Back to GetFilings.com
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-K
(MARK ONE)
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ______________ TO ______________
COMMISSION FILE NO. 1-10150
--------------------------
STARWOOD FINANCIAL INC. *
(Exact name of registrant as specified in its charter)
MARYLAND 95-6881527
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
1114 AVENUE OF THE AMERICAS, 27(TH) FLOOR 10036
NEW YORK, NY 10036 (Zip code)
(Address of principal executive offices)
Registrant's telephone number, including area code: (212)930-9400
--------------------------
Securities registered pursuant to Section 12(b) of the Act:
Title of each class: Name of Exchange on which registered:
COMMON STOCK, $0.001 PAR VALUE NEW YORK STOCK EXCHANGE
9.375% SERIES B CUMULATIVE REDEEMABLE NEW YORK STOCK EXCHANGE
PREFERRED STOCK, $0.001 PAR VALUE
9.200% SERIES C CUMULATIVE REDEEMABLE NEW YORK STOCK EXCHANGE
PREFERRED STOCK, $0.001 PAR VALUE
8.000% SERIES D CUMULATIVE REDEEMABLE NEW YORK STOCK EXCHANGE
PREFERRED STOCK, $0.001 PAR VALUE
Securities registered pursuant to Section 12(g) of the Act: NONE
Indicate by check mark whether the registrant; (i) 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 (ii) has been subject to such
filing requirements for the past 90 days. Yes /X/ No / /
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. / /
As of March 15, 2000, the aggregate market value of the common stock, $0.001
par value per share of Starwood Financial Inc. ("Common Stock") held by
non-affiliates(1) of the registrant was approximately $1,462 million, based upon
the closing price of $17.19 on the New York Stock Exchange composite tape on
such date.
As of March 15, 2000, there were 85,045,936 shares of Common Stock
outstanding.
* On November 4, 1999, the registrant completed a transaction in which its
name was changed from Starwood Financial Trust to Starwood Financial Inc., it
issued Common Stock in exchange for the class A and class B shares then
outstanding, and the registrant listed its Common Stock on the New York Stock
Exchange.
(1) For purposes of this Annual Report only, includes all outstanding Common
Stock other than Common Stock held directly by the Registrant's directors
and executive officers.
DOCUMENTS INCORPORATED BY REFERENCE
1. Portions of the registrant's definitive proxy statement for the registrant's
2000 Annual Meeting, to be filed within 120 days after the close of the
registrant's fiscal year, are incorporated by reference into Part III of
this Annual Report on Form 10-K.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
TABLE OF CONTENTS
PAGE
--------
PART I
Item 1. Business............................................ 3
Item 2. Properties.......................................... 16
Item 3. Legal Proceedings................................... 17
Item 4. Submission of Matters to a Vote of Security
Holders................................................... 17
PART II
Item 5. Market for Registrant's Equity and Related Share
Matters................................................... 18
Item 6. Selected Financial Data............................. 20
Item 7. Management's Discussion and Analysis of Financial
Condition
and Results of Operations............................. 23
Item 7a. Quantitative and Qualitative Disclosures about
Market Risk............................................... 29
Item 8. Financial Statements and Supplemental Data.......... 32
Item 9. Changes in and Disagreements with Accountants on
Accounting
and Financial Disclosure.................................... 81
PART III
Item 10. Directors and Executive Officers of the
Registrant................................................ 81
Item 11. Executive Compensation............................. 81
Item 12. Security Ownership of Certain Beneficial Owners and
Management................................................ 81
Item 13. Certain Relationships and Related Transactions..... 81
PART IV
Item 14. Exhibits, Financial Statement Schedules, and
Reports on Form 8-K....................................... 81
SIGNATURES.................................................. 84
2
PART I
ITEM 1. BUSINESS
EXPLANATORY NOTE FOR PURPOSES OF THE "SAFE HARBOR PROVISIONS" OF SECTION 21E OF
THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED
Except for historical information contained herein, this Annual Report on
Form 10-K contains forward-looking statements within the meaning of Section 21E
of the Securities Exchange Act of 1934, as amended, which involve certain risks
and uncertainties. Forward-looking statements are included with respect to,
among other things, the Company's current business plan, business strategy and
portfolio management. The Company's actual results or outcomes may differ
materially from those anticipated. Important factors that the Company believes
might cause such differences are discussed in the cautionary statements
presented under the caption "Factors That May Affect the Company's Business
Strategy" in Item 1 of this Form 10-K or otherwise accompany the forward-looking
statements contained in this Form 10-K. In assessing forward-looking statements
contained herein, readers are urged to read carefully all cautionary statements
contained in this Form 10-K.
OVERVIEW
Starwood Financial Inc. (the "Company") is the leading publicly traded
finance company focused on the commercial real estate industry. The Company,
which is taxed as a real estate investment trust, provides structured mortgage,
mezzanine and lease financing through its origination, acquisition and servicing
platform. The Company's mission is to maximize risk-adjusted returns on equity
by providing innovative and value-added financing solutions to private and
corporate owners of commercial properties in major metropolitan markets
nationwide.
The Company's primary product lines include:
- STRUCTURED FINANCE. The Company provides senior and subordinated loans
from $20 million to $100 million to borrowers controlling institutional
quality real estate. These loans may be either fixed or floating rate and
are structured to meet the specific financing needs of the borrowers,
including the acquisition, financing, repositioning or construction of
large, high-quality real estate. The Company offers borrowers a wide range
of structured finance options, including first mortgages, second
mortgages, partnership secured loans, participating debt and
interim/bridge facilities.
- PORTFOLIO FINANCE. The Company provides funding to regional and national
borrowers who own multiple properties in a geographically diverse
portfolio. Loans are cross-collateralized to give borrowers the benefit of
all available collateral and underwritten to recognize inherent portfolio
diversification. Property types include multifamily, suburban office,
all-suite, extended stay and limited service hotels and other property
types where individual property values are less than $20 million on
average. Loan terms are structured to meet the specific requirements of
the borrower and range in size from $25 million to $150 million.
- CORPORATE LENDING. The Company provides senior and subordinated debt
capital to corporations engaged in real estate or real estate-related
businesses. Loans may be either secured or unsecured and range in size
from $20 million to $100 million.
- LOAN ACQUISITION. The Company acquires whole loans and loan participations
which present attractive risk-reward opportunities. Loans are generally
acquired at a discount to the principal balance outstanding and may be
acquired with financing provided by the seller. Loan acquisitions range
from $5 million to $100 million and are collateralized by all major
property types.
- CREDIT TENANT LEASING. The Company provides capital to owners and
borrowers who control properties leased to single creditworthy tenants.
The Company's net leased facilities are generally subject to long-term
leases with rated corporate credit tenants, and provide for all expenses
at the
3
property to be paid by the tenant on a triple net lease basis. Credit
tenant transactions range in size from $20 million to $200 million.
- SERVICING. Through its Starwood Asset Services division, the Company
provides rated servicing to third-party, institutional loan portfolios, as
well as to the Company's own portfolio.
As more fully discussed in Note 4 to the Company's Consolidated Financial
Statements, the Company began its business in 1993 through private investment
funds formed to capitalize on inefficiencies in the real estate finance market.
In March 1998, these funds contributed their approximately $1.1 billion of
assets to the Company's predecessor, Starwood Financial Trust, in exchange for a
controlling interest in that company. Since that time, the Company has grown by
originating new lending and leasing transactions, as well as through corporate
acquisitions.
Specifically, in September 1998, the Company acquired the loan origination
and servicing business of a major insurance company, and in December 1998, the
Company acquired the mortgage and mezzanine loan portfolio of its largest
private competitor. Additionally, in November 1999, the Company acquired TriNet
Corporate Realty Trust, Inc., the largest publicly traded company specializing
in the net leasing of corporate office and industrial facilities. The TriNet
transaction was structured as a stock-for-stock merger of TriNet with a
subsidiary of the Company. We refer to TriNet throughout this document as the
"Leasing Subsidiary."
Concurrent with the TriNet transaction, the Company also acquired its
external advisor in exchange for shares of Common Stock and converted its
organizational form to a Maryland corporation. As part of the conversion to a
Maryland corporation, the Company replaced its dual class common share structure
with a single class of Common Stock. The Company's Common Stock began trading on
the New York Stock Exchange on November 4, 1999. Prior to this date, the
Company's common shares were traded on the American Stock Exchange.
INVESTMENT STRATEGY
The Company's investment strategy targets specific sectors of the real
estate credit markets in which it believes it can deliver value-added, flexible
financial solutions to its customers, thereby differentiating its financial
products from those offered by other capital providers.
The Company has implemented its investment strategy by:
- Focusing on the origination of large, highly structured mortgage,
mezzanine and lease financings where customers require flexible financial
solutions, and avoiding commodity businesses in which there is significant
direct competition from other providers of capital.
- Developing direct relationships with borrowers and corporate tenants as
opposed to sourcing transactions through intermediaries.
- Adding value beyond simply providing capital by offering borrowers and
corporate tenants specific lending expertise, flexibility, speed,
certainty and continuing relationships beyond the closing of a particular
financing transaction.
- Taking advantage of market anomalies in the real estate financing markets
when the Company believes credit is mispriced by other providers of
capital, such as the spread between lease yields and the yields on
corporate tenants' underlying credit obligations.
The Company intends to continue to emphasize a mix of portfolio financing
transactions to create asset diversification and single-asset financings for
properties with strong, long-term positioning. The Company's credit process will
continue to focus on:
- Building diversification by asset type, property type, obligor, loan/lease
maturity and geography.
4
- Financing high-quality commercial real estate assets in major metropolitan
markets.
- Underwriting assets using conservative assumptions regarding collateral
value and future property performance.
- Requiring adequate cash flow coverage on its investments.
- Stress testing potential investments for adverse economic and real estate
market conditions.
In June 1999, the Company announced its intention to dispose of
approximately $200 million of non-core properties held at the Leasing Subsidiary
which generally have short-term lease rollover risk or other characteristics
inconsistent with the Company's structured finance focus. Since that time, the
Leasing Subsidiary has sold or entered into agreements to sell $146.8 million of
assets.
As of December 31, 1999, based on current carrying values, the Company's
business consists of the following product lines:
PRODUCT LINE:
EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC
STRUCTRED FINANCE 27%
Portfoloio Finance 12%
Credit Tenant Lease 47%
Corporate Lending 3%
Loan Acquisitions 11%
The Company seeks to maintain an investment portfolio which is diversified
by asset type, underlying property type and geography. As of December 31, 1999,
based on current carrying values, the Company's total investment portfolio has
the following characteristics:
ASSET TYPE: PROPERTY TYPE: GEOGRAPHY:
EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC
FIRST MORTGAGES 30%
Second Mortgages 14%
Partnership/Corporate/Other 10%
Net Leases 46%
Hotel 12%
Mixed Use 5%
Office 52%
Industrial 8%
R&D 3%
Aparment/Residential 3%
Resort/Entertainment 5%
Retail 8%
Homebuilder/Land 4%
Southeast 11%
Mid-Atlantic 9%
Northeast 15%
North Central 2%
Central 7%
South 15%
Southwest 2%
West 35%
Northwest 4%
FINANCING STRATEGY
The Company has access to a wide range of debt and equity capital resources
to finance its investment and growth strategies. At December 31, 1999, the
Company had approximately $1.8 billion of tangible book equity capital and a
total market capitalization of approximately $4 billion. The Company believes
that its size, diversification, investor sponsorship and track record are
competitive advantages in obtaining attractive financing for its businesses.
5
The Company seeks to maximize risk-adjusted returns on equity and financial
flexibility by opportunistically accessing a variety of public and private debt
and equity capital sources, including:
- A match-funded, securitized debt program now in process.
- A combined $1.5 billion available under its revolving credit facilities
(both secured and unsecured).
- Long-term, unsecured corporate debt.
- Public and private common and preferred equity.
The Company's business model is premised on significantly lower leverage
than many other commercial finance companies. In this regard, the Company seeks
to:
- Target a maximum consolidated debt/book equity ratio of 1.5x to 2.0x.
- Maintain a minimum tangible equity base of $1.5 to $2.0 billion.
- Maintain conservative credit statistics.
- Match fund assets and liabilities.
A more detailed discussion of the Company's current capital resources is
provided in Item 7--"Management's Discussion and Analysis of Financial Condition
and Results of Operations--Liquidity and Capital Resources".
BUSINESS
REAL ESTATE LENDING:
The Company provides structured mortgage, mezzanine and corporate financing
to leading commercial real estate owners through its origination and acquisition
platform.
Set forth below is information regarding the Company's primary real estate
lending product lines as of December 31, 1999:
CURRENT
CARRYING PERCENTAGE
VALUE OF TOTAL
-------------- ----------
(IN THOUSANDS)
Structured finance................................... $1,016,148 50.5%
Portfolio finance.................................... 447,343 22.2%
Loan acquisition..................................... 424,880 21.2%
Corporate lending.................................... 122,635 6.1%
---------- -----
Gross carrying value............................... 2,011,006 100.0%
=====
Provision for possible credit losses............... (7,500)
----------
Total carrying value, net.......................... $2,003,506
==========
As more fully discussed in Note 3 to the Company's Consolidated Financial
Statements, the Company continually monitors borrower performance and completes
a detailed loan-by-loan formal credit review on a quarterly basis. After having
originated or acquired over $3 billion of lending transactions, neither the
Company nor its private investment fund predecessors have experienced any actual
losses on their loan investments. Further, based on current reviews of its
portfolio, management is not aware of any factors relating to specific loans
which indicate that such losses may be experienced in the forseeable future.
While no losses are currently expected, the Company has considered it
prudent to establish a policy of providing reserves for potential losses in the
current portfolio which may result in the future. Accordingly,
6
since the quarter ended June 30, 1998, management has reflected quarterly
provisions for possible credit losses in its operating results.
SUMMARY OF INTEREST CHARACTERISTICS
As more fully discussed in Item 7--"Management's Discussion and Analysis of
Financial Condition and Results of Operations--Liquidity and Capital Resources"
as well as "--Interest Rate Risks", the Company utilizes certain interest rate
risk management techniques, including both asset/liability matching and certain
other hedging techniques, in order to mitigate the Company's exposure to
interest rate risks.
As of December 31, 1999, the Company's Lending Business portfolio has the
following interest characteristics:
CURRENT
CARRYING PERCENTAGE
VALUE OF TOTAL
-------------- ----------
(IN THOUSANDS)
Fixed rate loans..................................... $1,268,005 63.1%
Variable rate loans.................................. 743,001 36.9%
---------- -----
Gross carrying value................................. $2,011,006 100.0%
========== =====
SUMMARY OF PREPAYMENT TERMS
The Company is exposed to risks of prepayment on its loan assets, and
generally seeks to protect itself from such risk by structuring its loans with
prepayment restrictions and/or penalties.
As of December 31, 1999, the Companys Lending Business portfolio has the
following prepayment term characteristics:
CURRENT
CARRYING PERCENTAGE
VALUE OF TOTAL
-------------- ----------
(IN THOUSANDS)
Yield maintenance.................................... $ 424,280 21.1%
Substantial lock-out for original term............... 570,688 28.4%
Fixed prepayment penalties........................... 635,509 31.6%
No significant prepayment protection................. 380,529 18.9%
---------- -----
Gross carrying value................................. $2,011,006 100.0%
========== =====
7
SUMMARY OF LOAN MATURITIES
As of December 31, 1999, the Company's Lending Business portfolio has the
following maturity term characteristics:
NUMBER OF CURRENT
LOANS CARRYING PERCENTAGE
YEAR OF LOAN MATURITY MATURING VALUE OF TOTAL
- --------------------- --------- ------------- ----------
(IN THOUSANDS)
2000...................................... 5 $ 204,295 10.2%
2001...................................... 7 295,438 14.7%
2002...................................... 8 272,601 13.6%
2003...................................... 5 261,282 13.0%
2004...................................... 11 504,852 25.1%
2005...................................... 5 86,922 4.3%
2006...................................... 2 50,763 2.5%
2007...................................... 7 255,598 12.7%
2008...................................... 3 41,208 2.0%
2009...................................... -- -- 0.0%
2010 and thereafter....................... 3 38,047 1.9%
------------- -----
Gross carrying value.................... $ 2,011,006 100.0%
============= =====
Weighted average maturity............... 3.7 years
=============
STRUCTURED FINANCE
The Company provides custom-tailored senior and subordinated loans from
$20 million to $100 million to borrowers controlling institutional quality real
estate. These loans may be either fixed or floating rate and are structured to
meet the specific financing needs of the borrowers, including financing related
to the acquisition, refinancing, repositioning or construction of large,
high-quality real estate. The Company offers borrowers a wide range of
structured finance options, including first mortgages, second mortgages,
partnership secured loans, participating debt and interim/bridge facilities.
As of December 31, 1999, the Company's structured finance investments have
the following characteristics:
WEIGHTED
CURRENT AVERAGE
# OF INITIAL CURRENT PRINCIPAL STATED
LOANS CARRYING CARRYING BALANCE PAY
INVESTMENT CLASS COLLATERAL TYPES IN CLASS VALUE VALUE(1) OUTSTANDING RATE
- ---------------- ------------------ -------- -------------- -------------- -------------- ----------------
(IN THOUSANDS) (IN THOUSANDS) (IN THOUSANDS)
First Mortgages:
Fixed....................... Residential/ 6 $188,092 $ 186,695 $ 188,201 10.78%
Resort/Mixed Use
Floating.................... Office 3 223,882 225,487 226,378 LIBOR + 2.40%
Second Mortgages:
Fixed....................... Office/Hotel/ 8 125,843 131,992 135,690 11.36%
Mixed Use/Resort
Floating.................... Office -- -- -- -- --
Partnership/Corporate/Other Loans:
Fixed....................... Office/Hotel/ 14 330,458 342,545 359,601 11.96%
Mixed Use Resort
Floating.................... Office 2 129,400 129,429 130,000 LIBOR + 4.80%
-- ---------- ----------
Total......................... 33 $1,016,148 $1,039,870
== ========== ==========
EXPLANATORY NOTES:
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
STATED ESTIMATED CURRENT
ACCRUAL ACCOUNTING LOAN-TO-
INVESTMENT CLASS RATE YIELD(2) VALUE(3)
- ---------------- ---------------- ---------- --------
First Mortgages:
Fixed....................... 11.12% 11.24% 62%
Floating.................... LIBOR + 2.82% 9.65% 76%
Second Mortgages:
Fixed....................... 12.36% 13.95% 71%
Floating.................... -- -- --
Partnership/Corporate/Other Lo
Fixed....................... 13.80% 11.91% 78%
Floating.................... LIBOR + 4.80% 10.81% 80%
Total.........................
EXPLANATORY NOTES:
- ----------------------------------------
(1) Where Current Carrying Value is less than Initial Carrying Value, difference
represents contractual amortization, partial prepayment of loan principal,
or amortization of acquired premiums, discounts or deferred loan fees.
(2) Estimated accounting yield represents the stated rate on the loan as
adjusted for the amortization of loan fee revenue and any direct loan costs
or acquisition premiums or discounts using the effective interest method
over the term of the loan. Such estimate is not adjusted for the effects of
expected early repayments of loans subject to prepayment penalties or the
effects of possible additional contingent interest on loan participation
features included under certain of the Company's loan investments.
(3) Weighted average ratio of current loan carrying value to underlying
collateral value using third-party collateral appraisal (where applicable)
or the Company's internal valuation (where no appraisal available).
8
PORTFOLIO FINANCE
The Company provides funding to regional and national borrowers who own
multiple properties in a geographically diverse portfolio. Loans are
cross-collateralized to give borrowers the benefit of all available collateral
and underwritten to recognize inherent diversification. Property types include
multifamily, suburban office, all-suite, extended stay and limited service
hotels and other property types where individual property values are less than
$20 million on average. Loan terms are structured to meet the specific
requirements of the borrower and range in size from $25 million to
$150 million.
As of December 31, 1999, the Company's portfolio finance investments have
the following characteristics:
CURRENT
# OF INITIAL CURRENT PRINCIPAL
LOANS CARRYING CARRYING BALANCE
INVESTMENT CLASS COLLATERAL TYPES IN CLASS VALUE VALUE(1) OUTSTANDING
- ---------------- ---------------------- -------- -------------- -------------- --------------
(IN THOUSANDS) (IN THOUSANDS) (IN THOUSANDS)
First Mortgages:
Fixed.................... Hotel/Land/Residential 1 $ 67,840 $ 64,259 $ 64,687
Floating................. Office/Residential 3 154,479 159,258 160,160
Second Mortgages:
Fixed.................... Hotel/Office 4 115,352 114,030 111,411
Floating................. Hotel 1 29,689 39,771 40,000
Partnership/Corporate/Other Loans:
Fixed.................... -- -- -- -- --
Floating................. Hotel 1 69,856 70,025 70,500
-- ----------- -----------
Total...................... 10 $ 447,343 $ 446,758
== =========== ===========
EXPLANATORY NOTES:
WEIGHTED WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE AVERAGE
STATED STATED ESTIMATED CURRENT
PAY ACCRUAL ACCOUNTING LOAN-TO-
INVESTMENT CLASS RATE RATE YIELD(2) VALUE(3)
- ---------------- ---------------- ---------------- ---------- --------
First Mortgages:
Fixed.................... 18.37% 20.75% 21.75% 50%
Floating................. LIBOR + 2.54% LIBOR + 2.54% 8.47% 70%
Second Mortgages:
Fixed.................... 11.79% 12.78% 13.69% 68%
Floating................. LIBOR + 5.86% LIBOR + 5.86% 11.58% 88%
Partnership/Corporate/Other
Fixed.................... -- -- -- --
Floating................. LIBOR + 5.37% LIBOR + 5.37% 11.11% 81%
Total......................
EXPLANATORY NOTES:
- ----------------------------------------
(1) Where Current Carrying Value is less than Initial Carrying Value, difference
represents contractual amortization, partial prepayment of loan principal,
or amortization of acquired premiums, discounts or deferred loan fees.
(2) Estimated accounting yield represents the stated rate on the loan as
adjusted for the amortization of loan fee revenue and any direct loan costs
or acquisition premiums or discounts using the effective interest method
over the term of the loan. Such estimate is not adjusted for the effects of
expected early repayments of loans subject to prepayment penalties or the
effects of possible additional contingent interest on loan participation
features included under certain of the Company's loan investments.
(3) Weighted average ratio of current loan carrying value in underlying
collateral value using third-party collateral appraisal (where applicable)
or the Company's internal collateral valuation (where no appraisal
available).
CORPORATE LENDING
The Company provides senior and subordinated debt capital to corporations
engaged in real estate or real estate-related businesses. Loans may be either
secured or unsecured and range in size from $20 million to $100 million.
Corporate loans may be either cash flow-oriented or asset-based.
9
As of December 31, 1999, the Company's corporate lending investments have
the following characteristics:
WEIGHTED
CURRENT AVERAGE
# OF INITIAL CURRENT PRINCIPAL STATED
LOANS CARRYING CARRYING BALANCE PAY
INVESTMENT CLASS COLLATERAL TYPES IN CLASS VALUE VALUE(1) OUTSTANDING RATE
- ---------------- -------------------- -------- -------------- -------------- -------------- ----------------
(IN THOUSANDS) (IN THOUSANDS) (IN THOUSANDS)
Second Mortgages:
Fixed.................... Homebuilder/Land 1 $50,500 $ 53,568 $ 54,231 10.00%
Floating................. -- -- -- -- -- --
Partnership/Corporate/Other Loans:
Fixed.................... Resort Entertainment 2 45,899 44,390 43,150 12.68%
Floating................. Homebuilder/Land 1 41,250 24,677 24,677 LIBOR + 6.00%
--- ---------- ----------
Total...................... 4 $ 122,635 $ 122,058
=== ========== ==========
EXPLANATORY NOTES:
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
STATED ESTIMATED CURRENT
ACCRUAL ACCOUNTING LOAN-TO-
INVESTMENT CLASS RATE YIELD(2) VALUE(3)
- ---------------- ---------------- ---------- ---------
Second Mortgages:
Fixed.................... 17.00% 15.64% 50%
Floating................. -- -- --
Partnership/Corporate/Other
Fixed.................... 12.68% 12.00% 73%
Floating................. LIBOR + 6.00% 12.50% 50%
Total......................
EXPLANATORY NOTES:
- ----------------------------------------
(1) Where Current Carrying Value is less than Initial Carrying Value, difference
represents contractual amortization, partial prepayment of loan principal,
or amortization of acquired premiums, discounts or deferred loan fees.
(2) Estimated accounting yield represents the stated rate on the loan as
adjusted for the amortization of loan fee revenue and any direct loan costs
or acquisition premiums or discounts using the effective interest method
over the term of the loan. Such estimate is not adjusted for the effects of
expected early repayments of loans subject to prepayment penalties or the
effects of possible additional contingent interest on loan participation
features included under certain of the Company's loan investments.
(3) Weighted average ratio of current loan carrying value to underlying
collateral value using third-party collateral appraisal (where applicable)
or the Company's internal collateral valuation (where no appraisal
available).
LOAN ACQUISITION
The Company acquires whole loans and loan participations which may be
performing, non-performing or sub-performing and which the Company believes
represent attractive risk-reward opportunities. Loans are generally acquired at
a discount to the principal balance outstanding and may be acquired with
financing provided by the seller. The Company restructures many of these loans
to performing status on terms favorable to the Company. In other cases, the
Company negotiates a payoff at a price above the Company's basis in the loan.
Loan acquisitions range from $5 million to $100 million and are collateralized
by all major property types.
For accounting purposes, these loans are initially reflected at the
Company's acquisition cost which represents the outstanding balance net of the
acquisition discount or premium. The Company amortizes such discounts or
premiums as an adjustment to increase or decrease the yield, respectively,
realized on these loans using the effective interest method. As such,
differences between carrying value and principle balances outstanding do not
represent embedded losses or gains as the Company generally plans to hold such
loans to maturity or negotiate a favorable restructuring of a discount loan.
10
As of December 31, 1999, the Company's loan acquisition investments have the
following characteristics:
CURRENT
# OF INITIAL CURRENT PRINCIPAL
LOANS CARRYING CARRYING BALANCE
INVESTMENT CLASS COLLATERAL TYPES IN CLASS VALUE VALUE(1) OUTSTANDING
- ---------------- --------------------------------- -------- -------------- -------------- --------------
(IN THOUSANDS) (IN THOUSANDS) (IN THOUSANDS)
First Mortgages:
Fixed.............. Office/Retail 4 $ 205,346 $ 202,905 $ 203,905
Floating........... Office 1 93,238 94,354 97,123
Second Mortgages:
Fixed.............. Retail 2 113,627 109,825 109,796
Floating........... -- -- -- -- --
Partnership/Corporate/Other Loans:
Fixed.............. Office/Residential/Hotel/Resort 1 17,532 17,796 25,905
Floating........... -- -- -- -- --
------ ----------- -----------
Total................................................... 8 $ 424,880 $ 436,729
====== =========== ===========
EXPLANATORY NOTES:
WEIGHTED WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE AVERAGE
STATED STATED ESTIMATED CURRENT
PAY ACCRUAL ACCOUNTING LOAN-TO-
INVESTMENT CLASS RATE RATE YIELD(2) VALUE(3)
- ---------------- ---------------- ---------------- ---------- --------
First Mortgages:
Fixed.............. 9.84% 9.84% 9.73% 82%
Floating........... LIBOR + 1.75% LIBOR + 1.75% 8.94% 68%
Second Mortgages:
Fixed.............. 9.72% 9.72% 7.59% 59%
Floating........... -- -- -- --
Partnership/Corporate
Fixed.............. 9.97% 9.97% 11.30% 69%
Floating........... -- -- -- --
Total................
EXPLANATORY NOTES:
- ----------------------------------------
(1) Where Current Carrying Value is less than Initial Carrying Value, difference
represents contractual amortization, partial prepayment of loan principal,
or amortization of acquired premiums, discounts or deferred loan fees.
(2) Estimated accounting yield represents the stated rate on the loan as
adjusted for the amortization of loan fee revenue and any direct loan costs
or acquisition premiums or discounts using the effective interest method
over the term of the loan. Such estimate is not adjusted for the effects of
expected early repayments of loans subject to prepayment penalties or the
effects of possible additional contingent interest on loan participation
features included under certain of the Company's loan investments.
(3) Weighted average ratio of current loan carrying value to underlying
collateral value using third-party collateral appraisal (where applicable)
or the Company's internal collateral valuation (where no appraisal
available).
LOAN SERVICING
Through its Starwood Asset Services division, the Company provides loan
servicing to third-party institutional owners of loan portfolios, as well as to
the Company's own asset base. Starwood Asset Services is currently rated "above
average" by Standard & Poor's as a master servicer. The Company's servicing
business focuses on maximizing risk-adjusted investment returns through active,
ongoing asset management with particular focus on risk management, asset
financing strategies and opportunistic responsiveness to changing
borrower/tenant needs.
In September 1998, a subsidiary of the Company acquired the loan origination
and servicing business of Phoenix Realty Services, Inc., a subsidiary of Phoenix
Home Life Insurance Company, for $2.0 million. This acquisition not only
expanded the Company's ability to service its own loans, but provided a platform
for third-party servicing and additional borrower relationships which may result
in investment opportunities in the future.
11
CREDIT TENANT LEASING:
The Company, directly and through its Leasing Subsidiary, provides capital
to corporate owners of real estate facilities. Net leased facilities are
generally subject to long-term leases to rated corporate credit tenants, and
typically provide for all expenses at the property to be paid by the tenant on a
triple net lease basis. Credit tenant lease ("CTL") transactions generally range
in size from $20 million to $200 million.
The Company pursues the origination of credit tenant lease transactions by
structuring purchase/ leasebacks and by acquiring facilities subject to existing
long-term net leases. In a typical purchase/ leaseback transaction, the Company
purchases a corporation's property and leases it back to that corporation
subject to a long-term net lease. This structure allows the corporate real
estate user to reinvest the proceeds from the sale of its real estate into its
core business while the Company capitalizes on its structured financing
expertise.
The Company generally intends to hold its net leased assets for long-term
investment. However, subject to certain tax restrictions, the Company may
dispose of an asset if it deems the disposition to be in the best interest of
the stockholders and may either reinvest the disposition proceeds, use the
proceeds to reduce debt, or distribute the proceeds to stockholders.
The Company's CTL investments primarily represent a diversified portfolio of
strategic office and industrial facilities subject to net lease agreements with
creditworthy corporate tenants. The Company generally seeks high-quality,
general-purpose real estate with residual values that represent a discount to
current market values and replacement cost. Under a typical net lease agreement,
the tenant agrees to pay a base monthly operating lease payment and all property
operating expenses (including taxes, maintenance and insurance) are the
responsibility of the tenant.
The Company generally seeks corporate tenants with the following
characteristics:
- Established companies with stable core businesses or market leaders in
rapidly growing industries.
- Investment-grade credit strength or appropriate credit enhancements if
tenant credit strength is not sufficient.
- Commitment to the facility as an important asset to their on-going
businesses.
As of December 31, 1999, the Company had more than 160 corporate tenants
operating in more than 10 industries, including aerospace, automotive, finance,
healthcare, hotel, technology and telecommunications. These tenants represent
well-recognized national and international companies, such as AlliedSignal,
Federal Express, IBM, Lucent, Microsoft, Nike, Hilton and Nokia.
As of December 31, 1999, the Company's CTL portfolio has the following
tenant credit characteristics:
ANNUALIZED
OPERATING
LEASE PERCENTAGE
PAYMENTS(2) OF TOTAL
-------------- ----------
(IN THOUSANDS)
Investment grade(1)................................ $ 85,698 44.8%
Non-investment grade............................... 29,040 15.2%
Unrated............................................ 76,592 40.0%
-------- -----
$191,330 100%
======== =====
EXPLANATORY NOTES:
- ------------------------------
(1) A tenant's credit rating is considered "Investment Grade" if it has a
published credit rating of Baa3/BBB- or above by one or more of the four
national rating agencies.
(2) Reflects annualized monthly base lease rates in effect on December 31, 1999.
12
PORTFOLIO AND ASSET MANAGEMENT STRATEGY. The Company believes that diligent
management of the CTL portfolio is an essential component of its long-term
strategy. There are several ways to optimize the performance and maximize the
value of net leases. The Company monitors its portfolio for changes that could
affect the performance of the markets, tenants and industries in which it has
invested. As part of this monitoring, the Company's asset management group
reviews market, tenant and industry data and frequently inspects its properties.
In addition, the Company attempts to develop strong relationships with its large
corporate tenants, which provide a source of information concerning the tenants'
real estate needs. These relationships allow the Company to be proactive in
obtaining early lease renewals and in conducting early marketing of assets where
the tenant has decided not to renew. The Company will seek to find a new tenant
prior to the expiration of the existing lease.
As of December 31, 1999, the Company owned 148 office and industrial
properties principally subject to net leases to more than 160 tenants,
comprising 18.5 million square feet in 25 states. The Company also has a
portfolio of 17 hotels under a long-term master lease with a single tenant.
Information regarding the Company's CTL properties as of December 31, 1999 is
set forth below:
% ANNUALIZED
# OF OPERATING LEASE %
INDUSTRY FACILITIES PAYMENTS(1) SQUARE FEET SIGNIFICANT TENANTS
- -------- ---------- --------------- ----------- -------------------------------------
Technology........................... 58 36.8% 27.8% IBM Corp., Sun Microsystems, Lucent
Technologies, 3Com Corp., Xerox Corp.
Unisys, Rational Software, Lotus
Development Corp., Computer Sciences
Corp., Microsoft.
Financial Services................... 12 11.9% 8.5% AT&T Capital, Wellpoint Health
Networks, New York Life Insurance
Co., Guardian Life Insurance Co.
Telecommunications................... 11 10.4% 6.1% ICG Holdings, Nokia, GTE
Communications, Northern Telecom
Food and Related Services............ 21 6.5% 7.0% Caterair, Welch Foods, Inc., Ralph's
Grocery Co., Shaw's Supermarkets
Automotive, Aerospace and Defense.... 11 6.0% 6.5% Volkswagen of America, Unison
Industries, Allied Signal, TRW Space
Communications, Lockheed Martin
Aerospace Corp.
Energy and Utilities................. 3 5.2% 3.2% Entergy Corp., Bay State Gas Company,
Mobil Oil Exploration
Consumer Goods....................... 10 4.7% 9.7% Lever Brothers, Rex Stores Corp.,
Sears Logistics
Manufacturing........................ 4 3.6% 7.3% Nike, Adidas America, Inc., Central
National-Gottlesman, Inc.
Transportation Services.............. 3 2.1% 1.1% Federal Express Corp.
Healthcare........................... 5 1.7% 1.5% Fresenius USA, Inc., Haemonetics
Corp., Biomerieux Vitek, Inc.
Government Services.................. 2 1.1% 0.7% Massachusetts Lottery, Cal Trans,
Consulate-General of Japan
Other 8 2.2% 5.4% San Jose State University, Guste,
Norstan
--- ----- -----
TOTAL LEASING SUBSIDIARY........... 148 92.2% 84.8%
Hotel................................ 17 7.8% 15.2% Hilton Hotels Corp.
--- ----- -----
TOTAL PARENT....................... 17 7.8% 15.2%
--- ----- -----
TOTAL COMPANY...................... 165 100.0% 100.0%
=== ===== =====
EXPLANATORY NOTE:
- ----------------------------------
(1) Reflects annualized monthly base lease rates in effect on December 31, 1999.
13
As of December 31, 1999, the Company's portfolio of lease expirations on its
CTL assets are as follows:
PERCENT OF TOTAL
NUMBER OF ANNUALIZED ANNUAL RENTS
LEASES OPERATING LEASE REPRESENTED BY
YEAR OF LEASE EXPIRATION EXPIRING PAYMENTS(1) EXPIRING LEASES
- ------------------------ --------- --------------- ----------------
(IN THOUSANDS)
2000.................................. 16 $ 7,477 3.91%
2001.................................. 23 18,774 9.81%
2002.................................. 27 21,861 11.43%
2003.................................. 22 23,149 12.10%
2004.................................. 29 24,669 12.89%
2005.................................. 11 9,520 4.98%
2006.................................. 19 22,840 11.94%
2007.................................. 8 12,149 6.35%
2008.................................. 9 8,544 4.46%
2009.................................. 8 8,896 4.65%
2010 and thereafter................... 22 33,451 17.48%
------ -------- ------
Total 194 $191,330 100.00%
====== ======== ======
Weighted average lease term 6.7 years
========
EXPLANATORY NOTE:
- ------------------------------
(1) Reflects annualized monthly base lease rates in effect on December 31, 1999.
POLICIES WITH RESPECT TO OTHER ACTIVITIES
At all times, the Company intends to make investments in a manner consistent
with the requirements of the Code for the Company to qualify as a REIT unless,
because of changing circumstances or changes in the Code (or in Treasury
Regulations), the Company's Board of Directors, with the consent of the holders
of a majority of the outstanding voting shares, determines that it is no longer
in the best interests of the Company to qualify as a REIT.
INVESTMENT RESTRICTIONS OR LIMITATIONS
The Company does not have any prescribed allocation among investments or
product lines. Instead, the Company focuses on corporate and real estate credit
underwriting to develop an in-depth analysis of the risk/reward ratios in
determining the pricing and advisability of each particular transaction.
The Company believes that it is not, and intends to conduct its operations
so as not to become, regulated as an investment company under the Investment
Company Act. The Investment Company Act generally exempts entities that are
"primarily engaged in purchasing or otherwise acquiring mortgages and other
liens on and interests in real estate" (collectively, "Qualifying Interests").
The Company intends to rely on current interpretations by the staff of the
Securities and Exchange Commission in an effort to qualify for this exemption.
To comply with the exemption, the Company, among other things, must maintain at
least 55% of its assets in Qualifying Interests and also may be required to
maintain an additional 25% in Qualifying Interests or other real estate-related
assets. Generally, the Company's senior mortgages and certain of its
subordinated mortgages constitute Qualifying Interests.
The Company is restricted from making certain types of investments which may
limit its flexibility in implementing its investment policy. Specifically,
without the amendment, termination or waiver of provisions of certain
non-competition agreements between Starwood Capital Group, L.L.C. and Starwood
Hotels & Resorts Worldwide, Inc. the Company is prohibited from: (i) making
investments in loans collateralized by hotel assets where it is anticipated that
the underlying equity will be acquired by the
14
debtholder within one year from the acquisition of such debt; (ii) acquiring
equity interests in hotels (other than acquisitions of warrants, equity
participations or similar rights incidental to a debt investment by the Company
or that are acquired as a result of the exercise of remedies in respect to a
loan in which the Company has an interest); or (iii) selling or contributing to
or acquiring any interests in Starwood Hotels & Resorts Worldwide, Inc.,
including debt positions or equity interests obtained by the Company under,
pursuant to or by reason of the Company's ownership of debt positions.
Subject to the limitations on ownership of certain types of assets and the
gross income tests imposed by the Federal Tax Code, the Company also may invest
in the securities of other REITs, other entities engaged in real estate
activities or other issuers, including for the purpose of exercising control
over such entities.
COMPETITION
The Company is engaged in a competitive business. In originating and
acquiring assets, the Company competes with public and private companies,
including other finance companies, mortgage banks, pension funds, savings and
loan associations, insurance companies, institutional investors, investment
banking firms and other lenders and industry participants, as well as individual
investors. Existing industry participants and potential new entrants compete
with the Company for the available supply of investments suitable for
origination or acquisition, as well as for debt and equity capital. Certain of
the Company's competitors are larger than the Company, have longer operating
histories, may have access to greater capital and other resources, may have
management personnel with more experience than the officers of the Company, and
may have other advantages over the Company in conducting certain businesses and
providing certain services.
REGULATION
The operations of the Company are subject, in certain instances, to
supervision and regulation by state and federal governmental authorities and may
be subject to various laws and judicial and administrative decisions imposing
various requirements and restrictions, which, among other things: (i) regulate
credit granting activities; (ii) establish maximum interest rates, finance
charges and other charges; (iii) require disclosures to customers; (iv) govern
secured transactions; and (v) set collection, foreclosure, repossession and
claims-handling procedures and other trade practices. Although most states do
not regulate commercial finance, certain states impose limitations on interest
rates and other charges and on certain collection practices and creditor
remedies and require licensing of lenders and financiers and adequate disclosure
of certain contract terms. The Company is also required to comply with certain
provisions of the Equal Credit Opportunity Act that are applicable to commercial
loans.
In the judgment of management, existing statutes and regulations have not
had a material adverse effect on the business conducted by the Company. However,
it is not possible to forecast the nature of future legislation, regulations,
judicial decisions, orders or interpretations, nor their impact upon the future
business, financial condition or results of operations or prospects of the
Company.
The Company has elected and expects to continue to make an election to be
taxed as a REIT under Section 856 through 860 of the Code. As a REIT, the
Company generally will not be subject to federal income tax if it distributes at
least 95% of its taxable income for each year to its shareholders. REITs are
also subject to a number of organizational and operational requirements in order
to elect and maintain REIT status. These requirements include specific share
ownership tests and assets and gross income composition tests. If the Company
fails to qualify as a REIT in any taxable year, the Company will be subject to
federal income tax (including any applicable alternative minimum tax) on its
taxable income at regular corporate tax rates. Even if the Company qualifies for
taxation as a REIT, the Company may be subject to state and local income taxes
and to federal income tax and excise tax on its undistributed income.
15
Although the Company did not qualify as a REIT for its fiscal years 1993
through 1997, it received a written agreement from the IRS confirming that the
Company was eligible to make an election under Section 856(c)(1) of the Code to
be taxed as a REIT for its taxable years beginning January 1, 1998.
FACTORS THAT MAY AFFECT THE COMPANY'S BUSINESS STRATEGY
The implementation of the Company's business strategy and investment
policies are subject to certain risks, including the effect of economic and
other conditions on property values, the general illiquidity of real estate
investments, the risks of borrower and tenant defaults, in risks resulting from
delays in enforcing remedies or in gaining control over the real estate
collateral following a default, risks that the properties collateralizing debt
instruments held by the Company or properties which are owned by the Company
will not generate revenues sufficient to meet operating expenses and to pay
scheduled debt service, the risk that prepayment restrictions may be
insufficient to deter prepayments, the existence of junior mortgages that may
affect the Company's rights, the effect of competition from properties owned by
others, liability associated with uninsurable losses and unknown environmental
liabilities.
ENVIRONMENTAL MATTERS
Under various federal, state and local environmental laws, ordinances and
regulations, a current or previous owner of real estate (including, in certain
circumstances, a secured lender that succeeds to ownership or control of a
property) may become liable for the costs of removal or remediation of certain
hazardous or toxic substances at, on, under or in its property. Those laws
typically impose cleanup responsibility and liability without regard to whether
the owner or control party knew of or was responsible for the release or
presence of such hazardous or toxic substances. The costs of investigation,
remediation or removal of those substances may be substantial. The owner or
control party of a site may be subject to common law claims by third parties
based on damages and costs resulting from environmental contamination emanating
from a site. Certain environmental laws also impose liability in connection with
the handling of or exposure to asbestos-containing materials, pursuant to which
third parties may seek recovery from owners of real properties for personal
injuries associated with asbestos-containing materials. Absent succeeding to
ownership or control of real property, a secured lender is not likely to be
subject to any of these forms of environmental liability. The Company is not
currently aware of any environmental issues which could materially affect the
Company.
EMPLOYEES
As of March 15, 2000, the Company had 111 employees and believes its
relationships with its employees to be good. The Company's employees are not
represented by a collective bargaining agreement.
ITEM 2. PROPERTIES
The Company's principal executive and administrative offices are located at
1114 Avenue of the Americas New York, NY 10036, 27th floor. Its telephone
number, general facsimile number and e-mail address are (212) 930-9400,
(212) 930-9494 and starwoodfinancial.com, respectively. The lease for the
Company's primary corporate office space expires in February 2010. The Company
believes that this office space is suitable for its operations for the
foreseeable future. The Company also maintains super-regional offices in San
Francisco, California, Hartford, Connecticut, and Atlanta, Georgia, as well as
regional offices in Dallas, Texas, Denver, Colorado and New Orleans, Louisiana.
See Item 1--"Credit Tenant Leasing" for a discussion of real estate
facilities held by the Company and its Leasing Subsidiary for investment
purposes and Item 8--"Schedule III--Real Estate and Accumulated Depreciation"
for a detailed listing of such properties.
16
ITEM 3. LEGAL PROCEEDINGS
The Company is not a party to any material litigation or legal proceedings,
or to the best of its knowledge, any threatened litigation or legal proceedings,
which, in the opinion of management, individually or in the aggregate, would
have a material adverse effect on its results of operations or financial
condition.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On November 3, 1999, the Company held a special meeting of shareholders to
vote on the following proposals:
1. To approve the acquisition of TriNet through the merger of TriNet with a
subsidiary of the Company, with TriNet surviving the merger as a
subsidiary of the Company.
2. To approve the acquisition of 100% of the ownership interests in the
Company's external advisor, Starwood Financial Advisors L.L.C., through a
merger and a contribution of interests by the owners of the external
advisor.
3. To approve the merger of the Company into a newly-formed corporation in
order to change its form of organization from a Maryland real estate
investment trust to a Maryland corporation and eliminate its dual class
common share structure.
PROPOSAL FOR AGAINST ABSTAIN
- -------- ---------- -------- --------
First Proposal.................................. 78,078,285 3,066 3,693
Second Proposal................................. 78,077,827 3,155 4,062
Third Proposal.................................. 78,078,464 2,604 3,976
17
PART II
ITEM 5. MARKET FOR REGISTRANT'S EQUITY AND RELATED SHARE MATTERS
In November 1999, the Company eliminated its dual class share structure by
exchanging its outstanding class A and class B shares for shares of a single
class of Common Stock. The Company's Common Stock began trading on the New York
Stock Exchange ("NYSE") under the symbol "SFI" on November 4, 1999. Prior to
November 4, 1999, the class A shares were traded on the American Stock Exchange
under the symbol "APT," and there was no established trading market for the
class B shares.
The high and low sales prices per share of Common Stock (or class A shares
for periods prior to November 4, 1999) are set forth below for the periods
indicated.
QUARTER ENDED HIGH(1) LOW(1)
- ------------- ---------- ------------
1998
March 31, 1998.............................................. $36 3/4 $27 3/8
June 30, 1998............................................... $56 $26 1/4
September 30, 1998.......................................... $59 1/4 $35 1/2
December 31, 1998........................................... $80 1/4 $45 1/4
1999
March 31, 1999.............................................. $63 $42 1/2
June 30, 1999............................................... $66 1/2 $31 5/8
September 30, 1999.......................................... $76 $27 7/8
December 31, 1999........................................... $27 5/8 $16 11/16
EXPLANATORY NOTE:
- ------------------------------
(1) As adjusted for a one-for-six reverse stock split effective June 19, 1998.
On March 15, 2000, the closing sale price of the Common Stock as reported by
the NYSE was $17.19. The Company had approximately 1,203 holders of record of
Common Stock as of March 15, 2000.
On June 12, 1998, the Frank Russell Company announced that the Company would
be included in the Russell 1000 and Russell 3000 equity indices. The Company
believes that index funds who were required to mirror the Russell indices'
performance purchased a large number of the Company's class A shares in the
public float. As a result of those purchases, and the limited availability of
the shares in the public float at that time, the "market" price for the class A
shares dramatically increased shortly after the June 12 announcement. From the
time of the Company's inclusion in the Russell indices through the announcement
that the Company had agreed to acquire TriNet, the reported stock price of the
Company was highly volatile and trading volume relatively low due to the very
limited number of shares available for trading at that time.
At December 31, 1999, the Company had four series of preferred stock
outstanding: Series A Preferred Stock (which currently pays dividends at the
rate of 9.50% per annum), 9.375% Series B Preferred Stock, 9.20% Series C
Preferred Stock and 8.00% Series D Preferred Stock. Each of the Series B, C, D
preferred stock was issued in connection with the TriNet acquisition and is
publicly traded.
On January 4, 5 and 6, 1999 the Company issued 37,776, 1,512 and 8,945
class A shares, respectively, upon exercise of stock options issued to employees
of the Company's external advisor. On March 15, 1999, the Company issued 15,000
class A shares upon exercise of stock options issued to an employee of the
Company's external advisor. The exercise price of the options was $15.00 per
share. As required by the Company's charter as in effect at that time, in
connection with those option exercises, 31,616 class B shares were issued to the
holders of the class B shares at par value.
The Board of Directors approved, and the Company has implemented, a stock
repurchase program under which the Company is authorized to repurchase up to
5.0 million shares of its Common Stock from
18
time to time, primarily using proceeds from the disposition of assets and excess
cash flow from operations, but also using borrowings under its credit facilities
if the Company determines that it is advantageous to do so. As of December 31,
1999, the Company had repurchased approximately 2.3 million shares at an
aggregate cost of approximately $40.4 million.
DIVIDENDS
The Company's management expects that any taxable income remaining after the
distribution of preferred dividends and the regular quarterly or other dividends
will be distributed annually to the holders of the Common Stock on or prior to
the date of the first regular quarterly divided payment date of the following
taxable year. The dividend policy with respect to the Common Stock is subject to
revision by the Board of Directors. All distributions in excess of dividends on
preferred stock or those required for the Company to maintain its REIT status
will be made by the Company at the sole discretion of the Board of Directors and
will depend on the taxable earnings of the Company, the financial condition of
the Company, and such other factors as the Board of Directors deems relevant.
The Board of Directors has not established any minimum distribution level. In
order to maintain its qualifications as a REIT, the Company intends to make
regular quarterly dividends to its shareholders that, on an annual basis, will
represent at least 95% of its taxable income (which may not necessarily equal
net income as calculated in accordance with generally accepted accounting
principles), determined without regard to the deduction for dividends paid and
excluding any net capital gains.
Holders of Common Stock will be entitled to receive distributions if, as and
when the Board of Directors authorizes and declares distributions. However,
rights to distributions may be subordinated to the rights of holders of
preferred stock, when preferred stock is issued and outstanding. In any
liquidation, dissolution or winding up of the Company each outstanding share of
Common Stock will entitle its holder to a proportionate share of the assets that
remain after the Company pays its liabilities and any preferential distributions
owed to preferred stockholders.
The following table sets forth the dividends paid or declared by the Company
on its Common Stock (or class A shares for periods prior to November 4, 1999):
STOCKHOLDER DIVIDEND/
QUARTERLY PERIOD ENDED RECORD DATE SHARE
- ---------------------- ----------------- ---------
1998
June 30, 1998.................................. June 30, 1998 $0.35
September 30, 1998............................. October 15, 1998 $0.38
December 31, 1998.............................. December 31, 1998 $0.41(1)
1999
March 31, 1999................................. April 15, 1999 $0.42
June 30, 1999.................................. July 15, 1999 $0.43
September 30, 1999............................. October 15, 1999 $0.44
December 31, 1999.............................. December 31, 1999 $0.57(2)
EXPLANATORY NOTES:
- ------------------------------
(1) A portion of this quarterly dividend (approximately $0.29 per share) was
treated as income to shareholders of record in 1998, and the remainder was
treated as 1999 income.
(2) A portion of this quarterly dividend (approximately $0.47 per share) was
treated as income to stockholders of record in 1999, and the remainder will
be treated as 2000 income.
In November 1999, the Company declared and paid a dividend of a total of one
million shares of Common Stock pro rata to all holders of record of Common Stock
as of the close of business on November 3, 1999. The Company also declared
dividends aggregating $20.9 million for the Series A preferred stock, which was
outstanding for the entire year ended December 31, 1999. In addition, the
Company also
19
declared dividends of $1.2 million, $0.7 million and $2.0 million on its
Series B, C and D preferred stock, respectively, for the year ended
December 31, 1999. The amounts for the Series B, C and D preferred stock
represent only fourth quarter dividends which were payable by the Company as a
result of its acquisition of TriNet. There are no dividend arrearages on any of
the series of preferred stock currently outstanding. Further, it declared and
paid dividends aggregating $0.2 million per quarter to the holders of class B
shares in connection with the March 31, June 30 and September 30 quarterly
dividends to the holders of the class A shares. As previously described, the
former class A and class B shares were converted into shares of Common Stock on
November 4, 1999. The Company did not declare any dividends for the period from
November 19, 1993 through the quarter ended March 31, 1998, representing its
partial first quarter of operations after the completion of the Recapitalization
Transactions.
Distributions to shareholders will generally be taxable as ordinary income,
although a portion of such dividends may be designated by the Company as capital
gain or may constitute a tax-free return of capital. The Company annually
furnishes to each of its shareholders a statement setting forth the
distributions paid during the preceding year and their characterization as
ordinary income, capital gain or return of capital.
The Company intends to continue to declare quarterly distributions on its
Common Stock. No assurance, however, can be given as to the amounts or timing of
future distributions, as such distributions are subject to the Company's
earnings, financial condition, capital requirements, and such other factors as
the Company's Board of Directors deems relevant.
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth selected financial data on a consolidated
historical basis for the Company. However, prior to the recapitalization of the
Company in March 1998, discussed more fully in Note 4 to the Company's
Consolidated Financial Statements (the "Recapitalization Transactions"), the
Company did not have substantial capital resources or operations. Prior to the
Recapitalization Transactions, the Company's structured finance operations were
conducted by two investment partnerships affiliated with Starwood Capital Group,
L.L.C., which contributed substantially all their structured finance assets to
the Company in the Recapitalization Transactions in exchange for cash and shares
of the Company.
Further, on November 4, 1999, as more fully discussed in Note 4 to the
Company's Consolidated Financial Statements, the Company acquired TriNet, which
substantially increased the size of the Company's operations, and also acquired
its external advisor. Operating results for the year ended December 31, 1999
reflect only the effects of these transactions subsequent to their consummation.
Accordingly, the historical balance sheet information as of and prior to
December 31, 1998, as well as the results of operations for the Company for all
periods reflected below, do not reflect the current operations of the Company as
a well capitalized, internally-managed finance company operating in the
commercial real estate industry. For these reasons, the Company believes that
the information contained in the following tables relating to the 1995 through
1997 periods is not indicative of the Company's current
20
business and should be read in conjunction with the discussions set forth in
Item 7--"Management's Discussion and Analysis of Financial Condition and Results
of Operations."
YEARS ENDED DECEMBER 31,
-----------------------------------------------------------
1999 1998 1997 1996 1995
----------- ----------- --------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
OPERATING DATA:
Interest income........................................... $ 209,848 $ 112,914 $ 896 $ 478 $ 145
Operating lease/rental income............................. 42,186 12,378 -- -- --
Other income.............................................. 12,763 2,804 991 10 3
----------- ----------- --------- -------- --------
Total revenue......................................... 264,797 128,096 1,887 488 148
----------- ----------- --------- -------- --------
Interest expense.......................................... 91,184 44,697 -- 272 --
Property operating costs.................................. 2,246 -- -- -- --
Depreciation and amortization............................. 10,340 4,287 -- -- --
General and administrative expense........................ 6,269 2,583 461 639 283
Advisory fees............................................. 16,193 7,837 -- -- --
Provision for possible credit losses...................... 4,750 2,750 -- -- --
Stock option compensation expense(1)...................... 412 5,985 -- -- --
Costs incurred in acquiring external advisor(2)........... 94,476 -- -- -- --
----------- ----------- --------- -------- --------
Total expenses........................................ 225,870 68,139 461 911 283
----------- ----------- --------- -------- --------
Income (loss) before minority interest.................... 38,927 59,957 1,426 (423) (135)
Minority interest(3)...................................... (41) (54) (1,415) (154) --
----------- ----------- --------- -------- --------
Net income (loss)......................................... $ 38,886 $ 59,903 $ 11 $ (577) $ (135)
Preferred dividend requirements........................... (23,843) (944) -- -- --
----------- ----------- --------- -------- --------
Net income allocable to common shareholders............... $ 15,043 $ 58,959 $ 11 $ (577) $ (135)
=========== =========== ========= ======== ========
Basic earnings (loss) per common share(4)................. $ 0.25 $ 1.40 $ 0.01 $ (1.36) $ (0.32)
=========== =========== ========= ======== ========
Diluted earnings (loss) per common share.................. $ 0.25 $ 1.36 $ 0.00 $ (1.36) $ (0.32)
=========== =========== ========= ======== ========
Dividends declared per common share(10)................... $ 1.86 $ 1.14 $ 0.00 $ 0.00 $ 0.00
=========== =========== ========= ======== ========
SUPPLEMENTAL DATA:
Dividends declared on preferred shares.................... $ 24,819 $ 929 $ -- $ -- $ --
Dividends declared on common shares....................... 116,813 60,343 -- -- --
Adjusted earnings allocable to common shareholders(7)..... 127,798 66,615 11 (577) (135)
Adjusted earnings per common
share--basic............................................ 2.19 1.59 0.01 (1.36) (0.32)
Adjusted earnings per common
share--diluted.......................................... 2.07 1.53 0.00 (1.36) (0.32)
Funds from operations allocable to common
shareholders(5)(6)...................................... 121,666 63,261 1,426 (423) (135)
Cash flows from:
Operating activities.................................. 122,549 54,915 1,271 (227) (184)
Investing activities.................................. (143,911) (1,271,309) (6,013) (522) 175
Financing activities.................................. 45,660 1,226,208 4,924 -- --
Pro Forma ratio of EBITDA to interest expense............. 2.83 2.84 -- -- --
Pro Forma ratio of EBITDA to combined fixed charges(8).... 2.23 2.44 -- -- --
Weighted average common shares outstanding--basic(9)...... 57,749 41,607 1,258 425 425
Weighted average common shares outstanding--diluted(9).... 60,393 43,460 2,562 425 425
BALANCE SHEET DATA:
Real estate loans and net lease investments, net.......... $ 3,717,790 $ 2,013,703 $ -- $ -- $ --
Total assets.............................................. 3,813,552 2,059,616 13,441 5,674 2,194
Debt obligations.......................................... 1,901,204 1,055,719 -- -- --
Minority interest in consolidated entities(3)............. 2,565 -- 5,175 3,917 --
Shareholders' equity...................................... 1,801,343 970,728 6,351 1,578 2,155
SUPPLEMENTAL DATA:
Total debt to shareholders' equity........................ 1.1x 1.1x -- -- --
21
EXPLANATORY NOTES:
- ------------------------------
(1) Historical stock option expense represents the option value of approximately
2.5 million fully-vested options to acquire class A shares which were issued
to the Company's external advisor upon consummation of the March 18, 1998
capitalization of the Company. A portion of those options were then
regranted to employees of the advisor subject to vesting periods which were
typically three years from the date of grant. The remainder of those options
were regranted on a fully-vested basis to an affiliate of Starwood Capital
Group L.L.C., which then further regranted those options to certain of its
employees subject to vesting restrictions.
(2) As more fully discussed in Note 4 to the Company's Consolidated Financial
Statements, this amount represents a non-recurring charge of approximately
$94.5 million relating to the acquisition of the Company's external advisor.
(3) Historical minority interest for the Company for fiscal 1998, 1997 and 1996
represents a minority interest in APMT Limited Partnership which was
converted into class A shares on March 18, 1998, the date the partnership
was liquidated and terminated. Minority interests in fiscal 1999 also
reflects minority interests in certain of the Leasing Subsidiary's
consolidated ventures.
(4) Earnings per common share excludes 1% of net income allocable to the
Company's class B shares prior to November 4, 1999. These class B shares
were exchanged for Common Stock in connection with the TriNet acquisition
and other related transactions on November 4, 1999. As a result, the Company
now has a single class of Common Stock outstanding.
(5) Management generally considers funds from operations, or FFO, to be one
measure of the financial performance which provides a relevant basis for
comparison among REITs. FFO is presented to assist investors in analyzing
the performance of REITs. In 1995, the National Association of Real Estate
Investment Trusts, or NAREIT, established new guidelines clarifying its
definition of FFO and requested that REITs adopt this new definition
beginning in 1996. FFO, as defined by NAREIT, is income (loss) before
minority interest (determined in accordance with generally accepted
accounting principles), excluding gains (losses) from debt restructuring and
sales of property, plus real estate-related depreciation and amortization
and after adjustments for unconsolidated partnerships and joint ventures.
FFO does not represent cash generated from operating activities in
accordance with generally accepted accounting principles and is not
necessarily indicative of cash available to fund cash needs. FFO should not
be considered an alternative to net income as an indication of financial
performance nor an alternative to cash flows from operating, investing, and
financing activities as measures of liquidity.
(6) Because of certain non-cash or non-recurring items included in income for
generally accepted accounting purposes, which are not adjusted for or
eliminated under the NAREIT definition of FFO, FFO may differ from actual
cash available for distribution to shareholders. These items include
amortization of premiums or discounts on loan investments, provisions for
possible credit losses, gains from sales of assets, deferred interest
arising from differences between loan accrual and payment rates, non-cash
rental revenues and capital expenditures. Accordingly, FFO is not
necessarily indicative of cash available to fund cash needs or to pay
dividends to shareholders.
(7) Adjusted earnings represent GAAP net income before depreciation and
amortization and, for the year ended December 31, 1999, exclude the
non-recurring cost incurred in acquiring the Company's external advisor (see
Note 4 to the Company's Consolidated Financial Statements).
(8) Combined fixed charges are comprised of interest expense, capitalized
interest, amortization of loan costs and preferred stock dividend
requirements.
(9) As adjusted for one-for-six reverse stock split effected by the Company on
June 19, 1998.
(10) The Company generally declares common and preferred dividends in the month
subsequent to the end of the quarter.
22
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
As more fully discussed in Note 4 to the Company's Consolidated Financial
Statements, on March 18, 1998, the Company completed the Recapitalization
Transactions which, among other things, substantially recapitalized the Company
and modified its investment policy. Effective June 18, 1998, the Company (which
was organized under California law) changed its domicile to Maryland by merging
with a newly-formed subsidiary organized under Maryland law, and issued new
shares of the subsidiary to the Company's shareholders in exchange for their
shares in the Company. Concurrently, the Company consummated a one-for-six
reverse stock split.
Immediately prior to the consummation of the Recapitalization Transactions,
the Company's assets primarily consisted of approximately $11.0 million in
short-term, liquid real estate investments, cash and cash equivalents.
On December 15, 1998, the Company sold $220.0 million of preferred shares
and warrants to purchase class A shares to a group of investors affiliated with
Lazard Freres. Concurrent with the sale of the preferred shares and warrants,
the Company purchased $280.3 million in real estate loans and participation
interests from a group of investors also affiliated with Lazard Freres. These
transactions are referred to collectively as the "Lazard Transaction."
As more fully discussed in Note 4 to the Company's Consolidated Financial
Statements, on November 3, 1999, the Company's shareholders approved a series of
transactions including: (i) the acquisition of TriNet; (ii) the acquisition of
the Company's external advisor; and (iii) the reorganization of the Company from
a trust to a corporation and the exchange of the class A and class B shares for
Common Stock. Pursuant to the TriNet acquisition, TriNet merged with and into a
subsidiary of the Company, with TriNet surviving as a wholly-owned subsidiary of
the Company. In the acquisition, each share of common stock of TriNet was
converted into 1.15 shares of Common Stock. Each share of TriNet Series A,
Series B and Series C Cumulative Redeemable Preferred Stock was converted into a
share of Series B, Series C or Series D (respectively) Cumulative Redeemable
Preferred Stock of the Company. The Company's preferred stock issued to the
former TriNet preferred stockholders has substantially the same terms as the
TriNet preferred stock, except that the new Series B, C, and D preferred stock
have additional voting rights not associated with the TriNet preferred stock.
The Company's Series A Preferred Stock remained outstanding with the same rights
and preferences as existed prior to the TriNet acquisition. As a consequence of
the acquisition of its external advisor, the Company is now self-advised and
will no longer pay external advisory fees.
The transactions described above and other related transactions have
materially impacted the historical operations of the Company and will continue
to impact the Company's future operations. Accordingly, the reported historical
financial information for periods prior to these transactions is not believed to
be fully indicative of the Company's future operating results or financial
condition.
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 1999 COMPARED TO YEAR ENDED DECEMBER 31, 1998
During fiscal year 1999, total revenue increased by approximately
$136.7 million over total revenue for fiscal year 1998. This increase is a
result of the interest generated by the loans and other investments contributed
in the Recapitalization Transactions, as well as approximately $663.4 million of
other loan investments newly-originated or acquired by the Company during 1999,
an additional $46.4 million funded under existing loan commitments, and
approximately $26.8 million in operating lease income generated from net lease
assets acquired in the TriNet acquisition. The increase was partially offset by
principal repayments of approximately $561.9 million made to the Company during
fiscal year 1999. Included in other income for fiscal year 1999 is a fee
associated with the repayment of a construction loan of
23
approximately $1.9 million, yield maintenance payments of approximately
$8.1 million resulting from the repayment of three loans, and approximately
$1.0 million in additional revenue from certain cash flow participation features
on five of the Company's loan investments.
The Company's total costs and expenses during fiscal 1999 increased by
approximately $157.7 million compared to fiscal 1998. These increases were
generally the result of the increased scope of the Company's operations as a
result of the Recapitalization Transactions, costs associated with additional
lending operations, the TriNet acquisition and the acquisition of the Company's
external advisor.
The Company's interest expense increased by $46.5 million as a result of
higher interest rates and higher average borrowings by the Company on its credit
facilities and other term loans, the proceeds of which were used to fund
additional loan origination and acquisition activities. Further, interest
expense includes interest incurred by the Leasing Subsidiary subsequent to its
acquisition.
Property operating costs represent unreimbursed property operating expenses
incurred by the Leasing Subsidiary subsequent to its acquisition. All costs of
this kind were borne directly by the tenant on the Company's pre-existing credit
tenant leasing portfolio.
Depreciation and amortization increased as a result of a full year's
depreciation on the Company's pre-existing credit tenant leasing portfolio,
which it acquired in the Recapitalization Transactions, as well as depreciation
on the Leasing Subsidiary's net leased assets subsequent to its acquisition.
General and administrative costs increased by approximately $3.7 million as
a result of additional costs incurred subsequent to the acquisition of the
Company's external advisor, as well as additional administrative expenses
associated with the Leasing Subsidiary subsequent to its acquisition.
Base advisory fees increased by approximately $5.3 million as a result of
fees being incurred from June 16, 1999 through year end in the prior year and
through November 4, 1999 in fiscal 1999. Further, as a result of the Company's
expanded operations, incentive fees paid under the prior advisory contract
increased from $2.3 million in 1998 to $5.4 million in 1999. Subsequent to the
acquisition of the Company's external advisor, the Company is now
internally-managed and no further advisory fees will be incurred.
The Company's charge for provision for possible credit losses increased by
approximately $2.0 million as a result of expanded lending operations as well as
additional seasoning of the Company's existing lending portfolio. As more fully
discussed in Note 5 to the Company's Consolidated Financial Statements, the
Company has not realized any actual losses on any of its loan investments to
date.
Stock compensation expense declined by approximately $5.6 million as a
result of the non-recurring charge relating to the original grant of stock
options to the Company's external advisor in fiscal 1998 concurrently with the
consummation of the Recapitalization Transactions.
Finally, as more fully discussed in Note 4 to the Company's Consolidated
Financial Statements, included in fiscal 1999 costs and expenses is a
non-recurring charge of approximately $94.5 million relating to the acquisition
of the Company's external advisor.
YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997
During fiscal year 1998, total revenue increased by approximately
$126.2 million over total revenue for fiscal year 1997. This increase is a
result of the interest generated by the loans and other investments contributed
in the Recapitalization Transactions, as well as approximately $1.0 billion of
other loan investments newly-originated or acquired by the Company during 1998,
and an additional $16.5 million funded under existing loan commitments. The
increase was partially offset by principal repayments of approximately
$103.9 million made to the Company during fiscal year 1998. Included in other
income for fiscal year 1998 are fees associated with the repayment of two first
mortgage loans aggregating approximately $1.2 million, a gain of approximately
$0.9 million resulting from the repayment of a $2.8 million loan participation
which had been acquired at a discount, and approximately $0.6 million in
additional
24
revenue from certain cash flow participation features on two of the Company's
loan investments. In 1997, a gain of approximately $1.0 million was recognized
in other income on the early repayment of a loan acquired at a discount.
The increase in the Company's total costs and expenses during fiscal year
1998 compared to fiscal year 1997 is primarily due to increased interest expense
on the Company's borrowings used to fund its asset growth as well as the expense
associated with the issuance to the Advisor of options to acquire approximately
2.5 million of the Company's class A shares (see Note 11 to the Company's
Consolidated Financial Statements). Additionally, general and administrative
costs associated with the implementation of the Company's business plan and
advisory fee expenses increased the Company's total costs and expenses during
fiscal 1998.
The Company believes that because of the significant expansion of the scope
of its operations following the Recapitalization Transactions which occurred on
March 18, 1998, prior periods are not necessarily indicative of the Company's
future operating results or financial condition.
LIQUIDITY AND CAPITAL RESOURCES
The Company requires capital to fund its investment origination and
acquisition activities and operating expenses. The Company's capital sources
include cash flow from operations, borrowings under lines of credit, additional
term borrowings, long-term financing secured by the Company's assets, unsecured
financing and the issuance of common, convertible and/or preferred equity
securities.
As a result of the Recapitalization Transactions, the Lazard Transaction,
the TriNet acquisition, the acquisition of the Company's external advisor, and
other transactions completed by the Company, the Company has significant access
to capital resources to fund its existing business plan, which includes the
expansion of its real estate lending and credit tenant leasing businesses.
Further, the Company may acquire other businesses or assets using its capital
stock, cash or a combination thereof.
The distribution requirements under the REIT provisions of the Code restrict
the Company's ability to retain earnings and thereby replenish capital committed
to its operations. However, the Company believes that its significant capital
resources and access to financing will provide it with financial flexibility and
market responsiveness at levels sufficient to meet current and anticipated
capital requirements, including expected new lending and leasing transactions.
The Company's ability to meet its long-term (i.e., beyond one year)
liquidity requirements is subject to the renewal of its credit lines and/or
obtaining other sources of financing, including issuing additional debt or
equity from time to time. Any decision by the Company's lenders and investors to
enter into such transactions with the Company will depend upon a number of
factors, such as compliance with the terms of its existing credit arrangements,
the Company's financial performance, industry or market trends, the general
availability of and rates applicable to financing transactions, such lenders'
and investors' resources and policies concerning the terms under which they make
such capital commitments and the relative attractiveness of alternative
investment or lending opportunities.
Based on its monthly interest and other expenses, monthly cash receipts,
existing investment commitments and funding plans, the Company believes that its
existing sources of funds will be adequate to purposes of meeting its short- and
long-term liquidity needs. Material increases in monthly interest expense or
material decreases in monthly cash receipts would negatively impact the
Company's liquidity. On the other hand, material decreases in monthly interest
expense would positively affect the Company's liquidity.
As more fully discussed in Note 7 to the Company's consolidated financial
statements, at December 31, 1999, the Company had existing fixed-rate borrowings
of approximately $153.6 million secured by real estate under operating leases
which mature in 2009, an aggregate of approximately $254.3 million in
LIBOR-based, variable-rate loans secured by various senior and subordinate
mortgage investments which
25
mature in fiscal 2000, fixed-rate corporate debt obligations aggregating
approximately $353.6 million which mature between 2001 and 2017, and other
variable- and fixed-rate secured debt obligations aggregating approximately
$151.6 million which mature at various dates through 2010.
In addition, the Company has entered into LIBOR-based secured revolving
credit facilities of $675.0 and $500.0 million which expire in fiscal 2001 and
2000 respectively. (Subsequent to December 31, 1999, the Company extended the
maturity of its $500.0 million facility to 2002). As of December 31, 1999, the
Company had drawn approximately $593.0 million and $170.0 million under these
facilities. Availability under these facilities is based on collateral provided
under a borrowing base calculation. In addition, the Leasing Subsidiary has an
agreement with a group of 13 banks led by Bank of America, N.A. which provides
it with a $350.0 million unsecured revolving credit facility. This facility
matures on May 31, 2001 and has a one-year extension period at the Company's
option. Interest incurred on the facility is LIBOR-based with a margin dependent
on the Company's credit ratings. Facility fees under the credit facility are
also tied to its credit ratings. All of the available commitment under the
facility may be borrowed for general corporate and working capital needs of the
Leasing Subsidiary, as well as for investments. Under the terms of this
facility, the Leasing Subsidiary is generally permitted to make cash
distributions to the Company in an amount equal to 85% of cash flow from
operations in any rolling four-quarter period. The facility requires
interest-only payments until maturity, at which time outstanding borrowings are
due and payable. As of December 31, 1999, the Company had $186.7 million drawn
and $163.3 million available under this facility.
The Company has entered into LIBOR interest rate caps struck at 9.00%, 7.50%
and 7.50% in notional amounts of $300.0 million, $40.4 million and
$38.3 million, respectively, which expire in March 2001, January 2001 and June
2001, respectively. At December 31, 1999, the fair value appreciation of the
Company's interest rate caps was $2.2 million.
The Company has originated or acquired certain assets using proceeds from
LIBOR-based borrowings. In connection with such borrowings, the Company entered
into approximately $205.2 million of interest rate swaps to effectively fix the
interest rate on such obligations. In addition, in connection with the TriNet
acquisition, the Company acquired an interest rate swap which, together with
certain existing interest rate cap agreements, effectively fix the interest rate
on $75.0 million of the Leasing Subsidiary's LIBOR-based borrowings at 5.58%
plus the applicable margin through December 1, 2004. Management expects that it
will have aggregate LIBOR based borrowings at the Leasing Subsidiary in excess
of the notional amount for the duration of the swap. The actual borrowing cost
to the Company with respect to indebtedness covered by the swap will depend upon
the applicable margin over LIBOR for such indebtedness, which will be determined
by the terms of the relevant debt instruments. At December 31, 1999, the fair
value appreciation of the Company's interest rate swaps was $3.4 million.
The Company is currently pursuing or has consummated certain anticipated
long-term fixed-rate borrowings and had entered into certain derivative
instruments based on U.S. Treasury securities to hedge the potential effects of
interest rate movements on these transactions. Under these agreements, the
Company would generally receive additional cash flow at settlement if interest
rates rise and pay cash if interest rates fall. The effects of such receipts or
payments will be deferred and amortized over the term of the specific related
fixed-rate borrowings. During the year ended December 31, 1999, the Company
settled an aggregate notional amount of approximately $63.0 million that was
outstanding under such agreements, resulting in a receipt of approximately
$0.6 million to be amortized over the term of the anticipated borrowing.
During the year ended December 31, 1999, the Company refinanced its
$125.0 million term loan maturing March 15, 1999 with a $155.4 million term loan
maturing March 5, 2009. The new term loan bears interest at 7.44% per annum,
payable monthly, and amortizes over an approximately 22-year schedule. The new
term loan represented one of the forecasted transactions for which the Company
had previously entered into U.S. Treasury-based hedging transactions. The net
$3.4 million cost of the
26
settlement of such hedges has been deferred and will be amortized as an increase
to the effective financing costs of the new term loan over its 10-year term.
In the event that, in the opinion of management, it is no longer probable
that the remaining forecasted transactions will occur under terms substantially
equivalent to those projected, the Company will cease recognizing such
transactions as hedges and immediately recognize related gains or losses based
on actual settlement or estimated settlement value. No such gains or losses have
been recognized by the company.
STOCK REPURCHASE PROGRAM: The Board of Directors approved, and the Company
has implemented, a stock repurchase program under which the Company is
authorized to repurchase up to 5.0 million shares of its Common Stock from time
to time, primarily using proceeds from the disposition of assets and excess cash
flow from operations, but also using borrowings under its credit facilities if
the Company determines that it is advantageous to do so. As of December 31,
1999, the Company had repurchased approximately 2.3 million shares, at an
aggregate cost of approximately $40.4 million.
YEAR 2000
The statements in the following section include Year 2000 readiness
disclosure within the meaning of the Year 2000 Information and Readiness
Disclosure Act. The Company intends such statements to be covered by the safe
harbor provisions for forward-looking statements contained in the Private
Securities Reform Act of 1995, and is including this statement for purposes of
complying with these safe harbor provisions. Forward-looking statements, which
are based on certain assumptions and describe future plans, strategies and
expectations of the Company are generally identifiable by use of the words
"believe," "expect," "intend," "anticipate," "estimate," "project" or similar
expressions. The Company's ability to predict results or the actual effect of
future plans or strategies is inherently uncertain. Although the Company
believes that the expectations reflected in such forward-looking statements are
based on reasonable assumptions, the Company's actual costs progress and
expenses with respect to its plan to address Year 2000 issues could differ
materially from those set forth in the forward-looking statements. Factors which
could have a material adverse effect on the Company's results and progress
include, but are not limited to , changes in the expense of or delays, in: the
identification and upgrade or replacement by the Company of computer systems
that do not relate to information technology but include embedded technology;
and the Year 2000 compliance of vendors (including vendors of the Company's
computer information systems) or third-party service providers (including the
Company's primary bank and payroll processor). These risks and uncertainties
should be considered in evaluating forward-looking statements and undue reliance
should not be placed on such statements.
The term "Year 2000 issue" is a general term used to describe various
problems that may result from the improper processing by computer systems of
dates after 1999. These problems could results in a system failure or
miscalculations causing disruptions of operations. The term "Year 2000
compliant" is used in this discussion to mean that the system or device in
question will perform its essential functions in the Year 2000 without
significant operational problems.
PARENT: The Company implemented a plan in 1999 to assess, test and correct,
to the extent necessary, potential Year 2000 issues. Additionally, the Company
assessed the potential impacts from outside parties and developed contingency
plans for business interruptions after the date rollover. The costs involved in
performing this internally managed plan were not significant to the Company's
financial position or results of operations in 1998 and 1999. Since January 1,
2000, the Company has not experienced any material adverse impacts due to the
Year 2000 issue. While the primary risk to the Company with respect to the Year
2000 issue continues to be the inability of external parties to provide services
in a timely and accurate manner, to date, the Company is not aware of any such
disruption. As a result, the Company does not expect any remaining Year 2000
risk to have a material adverse impact to the Company.
27
LEASING SUBSIDIARY: The Leasing Subsidiary recognized that the Year 2000
may result in risk and implemented a plan in 1998 to prepare for potential Year
2000 issues. The Leasing Subsidiary's efforts to address potential Year 2000
issues were focused in the following four areas: (i) reviewing and taking any
necessary steps to correct the Leasing Subsidiary's computer information systems
(i.e., software applications and hardware platforms); (ii) evaluating and making
any necessary modifications to other computer systems that do not relate to
information technology but include embedded technology at its properties, such
as security, heating, ventilation, and air conditioning, elevator, fire and
safety systems; (iii) communicating with certain significant third-party service
providers to determine whether there will be any interruption in their systems
that could affect the Leasing Subsidiary; and (iv) developing contingency plans
for business interruptions after the date rollover. The Leasing Subsidiary's
Year 2000 compliance program is substantially complete.
The cost involved in performing this internally managed plan were not
significant to the Leasing Subsidiary's financial position or results of
operations. The Leasing Subsidiary expects that a substantial portion of these
costs will be passed back to tenants through recoveries of operating expense and
that the remaining costs of addressing the Year 2000 issues will be funded
through operating cash flows.
Since the date rollover on January 1, 2000, the Leasing Subsidiary has not
experienced any material adverse impact due to the Year 2000 issue. While the
primary risk to the Leasing Subsidiary, with respect to the Year 2000 issue, is
the ability of certain third party service providers to continue to provide
services in a timely and accurate manner, to date, the Leasing Subsidiary is not
aware of any such disruption. While the Leasing Subsidiary's efforts to address
its Year 2000 issues may involve additional costs, the Leasing Subsidiary
believes, based on available information, that these costs will not have a
material adverse effect on its business, financial condition or results of
operations.
NEW ACCOUNTING STANDARDS
In June 1997, the FASB issued Statement No. 131, "Disclosure about Segments
of an Enterprise and Related Information" ("SFAS No. 131") effective for
financial statements issued for periods beginning after December 15, 1997. SFAS
No. 131 requires disclosures about segments of an enterprise and related
information regarding the different types of business activities in which an
enterprise engages and the different economic environments in which it operates.
The Company adopted the requirements of this pronouncement in its financial
statements beginn