION>
Security Capital Homestead Total
-------------------- -------------------- --------------------
1998 1997 1998 1997 1998 1997
--------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
Convertible debentures $ 15.7 $ 82.9 $ -- $ -- $ 15.7 $ 82.9
Lines of credit 15.6 5.8 9.7 -- 25.3 5.8
Senior unsecured notes 9.9 -- -- -- 9.9 --
Mortgage notes payable -- -- 24.3 59.6 24.3 59.6
Capitalized interest (0.9) -- (20.3) (59.6) (21.2) (59.6)
--------- --------- --------- --------- --------- ---------
Total $ 40.3 $ 88.7 $ 13.7 $ -- $ 54.0 $ 88.7
========= ========= ========= ========= ========= =========
</TABLE>
Interest expense on the Convertible Debentures decreased primarily due to the
conversion of $715.8 million principal amount of 2014 Convertible Debentures to
Class A Common Shares in the fourth quarter of 1997.
The increase in Security Capital's line of credit interest expense is primarily
due to increased weighted average borrowings, partially offset by decreased
average interest rates.
Depreciation and Amortization
Depreciation and amortization increased from $4.5 million to $9.2 million, a
104% increase for the three months ended September 30, 1998, compared to the
same period in 1997, and increased from $10.6 million to $24.1 million, a 127%
increase for the nine months ended September 30, 1998, compared to the same
period in 1997. These increases primarily resulted from additional Homestead
property openings, partially offset by decreased Financial Services Division
depreciation due to the sale of the REIT and property management companies.
Provision for Income Taxes
The effective tax rates for the three and nine month periods ending September
30, 1998, were less than 35%. This reduced rate reflects the impact of the
unbenefited net deferred tax assets in consolidated subsidiaries partially
offset by a substantially lower tax rate on revenue generated in a foreign
jurisdiction in which Security Capital is essentially permanently invested. The
27
<PAGE>
effective tax rates for the three and nine month ending September 30, 1997, were
greater than 35% primarily due to the value ($49.9 million) assigned to the
nondeductible Class B warrants issued to the ARCHSTONE and PROLOGIS
shareholders, the effects of deconsolidating ATLANTIC, and the impact of the net
deferred tax assets in consolidated subsidiaries.
Preferred Share Dividends
Preferred Share dividends increased from $2.6 million to $4.5 million, a 73%
increase for the three months ended September 30, 1998, compared to the same
period in 1997. This increase is due to the exchange of Series A Preferred
Shares and certain Class B Common Shares for new Series B Preferred Shares in
May 1998. See Note 5 to the Consolidated Financial Statements for further
discussion. Preferred Share dividends increased from $7.8 million to $30.6
million for the nine months ended September 30, 1998, compared to the same
period in 1997 due to the exchange plus a non-cash dividend of $19.8 million in
May 1998 as described in Note 5 to the Consolidated Financial Statements.
Extraordinary item
The extraordinary loss on the early extinguishment of debt, net of minority
interest, in the amount of $17.7 million for the three and nine months ended
September 30, 1998, relates to the mortgage loan purchase agreement entered into
by Homestead with ATLANTIC and Merrill Lynch Mortgage Capital Inc. (MLMC). See
the description of this transaction in Mortgage Notes Payable under Liquidity
and Capital Resources.
Liquidity and Capital Resources
Overview
Security Capital's investment activities consist primarily of investments in the
common shares of its Capital Division investees and research and capital
expenditures relating to expansion of its Financial Services Division business.
The investment activities of Security Capital's investee operating companies
consist primarily of the acquisition and development of real estate, or
strategic ownership positions in companies which conduct such activities. Other
affiliates make portfolio investments in the securities of publicly traded real
estate companies and/or intermediate-term investments primarily in the
convertible securities of publicly-traded real estate operating companies.
Security Capital has historically financed its investment activities through the
sale of stock and convertible securities, borrowings under lines of credit and,
in June 1998, issuance of unsecured long-term debt.
Operating Activities
Cash provided by operating activities increased by $66.7 million during the
first nine months of 1998 as compared to the first nine months of 1997. This
increase is primarily due to a $29.6 million increase in distributions from
unconsolidated investees to $107.7 million for the nine months ended September
30, 1998. The $37.1 million increase in net non-cash adjustments related to
equity in earnings of unconsolidated investees, provision for deferred taxes,
the change in unrealized appreciation on investments, depreciation and
amortization and the gain on sale of management companies in the third quarter
of 1997.
28
<PAGE>
Investing and Financing Activities
Security Capital's investing activities used approximately $614.4 million of
cash, and Homestead's used $393.2 million, for the nine months ended September
30, 1998, as compared to $405.0 million and $255.1 million, respectively, for
the nine months ended September 30, 1997. Security Capital's investing
activities during the nine months ended September 30, 1998, primarily consisted
of: (i) $336.3 million investment by Security Capital in common shares of SC-ER;
(ii) $175 million investment by Security Capital in securities of SHC; (iii)
$66.5 million investment in securities of various other affiliates, including
SC-USREALTY, SC-PG and others; and (iv) $36.6 million investment by Security
Capital in securities of publicly traded real estate securities. Security
Capital's investing activities during the nine months ended September 30, 1997,
consisted primarily of: (i) $303.5 million investment by Security Capital in
securities of various affiliates, and (ii) $101.5 million investment by Security
Capital in securities of other publicly traded real estate securities.
Security Capital's financing activities provided net cash flow of $905.9 million
for the nine months ended September 30, 1998, as compared to $933.9 million for
the nine months ended September 30, 1997. Security Capital's financing
activities in the first nine months of 1998 primarily consisted of: (i) net
proceeds from the lines of credit borrowings of $385.3 million; (ii) net
proceeds from the issuance of senior unsecured notes of $499.6 million and (iii)
proceeds from the sale of common stock to minority interest holders (Homestead)
of $32.2 million. Security Capital's financing activities in the first nine
months of 1997 primarily consisted of: (i) $691.6 million of net proceeds from
the issuance of common shares; (ii) $98.7 million of net proceeds from the
issuance of convertible debt; and (iii) $158.3 million of proceeds from the
issuance of mortgage notes payable by Homestead.
Security Capital has committed, through June 30, 1999, to purchase up to $200
million of subordinated convertible debentures of Homestead. In addition,
Security Capital and its affiliates have committed to $518 million in equity
subscriptions to SC-ER, of which $336.9 million has been funded as of September
30, 1998.
Based on Security Capital's current level of operations and anticipated growth
as a result of pending new business initiatives, Security Capital expects that
cash flows from operations (including dividends and fees received from its
operating companies) and funds currently available under its revolving line of
credit will be sufficient to enable Security Capital to satisfy its anticipated
cash requirements for operations and committed investments during 1998 and 1999.
In the longer term, Security Capital intends to finance its business activities
(including investments in new business initiatives and additional investments in
existing affiliates) through its line of credit and future issuances of equity
and debt securities. In September 1998 Security Capital filed a $1 billion shelf
registration statement with the Securities and Exchange Commission, which can be
issued as equity or debt as needed by Security Capital. In addition, Security
Capital anticipates that its operating affiliates will separately finance their
activities through cash flow from operations, sales of equity and debt
securities and the incurrence of mortgage debt or line of credit borrowings.
Security Capital does not guarantee the obligations of its operating affiliates.
Security Capital's consolidated investee had the following financing activities:
o In January 1998, Homestead completed a rights offering of common shares,
realizing $154.2 million of net proceeds.
29
<PAGE>
o Other resources to fund Homestead's development program consist of its
remaining capacity on its revolving line of credit facilities and to a
lesser extent, cash from operations in excess of operating needs.
o Also see "Lines of Credit - Homestead," below.
Lines of Credit
Security Capital
Security Capital has a $650 million revolving line of credit with Wells Fargo,
as agent for a syndicate of lenders. The line was increased from $400 million to
$700 million on April 6, 1998, and then on June 5, 1998, the line became
unsecured and was reduced to $650 million. The agreement is effective through
April 6, 2000, with an option to renew for successive one-year periods with the
approval of Wells Fargo and participating lenders. Borrowings bear interest at
the LIBOR rate plus 1%. Commitment fees range from 0.125% to 0.20% per annum
depending on the average unfunded line of credit balance. The line of credit is
guaranteed by SC Realty which is a wholly owned subsidiary of Security Capital.
The line of credit contains various financial and other covenants applicable to
Security Capital, including a minimum shareholders' equity test, a total
liabilities-to-net-worth ratio, a cash flow/fixed charge coverage ratio, a
secured debt limit, an unsecured liabilities to unencumbered pool value ratio,
as well as restrictions on Security Capital's ability to incur indebtedness and
effect consolidations, mergers (other than a consolidation or merger in which
Security Capital is the surviving entity) and sales of assets. The agreement
provides that so long as no event of default has occurred and is continuing,
Security Capital may pay cash dividends in an aggregate amount not to exceed 50%
of cash flow available for distribution and pay cash dividends to the holders of
the Series B Preferred Shares. As of September 30, 1998, there was $265.5
million outstanding under this line of credit and Security Capital and SC Realty
were in compliance with all financial covenants.
Homestead
Homestead's secured revolving line of credit facility with Commerzbank AG
("CAG") was renewed on April 24, 1998, for a one-year term, with an increase in
total borrowing capacity to $150 million, subject to collateral requirements.
Borrowings bear interest at the Eurodollar rate plus 1.5% to 2.5% per annum,
depending upon the percentage leverage of borrowings outstanding to the amount
of qualifying collateral. Alternatively, borrowings bear interest at a base rate
defined as the higher of prime rate plus a margin of 0.5% to 1.5% or the Federal
Funds rate plus a margin of 1% to 2%, with the margin dependent on the
percentage leverage of borrowings outstanding to the amount of qualifying
collateral. Additionally, the line calls for a commitment fee of 0.375% of the
average unfunded balance. The line requires maintenance of certain financial
covenants, specifically, aggregate indebtedness of no more than 55% of gross
asset value, as defined, or indebtedness secured by a lien of no more than 50%
of gross asset value, as defined. Homestead must also maintain a minimum debt
service coverage ratio of earnings before interest, income taxes, depreciation,
amortization and gains or losses on sales of assets to cash debt service, as
defined, of no less than 1.1 to 1 for the first quarter of 1998, no less than
1.25 to 1 for the second quarter of 1998, no less than 1.4 to 1 for the third
and fourth quarters of 1998, no less than 1.5 to 1 for the first quarter of 1999
and no less than 1.75 to 1 thereafter on a quarterly basis, and not allow
stockholders equity to be less than $325 million. The covenants also restrict
payment of dividends without lender approval. As of September 30, 1998,
Homestead was in compliance with all such covenants.
30
<PAGE>
On April 24, 1998, Homestead also entered into a separate $50 million one-year
revolving line of credit facility with CAG. These borrowings are subject to
collateral requirements. Borrowings will bear interest at the Eurodollar rate
plus 2.75% per annum or, alternatively, at a base rate defined as the higher of
prime rate plus 1.75% or the federal funds rate plus 2.25%. Average unfunded
balances bear a commitment fee of 0.5%. Covenants are identical to those under
the $150 million credit facility.
On June 15, 1998, Homestead entered into an additional $200 million line of
credit facility with CAG which bears interest at the Eurodollar rate plus 1%
(1.25% after six months) or at a base rate of prime (prime plus 0.25% after six
months). The average unfunded balance bears a commitment fee of 0.25%. The line
expires February 23, 1999, and is secured by a subscription receivable from
Security Capital for $200 million of convertible subordinated debentures. If the
subscription is called, the proceeds must be used to first repay the lines of
credit to CAG and second to fund projects under development which secure the
other CAG credit facilities. The subscription agreement expires June 30, 1999,
or 2 weeks after termination of the $200 million credit agreement. The
subscription obligation will be reduced or terminated to the extent Homestead
issues equity securities to any third party, or to Security Capital pursuant to
a separate offering, before June 30, 1999, and uses the proceeds to repay this
credit facility and uses any remaining proceeds to fund projects under
development which secure the other CAG credit facilities.
Homestead is exploring the possible sale of properties in certain non-strategic
markets. The proceeds of such a sale would be used to pay down existing debt. No
assurance can be given that such a sale will occur.
Capital resources in addition to those described above will be needed to fund
future land acquisitions and developments and to repay or refinance existing
debt upon maturity. Homestead may seek additional credit facilities and may seek
to issue additional debt or equity securities. Presently, Homestead is exploring
possible extensions of its bank lines of credit and is exploring alternatives to
refinancing the mortgage note to MLMC. Homestead has also filed a shelf
registration statement and is researching various financing alternatives
utilizing securities which could be issued under the shelf, once the shelf
registration is declared effective. However, there is no assurance that
Homestead will be able to obtain such financing as and when required or on
acceptable terms. As a result of the reorganization expenses Homestead
anticipates, it will not meet its bank lines of credit debt service coverage
ratio covenant for the fourth quarter of 1998. Homestead has initiated
discussions with the banks to seek a waiver of this covenant for the fourth
quarter of 1998.
As of September 30, 1998, Homestead had approximately $636 million of
indebtedness outstanding and expects to utilize an additional approximate $86
million of its lines of credit to fund developments in process. Approximately
$200 million of this indebtedness matures in the first quarter of 1999, and
approximately $300 million matures in the second quarter of 1999. Homestead is
in discussion with its lenders and other parties regarding the refinancing of
its indebtedness maturing next year and will seek to refinance or extend all of
this indebtedness. Homestead is also exploring other means to obtain financing
to replace existing idebtedness and to find additional development.
Senior Unsecured Notes
On June 23, 1998, Security Capital issued $500 million of Senior Unsecured Notes
in three tranches: (i) 6.95% notes, with an original principal amount of $200
million, net of original issue discount, due June 15, 2005; (ii) 7.15% notes,
with an original principal amount of $100 million, net of original issue
discount, due June 15, 2007; and (iii) 7.70% notes, with an original principal
amount of $200 million, due June 15, 2028. Interest is payable on all notes on
June 15 and December 15 of each year, commencing December 15, 1998. Such notes
were exchanged for identical registered securities on September 4, 1998.
All of the foregoing Senior Unsecured Notes are redeemable at any time at the
option of Security Capital, in whole or in part, at a redemption price equal to
the sum of the principal amount of the Senior Unsecured Notes being redeemed
plus accrued interest thereon to the redemption date plus an adjustment, if any,
based on the yield to maturity relative to market yields available at
redemption.
Under the terms of the Indenture, Security Capital can incur additional debt
only if, after giving effect to the debt being incurred, (i) the ratio of debt
to adjusted total assets, as defined, does not exceed 50%, and (ii) the fixed
charge coverage ratio, as defined, for the four preceding fiscal quarters is not
less than 1.5 to 1.0. In addition Security Capital will not at any time permit
its consolidated tangible net worth, as defined, to be less than $1.5 billion.
At September 30, 1998, Security Capital was in compliance with all debt
covenants relating to the Notes.
31
<PAGE>
Derivative Financial Instruments
Security Capital utilizes derivative instruments in anticipation of future
financing transactions in order to manage well-defined interest rate risk.
Through hedging, Security Capital believes it can effectively manage the risk of
increases in interest rates on future debt issuances. In May 1998, in
anticipation of the June 1998 $500 million debt offering, Security Capital
entered into three forward treasury lock transactions with a total notional
amount of $375 million. Upon the closing of the debt offering, these contracts
were terminated on June 18, 1998, resulting in losses totaling $9.5 million.
Such loss will be amortized and included as a component of interest expense over
the term of the related notes. As of September 30, 1998, the Company had no
interest rate hedging contracts outstanding.
Mortgage Notes Payable
Homestead has $221.3 million of convertible mortgage notes which are
convertible, at the option of ARCHSTONE, into shares of Homestead common stock.
The conversion price is equal to one share of Homestead common stock for every
$11.50 of principal amount outstanding.
On July 6, 1998, Homestead entered into a mortgage loan purchase agreement with
ARCHSTONE (through its merger with ATLANTIC) and MLMC whereby $98 million of
Homestead convertible mortgage notes that were held by ARCHSTONE were modified
to, among other things, eliminate their convertibility feature in exchange for a
payment of $21.4 million from Homestead to ARCHSTONE. The amount paid to
ARCHSTONE was based on trailing market prices of Homestead common stock at the
time the agreement was entered into, which exceeded the conversion price of the
mortgage at that date. Homestead funded the payment with the proceeds received
from the sale of $24 million of 7.5% convertible subordinated debentures. Also
pursuant to the mortgage loan purchase agreement ARCHSTONE sold such modified
notes to MLMC for $98 million. On August 7, 1998, Homestead converted the $98
million of mortgage notes and the $24 million of 7.5% convertible subordinated
debentures into a $122 million mortgage of a newly formed special purpose
subsidiary of Homestead. The note is collateralized by 26 Homestead properties
(totaling $227.0 million of historical cost at September 30, 1998) which were
formerly collateral for the ARCHSTONE mortgage notes. The $122 million mortgage
note matures June 30, 1999 (subject to extension by the holder of the mortgage
notes), and provides for interest-only monthly payments of LIBOR plus 1.70%
through September 30, 1998, LIBOR plus 2.0% through November 30, 1998, and LIBOR
plus 2.25% thereafter, with options to extend.
The transaction resulted in an early extinguishment of debt measured as the
difference between the $98.0 million carrying amount of the original mortgage
notes to ARCHSTONE and the amount paid to extinguish the debt, including
transaction costs. Such loss on extinguishment of debt and transaction costs
amounted to $25.3 million and was recorded as an extraordinary item in third
quarter of 1998.
2016 Convertible Debentures
At September 30, 1998, Security Capital had approximately $322.8 million
principal amount of 2016 Convertible Debentures outstanding. The 2016
Convertible Debentures accrue interest at an annual rate of 6.5% and require
semi-annual cash interest payments. The principal amount of the 2016 Convertible
Debentures are convertible into Class A Common Shares at $1,153.90 per share
(compared to a September 30, 1998, NYSE closing price of $910 per share) at the
option of the holder. The 2016 Convertible Debentures became convertible on
September 18, 1998. Security Capital may redeem the 2016 Convertible Debentures
at any time after March 29, 1999, in whole or in part, at par plus accrued and
unpaid interest to the date of redemption.
32
<PAGE>
Year 2000 Issue
The "Year 2000 Issue" has arisen because many existing computer programs and
chip-based embedded technology systems use only the last two digits to refer to
a year, and therefore do not properly recognize a year that begins with "20"
instead of the familiar "19." If not corrected, many computer applications could
fail or create erroneous results. The following disclosure provides information
regarding the current status of Security Capital's Year 2000 compliance program.
Security Capital has been working on the Year 2000 issue since July 1997.
Security Capital and most of its affiliates have had action programs since that
time to certify or replace all technology systems that might be affected,
including "embedded" systems such as elevators and HVAC equipment. As of October
30, 1998, Security Capital has either certified, replaced or expects to replace
by yearend substantially all of its critical systems with Year 2000 compliant
systems. The remaining systems are expected to be upgraded or replaced by June
1999. Among Security Capital's affiliates three have certified all of their
systems; the other affiliates are in various stages of conversion to Year 2000
compliant systems. The latest expected date for full compliance is July 1999.
Security Capital, as a real estate research, investment and operating management
company, believes that it has relatively modest potential exposure to Year 2000
issues. Security Capital intends to focus its efforts to ensure that none of
its affiliates will encounter Year 2000 issues, including providing direct and
indirect assistance to those companies.
The majority of the operating and financial management functions of the
affiliated operating companies supported by computer systems are billing tenants
and leasing space. Neither of these functions is likely in the worst case
scenarios to represent a serious financial impact since they could be manually
corrected or circumvented without significant revenue loss to the affiliated
operating companies.
Exposure to embedded system problems in elevators, HVAC, access control and
refrigeration systems for affiliated operating companies is expected to be
minimal. Most of these systems are no more than 6 years old and partially
completed surveys conducted by affiliates show that these systems are already
compliant or can be readily upgraded to Year 2000 compliant versions. Most of
the potential costs for determining compliance of embedded systems is due to the
internal and external staffing costs to identify, survey and test each system.
Assessing suppliers' readiness for Year 2000 has not been completed. Security
Capital and its affiliates have numerous properties throughout the United States
and in Europe and Mexico serviced by many generic service providers such as
utilities and telecommunications. In general, tenants have individual contracts
for generic services, so Security Capital's affiliates exposure is generally
limited to "common area" facilities. Security Capital and its affiliates have
little influence over utility providers and local exchange carriers; however,
Security Capital expects little potential risk in this highly scrutinized area.
Specialty (as opposed to commodity) services providers such as banks and benefit
administration companies have responded to surveys stating that they expect to
be Year 2000 compliant early in 1999. Security Capital and its affiliates will
perform tests of these systems during the first half of 1999 but expect no major
problem or exposure from any of the specialty service providers. There are no
commodity or specialty services provided to Security Capital or its affiliates
that are believed to represent a material risk or result in a material adverse
financial impact in the most likely worst case scenario.
33
<PAGE>
All of the major systems used by Security Capital are either Year 2000
compliant, specifically the corporate accounting, mutual fund management and
cash management systems, or will be converted to Year 2000 compliant ready
systems by the end of 1998, specifically the payroll system. Security Capital is
a tenant in a number of office buildings in the United States and Europe.
Landlord and supplier surveys for those buildings are not yet complete, but no
material impact is expected to be caused by building related problems.
Third party costs to address Year 2000 issues have been less than $50,000 to
date and are not expected to exceed $250,000 in any likely worst case scenario.
Security Captial does not separately track the internal costs incurred for Year
2000 compliance issues. Such costs are principally the related payroll costs of
its information technology group. Security Capital's investment in new
accounting, payroll and cash management systems is due to rapid growth over the
last five years and a desire to automate a greater number of processes, and is
not attributable to Year 2000 issues. However, in considering and implementing
these new systems, Security Capital believes it took all appropriate steps to
ensure that these new systems are Year 2000 compliant.
Contingency plans to deal with unexpected and undetected problems caused by Year
2000 are focused on manual correction and rework. No material revenue loss is
expected to be caused by late billings or accounting entries.
Potential liabilities to third parties would be limited to private and public
investors, because Security Capital is not providing management or operating
real estate. There is no "reasonably likely worst case" known or apparent to
Security Capital that would result in a material liability to a third party. The
risk of increased cost or lost revenue in the event of the most reasonably
likely worst case scenario is not expected to be material in any series of
events or potential problems caused by the Year 2000, either for Security
Capital directly or to any of its affiliated companies.
There can be no assurance that Year 2000 remediation by Security Capital and its
affiliates or third parties will be properly and timely completed and failure to
do so could have a material adverse effect on Security Capital, its business and
its financial condition. Security Capital cannot predict the actual effects to
it of the Year 2000 issue, which depends on numerous uncertainties, many of
which are outside its control, such as (i) whether significant third parties,
such as banks and utilities, properly and timely address the Year 2000 issue and
(ii) whether broad-based or systematic economic failures may occur. Security
Capital will continue to monitor these issues through its Year 2000 compliance
program.
34
<PAGE>
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
12.1 Computation of Ratio of Earnings to Fixed Charges
12.2 Computation of Ratio of Earnings to Combined Fixed Charges
and Preferred Share Dividends
15 Letter from Arthur Andersen LLP, dated November 12, 1998,
regarding unaudited financial information
27 Financial data schedule
(b) Reports on Form 8-K
None
35
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
SECURITY CAPITAL GROUP INCORPORATED
/s/ Paul E. Szurek
---------------------------------------
Paul E. Szurek, Chief Financial Officer
(Principal Financial Officer)
/s/ James C. Swaim
--------------------------------------
James C. Swaim, Vice President
(Principal Accounting Officer)
Date: November 16, 1998
36
<PAGE>
Exhibit 12.1
SECURITY CAPITAL GROUP INCORPORATED
COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES
(DOLLAR AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
Nine Months Ended
September 30, Year Ended December 31,
--------------------- ----------------------------------------------------------
1998 1997 1997 1996 1995 (1) 1994 1993
--------- --------- --------- --------- --------- --------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
Net Earnings (loss) from Operations $ 61,321 $ 11,192 $ 38,241 $ (9,693) $ (21,274) $ 11,849 $ 8,333
Add:
Interest Expense 54,038 88,655 104,434 117,224 103,804 53,789 3,786
--------- --------- --------- -------- --------- --------- ---------
Earnings as Adjusted $ 115,359 $ 99,847 $ 142,675 $ 107,531 $ 82,530 $ 65,638 $ 12,119
========= ========= ========= ========= ========= ========= =========
Fixed Charges:
Interest Expense $ 54,038 $ 88,655 $ 104,434 $ 117,224 $ 103,804 $ 53,789 $ 3,786
Capitalized Interest 21,211 59,559 69,883 11,448 4,404 3,184 98
--------- --------- --------- --------- --------- --------- ---------
Total Fixed Charges $ 75,249 $ 148,214 $ 174,317 $ 128,672 $ 108,208 $ 56,973 $ 3,884
========= ========= ========= ========= ========= ========= =========
Ratio of Earnings to Fixed Charges 1.5 0.7 0.8 0.8 0.8 1.2 3.1
========= ========= ========= ========= ========= ========= =========
</TABLE>
(1) Excludes a one-time non-cash expense item ($158.4 million) incurred in
acquiring the Services Division from a related party.
37
<PAGE>
Exhibit 12.2
SECURITY CAPITAL GROUP INCORPORATED
COMPUTATION OF RATIO OF EARNINGS TO COMBINED FIXED
CHARGES AND PREFERRED SHARE DIVIDENDS
(DOLLAR AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
Nine Months Ended
September 30, Year Ended December 31,
---------------------- ---------------------------------------------------------
1998 1997 1997 1996 1995(1) 1994 1993
--------- --------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
Net Earnings (loss) from Operations $ 61,321 $ 11,192 $ 38,241 $ (9,693) $ (21,274) $ 11,849 $ 8,333
Add:
Interest Expense 54,038 88,655 104,434 117,224 103,804 53,789 3,786
--------- --------- --------- --------- --------- --------- ---------
Earnings as Adjusted $ 115,359 $ 99,847 $ 142,675 $ 107,531 $ 82,530 $ 65,638 $ 12,119
========= ========= ========= ========= ========= ========= =========
Combined Fixed Charges and
Preferred Share Dividends:
Interest Expense $ 54,038 $ 88,655 $ 104,434 $ 117,224 $ 103,804 $ 53,789 $ 3,786
Capitalized Interest 21,211 59,559 69,883 11,448 4,404 3,184 98
--------- --------- --------- --------- --------- --------- ---------
75,249 148,214 174,317 128,672 108,208 56,973 3,884
Preferred Share Dividends (2) (3) 15,848(4) 16,947 15,416 12,352 -- --
--------- --------- --------- --------- --------- --------- ---------
Combined Fixed Charges and
Preferred Share Dividends $ 91,097 $ 165,161 $ 189,733 $ 141,024 $ 108,208 $ 56,973 $ 3,884
========= ========= ========= ========= ========= ========= =========
Ratio of Earnings to Combined Fixed
Charges and Preferred Share
Dividends 1.3 0.6 0.8 0.8 0.8 1.2 3.1
========= ========= ========= ========= ========= ========= =========
</TABLE>
(1) Excludes a one-time non-cash expense item ($158.4 million) incurred in
acquiring the Services Division from a related party.
(2) The Preferred dividends have been increased to show a pretax basis.
(3) Security Capital had no preferred dividends prior to 1996.
(4) Excludes a one-time non-cash dividend of $19.8 million incurred in
conjunction with the exchange of Series A Preferred Shares for Series B
Preferred Shares.
38
<PAGE>
Exhibit 15
November 12, 1998
Board of Directors and Shareholders
of Security Capital Group Incorporated:
We are aware that Security Capital Group Incorporated has incorporated by
reference in its Registration Statement Nos. 333-38521, 333-38523, 333-38525,
333-38527, 333-38531, 333-38533, 333-38537, 333-38539, 333-48167, 333-61395,
333-61401 and 333-64979 its Form 10-Q for the quarter ended September 30, 1998,
which includes our report dated November 12, 1998 covering the unaudited interim
financial information contained therein. Pursuant to Regulation C of the
Securities Act of 1933 (the "Act"), that report is not considered a part of the
registration statements prepared or certified by our firm or a report prepared
or certified by our firm within the meaning of Sections 7 and 11 of the Act.
Very truly yours,
ARTHUR ANDERSEN LLP
39
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains sumary financial information extracted from the Form 10-Q
for the nine months ended September 30, 1998, and is qualified in its entirety
by reference to such financial statements.
</LEGEND>
<CIK> 0000923687
<NAME> SECURITY CAPITAL GROUP INCORPORATED
<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> 16,710
<SECURITIES> 148,528
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 1,145,563
<DEPRECIATION> 37,666
<TOTAL-ASSETS> 4,450,129
<CURRENT-LIABILITIES> 0
<BONDS> 1,165,749
0
257,642
<COMMON> 478
<OTHER-SE> 2,161,077
<TOTAL-LIABILITY-AND-EQUITY> 4,450,129
<SALES> 0
<TOTAL-REVENUES> 59,829
<CGS> 0
<TOTAL-COSTS> 158,888
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 54,038
<INCOME-PRETAX> (153,097)
<INCOME-TAX> (49,382)
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 17,657
<CHANGES> 0
<NET-INCOME> (153,110)
<EPS-PRIMARY> (1.26)
<EPS-DILUTED> (1.26)
</TABLE>
