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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 September 30, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13
OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _________ to __________
Commission file number: 0-4408
RESOURCE AMERICA, INC.
------------------------------------------------------
(Exact name of registrant as specified in its charter)
DELAWARE 72-0654145
- ------------------------------- -------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1845 Walnut Street
Suite 1000
Philadelphia, PA 19103
- ---------------------------------------- ----------
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code: (215) 546-5005
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common stock, par value $.01 per share
(Title of class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
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. [X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [X] No [ ]
The aggregate market value of the voting common equity held by non-affiliates of
the registrant, based upon the closing price of such stock on December 15, 2003,
was approximately $229.6 million.
The number of outstanding shares of the registrant's common stock on December
15, 2003 was 17,354,300.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for registrant's 2003 Annual Meeting of
Stockholders are incorporated by reference in Part III of this Form 10-K.
[THIS PAGE INTENTIONALLY LEFT BLANK]
RESOURCE AMERICA, INC. AND SUBSIDIARIES
INDEX TO ANNUAL REPORT
ON FORM 10-K
Page
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PART I
Item 1: Business................................................................ 2 - 24
Item 2: Properties.............................................................. 24 - 28
Item 3: Legal Proceedings....................................................... 28
Item 4: Submission of Matters to a Vote of Security Holders..................... 28
PART II
Item 5: Market for Registrant's Common Equity and Related Stockholder Matters... 29
Item 6: Selected Financial Data................................................. 30
Item 7: Management's Discussion and Analysis of Financial Condition
and Results of Operation............................................... 31 - 50
Item 7A: Quantitative and Qualitative Disclosures about Market Risk.............. 51 - 52
Item 8: Financial Statements and Supplementary Data............................. 53 - 102
Item 9: Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure................................. 103
Item 9A: Controls and Procedures................................................. 103
PART III
Item 10: Directors and Executive Officers of the Registrant...................... 104
Item 11: Executive Compensation.................................................. 104
Item 12: Security Ownership of Certain Beneficial Owners and Management.......... 104
Item 13: Certain Relationships and Related Transactions.......................... 104
PART IV
Item 14: Principal Accountant Fees and Services.................................. 105
Item 15: Exhibits, Financial Statement Schedules and Reports on Form 8-K......... 105 - 107
SIGNATURES.............................................................................. 108
1
PART I
ITEM 1. BUSINESS
THE FOLLOWING DISCUSSION CONTAINS FORWARD-LOOKING STATEMENTS REGARDING EVENTS
AND FINANCIAL TRENDS WHICH MAY AFFECT THE REGISTRANT'S FUTURE OPERATING RESULTS
AND FINANCIAL POSITION. SUCH STATEMENTS ARE SUBJECT TO RISKS AND UNCERTAINTIES
THAT COULD CAUSE THE REGISTRANT'S ACTUAL RESULTS AND FINANCIAL POSITION TO
DIFFER MATERIALLY FROM THOSE ANTICIPATED IN SUCH STATEMENTS. IN OUR ENERGY
BUSINESS, THESE FACTORS INCLUDE, BUT ARE NOT LIMITED TO, LACK OF REVENUES,
COMPETITION, NEED FOR ADDITIONAL CAPITAL, RISKS ASSOCIATED WITH EXPLORING,
DEVELOPING, AND OPERATING OIL AND NATURAL GAS WELLS, AND FLUCTUATIONS IN THE
MARKET FOR NATURAL GAS AND OIL. IN REAL ESTATE, THESE FACTORS INCLUDE, BUT ARE
NOT LIMITED TO, RISKS OF LOAN DEFAULTS AND ADEQUACY OF OUR PROVISION FOR LOSSES
AND ILLIQUIDITY OF OUR PORTFOLIO. FOR A MORE COMPLETE DISCUSSION OF THE RISKS
AND UNCERTAINTIES TO WHICH WE ARE SUBJECT, SEE "RISK FACTORS" IN THIS ITEM 1.
General
We are a specialized asset management company that uses industry
specific expertise to generate and administer investment opportunities for our
own account and for outside investors in the energy, financial services, real
estate and equipment leasing sectors. As a specialized asset manager, we seek to
develop investment vehicles in which outside investors invest along with us and
for which we manage the assets acquired, pursuant to long-term management and
operating agreements. We limit our investment vehicles to investment areas where
we own existing operating companies or have specific expertise. We believe this
strategy enhances our return on investment as well as that of our third-party
investors. We typically receive an interest in the investment vehicle in
addition to the interest resulting from our investment. We managed approximately
$2.6 billion in assets at the end of fiscal 2003, as follows:
- $516 million of energy assets (20%) (1)
- $682 million of real estate assets (27%) (2)
- $1.3 billion of financial services assets (51%), (3) and
- $63 million of equipment leasing assets (2%) (4)
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(1) We value our managed energy assets as the sum of the PV-10 values, as
of September 30, 2003, of the proved reserves owned by us and the
investment partnerships and other entities whose assets we manage, plus
the book value, as of September 30, 2003, of the total assets of Atlas
Pipeline Partners, L.P. For a definition of the term "PV-10 value" see
Note 6 at page 3 of this report.
(2) We value our managed real estate assets as the sum of the amount of our
outstanding loan receivables, including the loans underlying the assets
and liabilities consolidated pursuant to Financial Accounting Standards
Board Interpretation No. 46, plus the book value of our interests in
real estate and the sum of the book values of real estate assets and
other assets held by a real estate investment partnership we managed as
of September 30, 2003.
(3) We value our financial services assets as the acquisition cost of
securities acquired by ventures which we co-manage that acquired trust
preferred securities of regional banks and bank holding companies.
(4) We value our equipment leasing assets as the sum of the book values of
equipment held by equipment leasing ventures or partnerships which we
managed as of September 30, 2003.
2
During fiscal 2003, we continued developing our energy operations,
which account for approximately 79% of our total revenues and 35% of our total
assets. The number of gross wells we drilled increased 17% and the number of net
wells increased 16% in fiscal 2003 as compared to fiscal 2002. We have funded
our development operations primarily by sponsoring drilling investment
partnerships. We, and our drilling investment partnerships, own interests in
approximately 5,300 wells, 85% of which we operate. At September 30, 2003,
proved reserves net to our interest were approximately 144.4 Bcfe (5) with a
PV-10 value (6) of $191.4 million and a standardized measure value(7) of $144.3
million. Of these reserves, 92% were natural gas and 68% were classified as
proved developed reserves.
We also developing our natural gas transportation operations, which we
conduct through Atlas Pipeline Partners, L.P., a publicly held (AMEX: APL)
natural gas pipeline master limited partnership of which a subsidiary of ours is
the general partner and in which we own a 39% interest. At September 30, 2003,
Atlas Pipeline Partners owned approximately 1,400 miles of intrastate gathering
systems located in eastern Ohio, western New York and western Pennsylvania, to
which approximately 4,200 natural gas wells were connected. In September 2003,
Atlas Pipeline Partners entered into an agreement to acquire the Alaska Pipeline
Company, LLC, the owner of approximately 354 miles of natural gas gathering
systems in the Anchorage, Alaska area.
In real estate finance, we continued to implement our strategic shift
from loan acquisition and resolution to the sponsorship and management of real
estate investments and the management of our existing loan portfolio. We
sponsored two private real estate partnerships, one of which was fully funded in
fiscal 2003 and anticipates full investment in properties in December 2003, and
one of which is in the offering stage. We have not purchased any loans since
fiscal 1999 although, as part of our portfolio management activities, we have
from time to time purchased senior lien interests relating to properties in
which we have junior lien interests. We did not purchase any loan participations
in fiscal 2003, but did acquire property interests through loan restructurings
and foreclosures.
We have also continued the development of our financial services and
equipment leasing operations. In financial services, we have co-sponsored and
are the co-manager of five investment entities that were formed to acquire the
trust preferred securities of small to mid-sized regional banks and bank holding
companies. One of these entities was sponsored in fiscal 2002 and became funded
and fully invested in fiscal 2002. Two of these entities were sponsored, funded
and became fully invested during fiscal 2003. The fourth and fifth entities were
in the offering stage in fiscal 2003, and became funded and fully invested by
December 2003. In equipment leasing, our Lease Equity Appreciation Fund I, L.P.
("LEAF I LP"), lease investment partnership commenced operations in March
2003, and continues in its offering stage. In April 2003, we entered into an
agreement with a third party under which we originate equipment leases for sale
to that party, to a maximum of $300.0 million of equipment leases, retaining
management and servicing of these leases.
- ----------
(5) "Mcfe," "Mmcfe" and "Bcfe" mean thousand cubic feet equivalent, million
cubic feet equivalent and billion cubic feet equivalent, respectively.
Natural gas volumes are converted to barrels, or "Bbls", of oil
equivalent using the ratio of six thousand cubic feet, or "Mcf" of
natural gas to one Bbl of oil and are stated at the official
temperature and pressure bases of the area in which the reserves are
located.
(6) "PV-10 value" means, in accordance with SEC guidelines, the estimated
future net cash flow to be generated from the production of proved
reserves discounted to present value using an annual discount rate of
10%. This amount is calculated net of estimated production costs and
future development costs, using prices and costs in effect as of a
specified date, without escalation and without giving effect to
non-property or non-production related expenses such as general
administrative expenses, debt service or future income tax expense, or
to depreciation, depletion and amortization.
(7) "Standardized measure value" means the estimated future net cash flows
to be generated from the production of proved reserves less a 10%
discount. This amount is calculated using year-end prices, adjusted for
only fixed and determinable increases in natural gas prices provided by
contractual arrangements. Future net cash flows are reduced by
estimated future costs to develop and produce the proved reserves,
based on year-end cost levels. See Note 18 to our Consolidated
Financial Statements. The difference between this amount and the total
PV-10 value is attributable to estimated income taxes.
3
During 2003 we reduced the amount of our outstanding 12% senior notes
due 2004 and expect to have fully paid them off by January 2004, seven months
ahead of their maturity date. We repurchased $11.3 million of senior notes
during fiscal 2003 and, subsequent to fiscal year-end, repurchased an additional
$1.0 million of senior notes. Also subsequent to year end, in November 2003 we
called our senior notes for redemption, of which $40.0 million are scheduled for
redemption on December 22, 2003 and the balance on January 20, 2004. After we
sent notice of redemption, we repurchased $26.9 million of senior notes in
November 2003 and applied them to the December 22, 2003 redemption amount.
Our consolidated financial statements for fiscal 2003 have been
affected by our early adoption of Financial Accounting Standards Board's
Interpretation 46, "Consolidation of Variable Interest Entities," which we refer
to as FIN 46. As a result, we have consolidated certain entities in our real
estate loan business into our financial statements for the first time. FIN 46,
intended to increase the transparency of off-balance sheet transactions and
structures, affects our holding of real estate loans acquired at a discount
between 1991 and 1998. Since we control certain important indicia relating to
these loans, including cash flow and appointment of a property manager, FIN 46
affects our accounting for these holdings. FIN 46's consolidation criteria are
based on analysis of risks and rewards, not formalities of control and
ownership, and represent a significant and complex modification of previous
accounting principles. The adoption of FIN 46 resulted in a non-cash cumulative
effect adjustment of $13.9 million, net of taxes, in the fourth quarter of
fiscal 2003, as well as in our recording assets and liabilities of $78.2 million
and $45.2 million, respectively, related to the newly consolidated entities. In
line with our strategic focus in real estate, we classified an additional $222.7
million of our FIN 46 assets as being held for sale along with $141.5 million of
associated liabilities. For a more detailed discussion of FIN 46, you should
read Item 7, "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Cumulative Effect of Change in Accounting Principle" and
Note 3, Adoption of FASB Interpretation 46, to our Consolidated Financial
Statements.
For financial information about our operating segments, see Note 17,
Operating Segment Information and Major Customer Information, to our
Consolidated Financial Statements.
Energy
General. We concentrate our energy operations in the western New York,
eastern Ohio and western Pennsylvania region of the Appalachian Basin. As of
September 30, 2003, we owned proved reserves of approximately 144.4 Bcfe as
compared to 123.7 Bcfe at the beginning of fiscal 2000. As of September 30,
2003:
- We had, either directly or through investment partnerships
managed by us, interests in approximately 5,300 gross wells,
including royalty or overriding royalty interests in over 600
wells. We operate 85% of these wells.
- Wells in which we have an interest produced, net to our
interest, approximately 19,100 Mcf of natural gas and 438 Bbls
of oil per day.
- We had an acreage position of approximately 431,200 gross
(379,000 net) acres, of which 205,400 gross (190,500 net)
acres were undeveloped.
- We owned and operated, either directly or through Atlas
Pipeline Partners, approximately 1,600 miles of gas gathering
systems and pipelines.
4
Since 1976, we or our predecessors have funded our development
operations through private and, since 1992, public drilling investment
partnerships. We act as the managing general partner of each of these
partnerships, contribute the leases on which the partnership drills, and
contribute a proportionate share of the partnership's capital. We receive an
interest in a partnership proportionate to the capital and leases we contribute,
generally 25% to 27%, plus a 7% carried interest. We typically subordinate a
portion of our partnership interest to a preferred return to the limited
partners for the first five years of distributions. We also receive monthly
operating fees of approximately $275 per well and monthly administrative fees of
$75 per well. In addition, we typically act as the drilling contractor and
operator of the wells drilled by the partnerships on a cost-plus basis. In
fiscal 2003, our drilling partnerships invested $68.6 million in drilling and
completing wells, of which we contributed $15.7 million. In fiscal 2002, our
drilling partnerships invested $75.5 million in drilling and completing wells,
of which we contributed $19.7 million. In fiscal 2001, our drilling partnerships
invested $55.1 million in drilling and completing wells of which we contributed
$14.3 million. Additionally, we invested $9.3 million, $10.6 million and $8.8
million in syndication and organization costs related to these partnerships in
fiscal 2003, 2002 and 2001, respectively.
We transport the natural gas produced from wells we operate through the
gas gathering pipeline systems owned and operated by Atlas Pipeline Partners.
See "Energy- Pipeline Operations." We also own directly approximately 200 miles
of gathering systems. The gathering systems transport the natural gas to public
utility pipelines for delivery to customers. To a lesser extent, the gathering
systems deliver natural gas directly to customers. We sell the natural gas we
produce to customers such as gas brokers and local utilities under a variety of
contractual arrangements. We sell the oil we produce to regional oil refining
companies at the prevailing spot price for Appalachian crude oil.
Appalachian Basin Overview. The Appalachian Basin includes the states
of Kentucky, Maryland, New York, Ohio, Pennsylvania, Virginia, West Virginia and
Tennessee. It is the most mature oil and gas producing region in the United
States, having established the first oil production in 1859. In addition, the
Appalachian Basin is strategically located near the energy-consuming regions of
the mid-Atlantic and northeastern United States which has historically resulted
in Appalachian producers selling their natural gas at a premium to the benchmark
price for natural gas on the New York Mercantile Exchange, or NYMEX. According
to the Energy Information Administration, a branch of the U.S. Department of
Energy, in 2002 there were 22.8 trillion cubic feet, or Tcf, of natural gas
consumed in the United States which represented approximately 23.9% of the total
energy used. Additionally, at December 31, 2001, there were approximately
137,000 gas wells in the Appalachian Basin which represented approximately 37.3%
of the total number of gas wells in the United States. Of those wells, we and
our drilling investment partnerships own interests in approximately 5,600 wells,
85% of which we operate. The Appalachian Basin accounted for approximately 3.1%
of total 2002 domestic natural gas production, or 603 Bcf. Furthermore,
according to the Advance Summary 2002 Annual Report published by the Energy
Information Administration, Office of Oil and Gas in October 2003, the
Appalachian Basin holds 10.6 Tcf of economically recoverable reserves,
representing approximately 5.7% of total domestic reserves as of December 31,
2002. The raised forecast in August 2003 of World Oil magazine predicted that
approximately 5,060 gas wells would be drilled in the Appalachian Basin during
2003, representing approximately 17.1% of the total number of wells to be
drilled in the United States, and that the average depth of those 4,600 wells
would be approximately 3,200 feet, compared to an estimated average depth of
5,100 feet for nationwide drilling efforts in 2003. The American Petroleum
Institute has reported that in recent years the drilling success rate in the
Appalachian basin has exceeded 90%. Our success rates have averaged in excess of
95% over the past 15 years.
Natural Gas and Oil Properties. For information concerning our natural
gas and oil properties, including the number of wells in which we have a working
interest, production, reserve and acreage information and information concerning
future dismantlement, restoration, reclamation and abandonment costs and salvage
values, see Item 2, "Properties - Energy."
5
Natural Gas Hedging. Pricing for gas and oil production has been
volatile and unpredictable for many years. To limit exposure to changing natural
gas prices, from time to time we use hedges. Through our hedges, we seek to
provide a measure of stability in the volatile environment of natural gas
prices. Our risk management objective is to lock in a range of pricing for
expected production volumes. This allows us to forecast future earnings within a
predictable range. For the fiscal year ended September 30, 2003, approximately
61% of our volumes produced were hedged in this manner. For the fiscal year
ending September 30, 2004, we estimate that approximately 50% of our natural gas
volumes produced will be hedged in this manner, leaving our remaining production
volumes to be sold at prevailing spot market prices in the month produced. For
information concerning our natural gas hedging, see Item 7A, "Quantitative and
Qualitative Disclosures about Market Risk - Energy - Commodity Price Risk."
Pipeline Operations. Atlas Pipeline Partners GP LLC, our indirect
wholly owned subsidiary, is the general partner of Atlas Pipeline Partners. On a
consolidated basis, it has a 2% interest in Atlas Pipeline Partners. In
addition, as of September 30, 2003, we owned 1,641,026 subordinated units of
Atlas Pipeline Partners, constituting a 37% interest in it. Atlas Pipeline
Partners GP manages the activities of Atlas Pipeline Partners using Atlas
America, Inc. a wholly owned subsidiary, personnel who act as its officers and
employees.
At September 30, 2003, Atlas Pipeline Partners owned approximately
1,400 miles of intrastate gathering systems located in eastern Ohio, western New
York and western Pennsylvania, to which approximately 4,200 natural gas wells
were connected. Atlas Pipeline Partners' gathering systems had an average daily
throughput of 52.7 Mmcf , 49.7 Mmcf and 45.1 Mmcf of natural gas in fiscal 2003,
2002 and 2001, respectively.
In May 2003, Atlas Pipeline Partners concluded a public offering of
1,092,500 common units, obtaining net proceeds of $25.2 million after deduction
of expenses, including underwriting discounts and commissions. The offering
proceeds were used to pay down Atlas Pipeline Partners' credit facility and to
provide funding for planned capital projects and working capital.
Our subordinated units in Atlas Pipeline Partners are a special class
of interest under which our right to receive distributions is subordinated to
those of the publicly held common units. The subordination period is scheduled
to expire on December 31, 2004 unless certain financial tests specified in the
partnership agreement are not met. Upon expiration of the subordination period,
our subordinated units will convert to an equal number of common units.
As general partner, we have the right to receive incentive
distributions if Atlas Pipeline Partners meets or exceeds its minimum quarterly
distribution obligations to the common and subordinated units. The incentive
distributions are as follows:
- of the first $.10 per unit available for distribution in
excess of the $.42 minimum quarterly distribution, 85% goes to
all unit holders (including to us as a subordinated unit
holder) and 15% goes to us as a general partner;
- of the next $.08 per unit available for distribution, 75% goes
to all unit holders and 25% goes to us as a general partner,
and
- after that, 50% goes to all unit holders and 50% goes to us as
a general partner.
We have agreements with Atlas Pipeline Partners that require us to do
the following:
- Pay gathering fees to Atlas Pipeline Partners for natural gas
gathered by the gathering systems equal to the greater of $.35
per Mcf ($.40 per Mcf in certain instances) or 16% of the
gross sales price of the natural gas transported. For the
years ended September 30, 2003, 2002 and 2001, these gathering
fees averaged $.75, $.57 and $.81 per Mcf, respectively.
- Connect wells owned or controlled by us that are within
specified distances of Atlas Pipeline Partners' gathering
systems to those gathering systems.
6
- Provide stand-by construction financing to Atlas Pipeline
Partners, at its request, for gathering system extensions and
additions, to a maximum of $1.5 million per year, until 2005.
We have not been required to provide any construction
financing under this agreement since Atlas Pipeline Partners'
inception.
We believe that we comply with all the requirements of these
agreements.
On September 16, 2003, Atlas Pipeline Partners entered into an
agreement to acquire the Alaska Pipeline Company for $95.0 million. Completion
of the acquisition is conditioned upon obtaining approval of the Regulatory
Commission of Alaska, which regulates Alaska Pipeline Company's operations, and
the expiration, without adverse action, of the waiting period under the
Hart-Scott-Rodino Antitrust Improvements Act of 1976. At closing, the seller
will enter into various agreements that will require the seller to pay Alaska
Pipeline Company a minimum monthly capacity reservation fee and a volume-based
transportation fee for 10 years. These agreements also require the seller to
provide operational, maintenance and administrative services for five years at a
specified fee, subject to inflation-based adjustments in the fourth and fifth
contract years. Atlas Pipeline Partners will form a subsidiary to implement the
acquisition. The subsidiary will fund the acquisition with a combination of debt
and preferred equity financing and an equity contribution from Atlas Pipeline
Partners. Atlas Pipeline Partners equity contribution will be funded in part by
a draw on its existing line of credit.
Availability of Oil Field Services. We contract for drilling rigs and
purchase goods and services necessary for the drilling and completion of wells
from a number of drillers and suppliers, none of which supplies a significant
portion of our annual needs. During fiscal 2003, we faced no shortage of these
goods and services. We cannot predict the duration of the current supply and
demand situation for drilling rigs and other goods and services with any
certainty due to numerous factors affecting the energy industry and the demand
for natural gas and oil.
Major Customers. During fiscal 2003, 2002 and 2001, gas sales to First
Energy Solutions Corporation accounted for 14%, 13% and 14%, respectively, of
our total consolidated revenues.
Competition. The energy industry is intensely competitive in all of its
aspects. Competition arises not only from numerous domestic and foreign sources
of natural gas and oil but also from other industries that supply alternative
sources of energy. Competition is intense for the acquisition of leases
considered favorable for the development of natural gas and oil in commercial
quantities. Product availability and price are the principal means of
competition in selling oil and natural gas. Many of our competitors possess
greater financial and other resources than ours which may enable them to
identify and acquire desirable properties and market their natural gas and oil
production more effectively than we do. While it is impossible for us to
accurately determine our comparative industry position, we do not consider our
operations to be a significant factor in the industry. Moreover, we also compete
with a number of other companies that offer interests in drilling partnerships.
As a result, competition for investment capital to fund drilling partnerships is
intense.
Markets. The availability of a ready market for natural gas and oil
produced by us, and the price obtained, depends upon numerous factors beyond our
control, including the extent of domestic production, import of foreign natural
gas and oil, political instability in oil and gas producing countries and
regions, market demand, the effect of federal regulation on the sale of natural
gas and oil in interstate commerce, other governmental regulation of the
production and transportation of natural gas and oil and the proximity,
availability and capacity of pipelines and other required facilities. During
fiscal 2003, 2002 and 2001, we experienced no problems in selling our natural
gas and oil, although prices have varied significantly during and after those
periods.
7
Governmental Regulation. Our energy business and the energy industry in
general are heavily regulated by federal and state authorities, including
regulation of production, environmental quality, pollution control, and pipeline
construction and operation. The intent of federal and state regulations
generally is to prevent waste, protect rights to produce natural gas and oil
between owners in a common reservoir and control contamination of the
environment. Failure to comply with regulatory requirements can result in
substantial fines and other penalties. We believe that we substantially comply
with applicable regulatory requirements. The following discussion of the
regulations of the United States energy industry does not intend to constitute a
complete discussion of the various statutes, rules, regulations and
environmental orders to which our operations may be subject.
Regulation of Exploration and Production. Many states require permits
for drilling operations, drilling bonds and reports concerning operations, and
impose requirements concerning the location of wells, the method of drilling and
casing wells, the surface use and restoration of properties on which wells are
drilled, the plugging and abandoning of wells and the disposal of fluids used in
connection with these operations. Many states also impose conservation
requirements, principally regulating the density of wells which may be drilled
and the unitization or pooling of properties. In this regard, some states allow
the forced pooling or integration of tracts to facilitate exploration while
other states rely primarily or exclusively on voluntary pooling of lands and
leases. In areas where pooling is voluntary, it may be more difficult to form
units and, therefore, more difficult to develop a project if the operator owns
less than 100% of the leasehold. In addition, some state conservation laws
establish requirements regarding production rates and related matters. The
effect of these regulations may limit the amount we can produce and may limit
the number of wells or the locations which we can drill. The regulatory burden
on the energy industry increases our costs of doing business and, consequently,
affects our profitability. Since these laws and regulations are frequently
expanded, amended and reinterpreted, we are unable to predict the future cost or
impact of complying with such regulations.
Regulation of Pipelines. While natural gas pipelines generally are
subject to regulation by the Federal Energy Regulatory Commission ("FERC") under
the Natural Gas Act of 1938, because Atlas Pipeline Partners' individual
gathering systems perform primarily a gathering function, as opposed to the
transportation of natural gas in interstate commerce, Atlas Pipeline Partners
believes that it is not subject to regulation under the Natural Gas Act.
However, Atlas Pipeline Partners delivers a significant portion of the natural
gas it transports to interstate pipelines subject to FERC regulation. The
regulation principally involves transportation rates and service conditions
which affect revenues we receive for our natural gas production. Through a
series of initiatives by FERC, the interstate natural gas transportation and
marketing system has been substantially restructured to increase competition. In
particular, in Order No. 636, FERC required that interstate pipelines provide
transportation separate, or "unbundled," from their sales activities, and
required that interstate pipelines provide transportation on an open access
basis that is equal for all natural gas suppliers. Although Order No. 636 does
not directly regulate our production and marketing activities, it does affect
how buyers and sellers gain access to the necessary transportation facilities
and how we and our competitors sell natural gas in the marketplace. Courts have
largely affirmed the significant features of Order No. 636 and the numerous
related orders pertaining to individual pipelines, although some appeals remain
pending and FERC continues to review and modify its regulations regarding the
transportation of natural gas. We cannot predict what actions FERC will take in
the future. However, we do not believe that any action taken will affect us in a
way that materially differs from the way it affects other natural gas producers,
gatherers and marketers.
State-level regulation for pipeline operations, similar to that of
Atlas Pipeline Partners', is through the Public Utility Commission of Ohio, the
New York Public Service Commission and the Pennsylvania Public Utilities
Commission. Atlas Pipeline Partners has been granted an exemption from
regulation by the Public Utility Commission of Ohio, and believes that it is not
subject to New York or Pennsylvania regulation since it does not generally
provide service to the public. Alaska Pipeline Company, upon its acquisition by
Atlas Pipeline Partners, will be subject to regulation by the Regulatory
Commission of Alaska as to rates for natural gas transportation, construction of
new facilities, pipeline extensions, abandonment of services and similar
matters.
8
Environmental and Safety Regulation. Under the Comprehensive
Environmental Response, Compensation and Liability Act, the Toxic Substances
Control Act, the Resource Conservation and Recovery Act, the Oil Pollution Act
of 1990, the Clean Air Act, and other federal and state laws relating to the
environment, owners and operators of wells producing natural gas or oil, and
pipelines, can be liable for fines, penalties and clean-up costs for pollution
caused by the wells or the pipelines. Moreover, the owners' or operators'
liability can extend to pollution costs from situations that occurred prior to
their acquisition of the assets. Natural gas pipelines are also subject to
safety regulation under the Natural Gas Pipeline Safety Act of 1968 and the
Pipeline Safety Act of 1992 which, among other things, dictate the type of
pipeline, quality of pipeline, depth, and methods of welding and other
construction-related standards. State public utility regulators in New York,
Ohio and Pennsylvania have either adopted federal standards or promulgated their
own safety requirements consistent with federal regulations.
We do not anticipate that we will be required in the near future to
expend amounts that are material in relation to our revenues by reason of
environmental laws and regulations, but since these laws and regulations change
frequently, we cannot predict the ultimate cost of compliance. We cannot assure
you that more stringent laws and regulations protecting the environment will not
be adopted or that we will not otherwise incur material expenses in connection
with environmental laws and regulations in the future.
Real Estate Finance
General. From fiscal 1991 through fiscal 1999, we sought to purchase
commercial real estate loans at discounts to their outstanding loan balances and
the appraised value of their underlying properties. In 1999, we shifted our
focus to managing our existing loan portfolio and, beginning in 2002, have
sought to expand our real estate operations through the sponsorship and
management of real estate investment partnerships. While we may sell, purchase
or originate portfolio loans or real property investments in the future as part
of our management process or as opportunities arise, during fiscal 2003 we
reduced the number of loans in our portfolio through the repayment of two loans,
the restructuring of one loan and the foreclosure of four loans. We have
retained interests in the properties underlying the restructured and foreclosed
loans. In fiscal 2002, we sponsored one real estate investment program, SR Real
Estate Investors, L.P., which completed a $20.0 million private equity offering
in fiscal 2003. This partnership is currently in the acquisition stage, which it
expects to complete in December 2003. At the conclusion of the acquisition
stage, we expect that the partnership will own approximately $87.8 million (net
book value) of multi-family residential properties. In fiscal 2003, we sponsored
a second program, S.R. Real Estate Investors II, L.P. which commenced operations
subsequent to fiscal year end and continues in its offering stage.
Real Estate Loan Portfolio. The following table sets forth information
concerning our portfolio loans at September 30, 2003. We include in this table
loans that we account for under FIN 46, presented in accordance with the legal
relationship of creditor/debtor between us and the borrowers.
9
Loan Status - Portfolio Loans. The following table sets forth
information about our portfolio loans, classified as portfolio loans on our
consolidated balance sheet, grouped by the type of property underlying the
loans, as of September 30, 2003 (in thousands):
Fiscal Appraised
Year Outstanding Value of
Loan Type of Loan Loan Property Cost of Third Party
Number Property Location Acquired Receivable(1) Loan(2) Investment(3) Liens (4)
---------- ------------ -------------- -------- ------------- --------- ------------- -----------
020 (15) Office New Jersey 1996 $ 8,822 $ 4,700 $ 3,300 $ 2,258
035 (09)(10) Office Pennsylvania 1997 2,799 2,900 1,846 1,664
053 (13) Office Washington, DC 1999 136,918 94,700 71,830 63,354
------------- --------- ------------- -----------
Office Total $ 148,539 $ 102,300 $ 76,976 $ 67,276
------------- --------- ------------- -----------
022 Multi-family Pennsylvania 1996 $ 6,326 $ 5,200 $ 2,472 $ 3,310
024 Multi-family Pennsylvania 1996 3,196 4,300 2,743 2,342
041 Multi-Family Connecticut 1998 20,974 22,600 14,737 13,312
------------- --------- ------------- -----------
Multifamily Total $ 30,496 $ 32,100 $ 19,952 $ 18,964
------------- --------- ------------- -----------
013 (9)(14) Single User/
Commercial California 1994 $ 2,492 $ 2,700 $ 1,705 $ 2,273
018 Single User/
Retail California 1996 3,403 6,800 2,678 1,969
------------- --------- ------------- -----------
Commercial Total $ 5,895 $ 9,500 $ 4,383 $ 4,242
------------- --------- ------------- -----------
Condo/
Multifamily Pennsylvania 2001 $ 596 - $ 596 -
Office Pennsylvania 2003 1,350 - 1,350 -
------------- -------------
Other Total $ 1,946 - $ 1,946 -
------------- -------------
Balance as of September 30, 2003 $ 186,876 $ 143,900 $ 103,257 $ 90,482
============= ========= ============= ===========
Company's Net
Interest in
Carried Cost Outstanding
Loan Type of Net of Loan
Number Property Investment(5) Investment(6) Receivables (7)
---------- ------------ ------------- ------------- ---------------
020 (15) Office $ 768 $ 2,322 $ 6,564
035 (09)(10) Office 96 961 1,135
053 (13) Office 6,830 24,331 73,564
------------- ------------- ---------------
Office Total $ 7,694 $ 27,614 $ 81,263
------------- ------------- ---------------
022 Multi-family $ (963) $ 981 $ 3,016
024 Multi-family 424 764 854
041 Multi-Family 637 7,757 7,662
------------- ------------- ---------------
Multifamily Total $ 98 $ 9,502 $ 11,532
------------- ------------- ---------------
013 (9)(14) Single User/
Commerical $ (543) $ 122 $ 219
018 Single User/
Retail 709 1,221 1,434
------------- ------------- ---------------
Commercial Total $ 166 $ 1,343 $ 1,653
------------- ------------- ---------------
Condo/ $ 596 $ 596 $ 596
Multifamily
Office 1,350 1,361 1,350
------------- ------------- ---------------
Other Total $ 1,946 $ 1,957 $ 1,946
------------- ------------- ---------------
Balance as of September 30, 2003 $ 9,904 $ 40,416 $ 96,394
============= ============= ===============
10
Loan status - Loans held as FIN 46 Entities' Assets. The following
table sets forth information about our portfolio loans, classified as FIN 46
entities assets on our consolidated balance sheet, grouped by the type of
property underlying the loans, as of September 30, 2003 (in thousands).
Fiscal Appraised
Year Outstanding Value of
Loan Type of Loan Loan Property Cost of Third Party
Number Property Location Acquired Receivable(1) Loan(2) Investment(3) Liens(4)
----------- ------------ -------------- -------- ------------- ----------- ------------- -----------
005 (16) Office Pennsylvania 1993 $ 11,788 $ 1,700 $ 1,747 $ -
014 (8) Office Washington, DC 1995 22,975 14,300 12,696 5,895
026 (9) Office Pennsylvania 1997 11,380 4,700 2,953 1,961
029 Office Pennsylvania 1997 10,144 4,075 3,186 -
044 (11) Office Washington, DC 1998 118,446 108,525 85,120 65,661
049 (12) Office Maryland 1998 111,209 99,000 92,328 57,552
------------- ----------- ------------ ------------
Office Total $ 285,942 $ 232,300 $ 198,030 $ 131,069
------------- ----------- ------------ ------------
015 Condo/
Multifamily North Carolina 1995 & $ 6,403 $ 5,917 $ 2,337 $ 2,808
028 Condo/ 1997
Multifamily North Carolina 1997 640 498 452 -
031 Multifamily Connecticut 1997 12,089 12,000 4,788 8,833
032 Multifamily New Jersey 1997 14,684 14,300 7,404 -
050 Multifamily Illinois 1998 57,124 24,000 20,014 14,845
------------- ----------- ------------ ------------
Multifamily
Total $ 90,940 $ 56,715 $ 34,995 $ 26,486
------------- ----------- ------------ ------------
007 (9)(17) Single User/
Retail Minnesota 1993 $ 6,045 $ 2,300 $ 1,490 $ 1,706
017 (9) Single User/
Retail West Virginia 1996 1,705 1,600 904 932
------------- ----------- ------------ ------------
Commercial
Total $ 7,750 $ 3,900 $ 2,394 $ 2,638
------------- ----------- ------------ ------------
025 Hotel/
Commercial Georgia $ 8,919 $ 10,173 $ 7,263 $ -
------------- ----------- ------------ ------------
Hotel Total $ 8,919 $ 10,173 $ 7,263 $ -
------------- ----------- ------------ ------------
Balance as of September 30, 2003 $ 393,551 $ 303,088 $ 242,682 $ 160,193
============= =========== ============ ============
Company's Net
Interest in
Carried Cost Outstanding
Loan Type of Net of Loan
Number Property Investment(5) Investment(6) Receivables (7)
------------ ------------ ------------ ------------- ---------------
005 (16) Office $ 1,747 $ 1,484 $ 11,788
014 (8) Office 6,209 6,552 17,080
026 (9) Office 721 1,310 9,419
029 Office 3,186 3,002 10,144
044 (11) Office 21,472 36,650 52,785
049 (12) Office 32,329 35,841 53,657
------------ ------------- ---------------
Office Total $ 65,664 $ 84,839 $ 154,873
------------ ------------- ---------------
015 Condo/
Multifamily $ (663) $ 1,319 $ 3,595
028 Condo/
Multifamily 452 233 640
031 Multifamily (4,587) 172 3,256
032 (12) Multifamily 7,404 11,249 14,684
050 Multifamily 4,664 6,969 42,279
------------ ------------- ---------------
Multifamily Total $ 7,270 $ 19,942 $ 64,454
------------ ------------- ---------------
007 (9)(17) Single User/
Retail $ (609) $ 394 $ 4,339
017 (9) Single User/
Retail (95) 631 773
------------ ------------- ---------------
Commercial Total $ (704) $ 1,025 $ 5,112
------------ ------------- ---------------
025 Hotel/
Commercial $ 6,388 $ 7,796 $ 8,919
------------ ------------- ---------------
Hotel Total $ 6,388 $ 7,796 $ 8,919
------------ ------------- ---------------
Balance as of September 30, 2003 $ 78,618 $ 113,602 $ 233,358
============ ============= ===============
The following table reconciles the carried cost of investment for our
portfolio loans classified as FIN 46 assets to our consolidated balance at
September 30, 2003 (in thousands).
FIN 46 entities' assets and other assets held for sale........................ $ 222,677
FIN 46 entities' liabilities and other liabilities associated with
assets held for sale................................................... (141,473)
Real estate owned classified as held for sale net of related debt............. (665)
FIN 46 entities' assets....................................................... 78,247
FIN 46 entities' liabilities.................................................. (45,184)
-----------
Balance at September 30, 2003................................................. $ 113,602
===========
- ----------
(1) Consists of the original stated or face value of the obligation plus
interest and the amount of the senior lien interest at September 30,
2003.
(2) We generally obtain appraisals on each of the properties underlying our
portfolio loans at least once every three years.
(3) Consists of the original cost of our investment, including the amount
of any senior lien obligation to which the property remains subject,
plus subsequent advances, but excludes the proceeds to us from the sale
of senior lien interests or borrower refinancings.
11
(4) Represents the amount of the senior lien interests at September 30,
2003.
(5) Represents the unrecovered costs of our investment, calculated as the
cash investment made in acquiring the loan plus subsequent advances,
less cash received from the sale of a senior lien interest in or
borrower refinancing of the loan. Negative amounts represent our
receipt of proceeds from the sale of senior lien interests or borrower
refinancings in excess of our investment.
(6) Represents the book cost of our investment, including subsequent
advances, after accretion of discount and allocation of gains from the
sale of a senior lien interest in, or borrower refinancing of, the
loan, but excludes an allowance for possible losses of $1.4 million.
For loans held as FIN 46 entities' assets, the carried costs represents
the book cost of our investment adjusted to reflect the requirements
of FIN 46.
(7) Consists of the amount set forth in the column "Outstanding Loan
Receivable" less senior lien interests at September 30, 2003.
(8) The borrower, Washington Properties Limited Partnership, is a limited
partnership in which Edward E. Cohen, our Chairman, Chief Executive
Officer and President, Jonathan Z. Cohen, our Chief Operating Officer,
Executive Vice President and director, Scott F. Schaeffer, our former
Vice Chairman and Executive Vice President, and Adam Kauffman, the
president of Brandywine Construction & Management are equal limited
partners.
(9) With respect to loans 7 and 17, A. Kaufman is the general partner of
the borrower and, with respect to loan 29, he is the president of the
sole general partner of the borrower. With respect to loans 26 and 35,
Mr. Kauffman is the sole shareholder of the general partner of the
borrower.
(10) The borrower, New 1521 Associates, is a limited partnership formed in
1991. The general partner, New 1521 G.P., Inc., is a corporation of
which A. Kauffman is the sole shareholder. E. Cohen, and his wife,
Betsy Z. Cohen, beneficially own a 49% limited partnership interest in
the partnership and A. Kauffman owns a 24.75% limited partnership
interest.
(11) The borrower, Evening Star Associates, is a limited partnership in
which one of our subsidiaries, Resource Properties, Inc., is the sole
shareholder of ES GP, Inc., the sole general partner of the borrower.
E. Cohen, B. Cohen, D. Gideon Cohen, our former President, Chief
Operating Officer and director, and S. Schaeffer are limited partners
of Evening Star Associates.
(12) The borrower, Commerce Place Associates, LLC, is a limited liability
company whose manager is a corporation of which S. Schaeffer, is the
sole shareholder, officer and director. Messrs. E. Cohen, D. Cohen,
Schaeffer and Kauffman are equal limited partners of an entity,
Brandywine Equity Investors, L.P., that owns approximately 30% of the
borrower.
(13) Our subsidiary, Resource Press Building Manager, Inc., is the manager
of the borrower, Resource/Press Building Realty, LLC.
(14) E. Cohen and B. Cohen beneficially own a 40% limited partnership
interest in the borrower, Pasadena Industrial Associates. A. Kauffman
is the general partner of the borrower.
(15) The property is owned by EJGB, LLC, a limited liability company in
which D. Cohen owns a 94% interest.
(16) The borrower, Granite GEC (Pittsburgh), L.L.C., is a limited liability
company. D. Cohen owns 79% of Odessa Real Estate Management, Inc., the
assistant managing member of the borrower.
(17) The borrower, St. Cloud Associates, is a limited partnership of which
A. Kauffman is the sole general partner.
12
We seek to reduce the amount of our capital invested in portfolio
loans, and to enhance our returns, through borrower refinancing of the
properties underlying our loans. At September 30, 2003, senior lien holders on
these properties held outstanding obligations of $90.5 million. Pursuant to
agreements with most borrowers, we generally retain the excess of operating cash
flow after required debt service on senior lien obligations as debt service on
the outstanding balance of our loans.
After a refinancing of a senior lien interest, our retained interest
will usually be secured by a subordinate lien on the property. In some
situations, however, our retained interest may not be formally secured by a
mortgage because of conditions imposed by the senior lender. In these
situations, we may be protected by a judgment lien, an unrecorded deed-in-lieu
of foreclosure, the borrower's covenant not to further encumber the property
without our consent, a pledge of the borrower's equity or similar devices. As of
September 30, 2003, we have six retained interests aggregating $55.7 million and
constituting 36%, by carried cost of investment, of our loan portfolio and FIN
46 investments that are not secured by a lien on the underlying property. As of
September 30, 2003, senior lien interests with an aggregate balance of $4.9
million relating to three portfolio loans obligate us, in the event of a default
on a loan, to replace the loan with a performing loan.
Because our loans typically were not performing in accordance with the
original terms when we acquired them, they generally are subject to forbearance
agreements that defer foreclosure or other action so long as the borrower meets
the terms of the forbearance agreement. These terms are generally designed to
give us control over the operations and cash flow of the underlying properties,
subject to the rights of senior lien holders. We may permit a borrower to obtain
management control of a property's cash flow where we believe that operating
problems have been substantially resolved.
Our forbearance agreements require borrowers to retain a property
management firm acceptable to us. As a result, Brandywine Construction &
Management, Inc., a property manager affiliated with us, has assumed
responsibility for supervisory and, in many cases, day-to-day management of the
underlying properties with respect to substantially our entire loan portfolio as
of September 30, 2003. In seven instances, the president of Brandywine
Construction & Management, or an entity affiliated with him, has also acted as
the general partner, president or trustee of the borrower.
The minimum payments required under a forbearance agreement are
normally materially less than the debt service payments called for by the
original terms of the loan. The difference between the minimum required payments
under the forbearance agreement and the payments called for by the original loan
terms continues to accrue. However, except for amounts we recognize as accretion
of discount, we do not recognize the accrued but unpaid amounts as revenue until
actually paid. For a discussion of how we account for accretion of discount, you
should read "Real Estate Finance-Accounting for Discounted Loans."
At the end of a forbearance agreement, the borrower must pay the loan
in full. The borrower's ability to do so, however, will depend upon a number of
factors, including prevailing conditions of the underlying property, the state
of real estate and financial markets generally and as they pertain to the
particular property, and general economic conditions. If the borrower does not
or cannot repay the loan, we anticipate it will seek to sell the property
underlying the loan or otherwise liquidate the loan. If the borrower is
unsuccessful, we may foreclose on the underlying property. Alternatively, where
we already control all of the cash flow and other economic benefits from the
property, or where we believe that the cost of foreclosure is more than any
benefit we could obtain from foreclosure, we may continue our forbearance.
Investments in Real Estate. As part of the process of resolving our
loans, we may foreclose on a property underlying a loan or accept a deed-in-lieu
of foreclosure. In fiscal 2003, we foreclosed or accepted deeds-in-lieu of
foreclosure on four properties. Also, when we restructure a loan, we typically
retain an interest in the underlying property or in an entity owning the
property. We had one such restructuring in fiscal 2003, while in fiscal 2002 we
had one such restructuring. Moreover, in fiscal 2002 we invested in three
limited partnerships which acquired properties adjacent to a property in which
we had received a 50% interest in satisfaction of another portfolio loan in June
1999.
13
Accounting for Discounted Loans. We accrete the difference between our
cost basis in a portfolio loan and the sum of projected cash flows from the loan
into interest income over the estimated life of the loan using the interest
method, which results in a level rate of interest over the life of the loan. We
review projected cash flows, which include amounts realizable from the
disposition of the underlying property, on a quarterly basis. Changes to
projected cash flows reduce or increase the amounts accreted into interest
income over the remaining life of the loan.
We record our investments in real estate loans at cost, which is
discounted significantly from the stated principal amount plus accrued interest
and penalties on the loans. We refer to the stated principal, accrued interest
and penalties as the face value of the loan. The discount from face value, as
adjusted to give effect to refinancings totaled $56.0 million, $165.2 million
and $150.7 million at September 30, 2003, 2002 and 2001, respectively. We review
the carrying value of each of our loans quarterly to determine whether it is
greater than the sum of the future projected cash flows. Because of our
knowledge of the underlying properties, our monitoring of and influence over
their respective operating budgets and, for most properties, management of the
property by our affiliate, Brandywine Construction and Management, we believe
that we can reasonably estimate the amount and timing of our probable
collections from the underlying properties. For a discussion of our involvement
with the properties underlying our loans, see "Real Estate Finance-General." If
we determine that the carrying value is greater, we provide an appropriate
allowance through a charge to operations. In establishing our allowance for
possible losses, we also consider the historic performance of our loan
portfolio, characteristics of the loans and their underlying properties,
industry statistics and experience regarding losses in similar loans, payment
history on specific loans as well as general economic conditions in the United
States, in the borrower's geographic area or in the borrower's or its tenants'
specific industries.
Accounting for FIN 46 Assets. Subsequent to the adoption of FIN 46 in
July 2003, we record the assets, liabilities and operations of cerain entities
in which we hold loans in our consolidated financial statements. We have
classified certain of these entities' assets as held for sale and accordingly
show their operations as discontinued in our consolidated financial statements.
Allowance for Possible Losses. For the year ended September 30, 2003,
we recorded a provision for possible losses of $1.8 million. Our allowance for
possible losses was $1.4 million at September 30, 2003 after write-downs of $3.9
million on three loans.
In determining our allowance for possible losses related to our real
estate loans, we consider general and local economic conditions, neighborhood
values, competitive overbuilding, casualty losses and other factors which may
affect the value of loans. The value of our loans may also be affected by
factors such as the cost of compliance with regulations and liability under
applicable environment laws, changes in interest rates and the availability of
financing. Income from a property will be reduced if a significant number of
tenants are unable to pay rent or if available space cannot be rented on
favorable terms. In addition, we continuously monitor collections and payments
from our borrowers and maintain an allowance for estimated losses based upon our
historical experience and our knowledge of specific borrower collection issues
identified. We reduce our investment in real estate loans by an allowance for
amounts that may become unrealizable in the future. Such allowance can be either
specific to a particular loan or venture or general to all loans.
We also follow the cost recovery method for certain loans due to
unanticipated events such as the loss of a major tenant of one underlying
property, the declaration of bankruptcy and voiding of the lease by a sole
tenant of another property and, for a hotel property underlying one loan, the
severe effect of the post-9/11 travel slump.
Financial Services
Our financial services operations currently focus on managing entities
that invest in trust preferred securities of small to mid-size regional banks
and bank holding companies and debt securities collateralized by these trust
preferred securities.
14
Beginning in fiscal 2002, through December 2003, we have co-sponsored a
series of five investments involving issuers of collateralized debt obligations,
or CDOs. The collateralized debt obligations of each CDO issuer are supported by
a pool of trust preferred securities issued by trusts affiliated with, and whose
preferred securities are guaranteed by small to mid-size regional banks and bank
holding companies. We own a 50% interest in the entities that act as the general
partners of the limited partnerships that own the equity interest in the CDO
issuers. We also invest in the partnerships, for which we receive partnership
interests. The issuers are Trapeza CDO I, LLC through Trapeza CDO V, Ltd. The
general partners are Trapeza Funding, LLC through Trapeza Funding V, LLC, and
the partnerships are Trapeza Partners L.P. through Trapeza Partners V L.P. We
also own a 50% interest in Trapeza Capital Management, LLC which acts as
collateral manager of the trust preferred securities pools. Through Trapeza
Capital Management the Trapeza Funding entities and the Trapeza partnerships, we
receive collateral management fees from the CDO issuers, as well as general
partner and limited partner distributions and partnership administration fees.
We also own a 50% interest in 1845 Warehouse, LLC, an entity created to support
a warehouse line of credit to be used to provide financing to CDO issuers we
sponsor in the future. We invested $2.5 million in 1845 Warehouse in November
2003 along with a like amount by the other owner of 1845 Warehouse. 1845
Warehouse has obtained a warehouse line of credit for its own account from an
unaffiliated third party. We expect that 1845 Warehouse will receive
distributions from future CDO closings equal to a portion of the positive spread
between its warehouse financing costs and the interest received on the trust
preferred securities it finances. The third party lender will receive the
balance of such positive spread.
We sponsored Trapeza CDO I in fiscal 2002, which, in November 2002
acquired $330.0 million of trust preferred securities. Trapeza Partners I, the
equity owner of Trapeza CDO I, raised $27.4 million for its equity investment,
including $2.8 million from us and a like amount from our co-sponsor. We also
provided a $5.0 million bridge loan, which was repaid in fiscal 2003, to
facilitate its purchase of trust preferred securities.
We sponsored Trapeza CDO II, Trapeza CDO III and Trapeza CDO IV in
fiscal 2003. Trapeza CDO IV was in the offering stage at September 30, 2003, and
thereafter closed in October 2003. These three Trapeza CDO issuers acquired $1.0
billion of trust preferred securities. The related partnerships invested $58.8
million in the Trapeza CDO issuers, including $2.4 million from us and a like
amount from our co-sponsor. Subsequent to September 30, 2003, we sponsored
Trapeza CDO V, Ltd., which we anticipate closed in December 2003 and acquired an
additional $300.0 million of trust preferred securities.
Equipment Leasing
We operate our equipment leasing business through LEAF Financial
Corporation, a wholly-owned subsidiary. A subsidiary of LEAF Financial acts as
the general partner of a public equipment leasing partnership, Lease Equity
Appreciation Fund I. The partnership began operations in March 2003 and, as of
September 30, 2003, had $18.5 million (original equipment cost) of equipment
under lease. As of September 30, 2003, LEAF Financial had invested $401,000 in
the partnership. The partnership continues in its offering stage.
In April 2003, LEAF Financial entered into a multi-year agreement to
originate and service equipment leases on behalf of Merrill Lynch Equipment
Finance LLC. Under this financing and service arrangement, LEAF Funding, Inc., a
subsidiary of LEAF Financial, will originate and, through a subsidiary, sell
equipment leases to Merrill Lynch Equipment Finance. LEAF Funding will receive
cash consideration for these leases equal to the present value of the remaining
scheduled payments under each lease plus the estimated residual value of the
leased equipment at the end of the lease. An affiliate of Merrill Lynch
Equipment Finance will finance its purchase of the equipment and leases to an
aggregate maximum amount of $300.0 million. Pursuant to a servicing agreement,
LEAF Financial will manage, administer and service the leases, for which it will
receive servicing and asset management fees. These agreements terminate on April
8, 2005, unless otherwise extended.
At the time we acquired LEAF Financial in 1995, it acted as the general
partner of a series of public equipment leasing partnerships. These partnerships
began their liquidation periods at various times commencing in December 1995. We
anticipate that the last four of these partnerships will complete their
liquidation procedures in December 2003.
15
Credit Facilities and Senior Notes
Credit Facilities. In July 2002, our principal energy subsidiary, Atlas
America, entered into a $75.0 million credit facility administered by Wachovia
Bank. The revolving credit facility is guaranteed by Atlas America's
subsidiaries and by us. Credit availability, which is principally based on the
value of Atlas America's assets, was $54.2 million at September 30, 2003. Up to
$10.0 million of the borrowings under the facility may be in the form of standby
letters of credit. Borrowings under the facility are secured by the assets of
Atlas America and its subsidiaries, including the stock of Atlas America's
subsidiaries and our interests in Atlas Pipeline Partners and its general
partner.
Loans under the facility bear interest at one of the following two
rates, at the borrower's election:
- the base rate plus the applicable margin; or
- the adjusted London Interbank Offered Rates or LIBOR plus the
applicable margin.
The base rate for any day equals the higher of the federal funds rate
plus 1/2 of 1% or the Wachovia Bank prime rate. Adjusted LIBOR is LIBOR divided
by 1.00 minus the percentage prescribed by the Federal Reserve Board for
determining the reserve requirement for euro currency funding. The applicable
margin is as follows:
- where utilization of the borrowing base is equal to or less
than 50%, the applicable margin is 0.25% for base rate loans
and 1.75% for LIBOR loans;
- where utilization of the borrowing base is greater than 50%,
but equal to or less than 75%, the applicable margin is 0.50%
for base rate loans and 2.00% for LIBOR loans; and
- where utilization of the borrowing base is greater than 75%,
the applicable margin is 0.75% for base rate loans and 2.25%
for LIBOR loans.
At September 30, 2003, borrowings under the Wachovia credit facility
bore interest at rates ranging from 2.88% to 2.90%.
The Wachovia credit facility requires Atlas America to maintain
specified net worth and specified ratios of current assets to current
liabilities and debt to EBITDA, and requires us to maintain a specified interest
coverage ratio. In addition, the facility limits sales, leases or transfers of
assets and the incurrence of additional indebtedness. The facility limits the
dividends payable by Atlas America to us, on a cumulative basis, to 50% of Atlas
America's net income from and after April 1, 2002 plus $5.0 million. In
addition, Atlas America is permitted to repay intercompany debt to us only up to
the amount of our federal income tax liability attributable to Atlas America and
accrued interest on the our senior notes. The facility terminates in July 2005,
when all outstanding borrowings must be repaid. At September 30, 2003, $31.0
million was outstanding under this facility.
Through our real estate subsidiaries, we have an $18.0 million line of
credit with Sovereign Bank. The facility bears interest at the prime rate
reported in The Wall Street Journal and expires in July 2005. Advances under
this facility must be used to acquire real property, loans on real property or
to reduce indebtedness on property loans. The facility is secured by the
interest of our subsidiaries in assets they acquire using advances under the
line of credit. Credit availability is based on the value of the assets pledged
as security and was $18.0 million as of September 30, 2003, all of which had
been drawn at that date. The facility imposes limitations on the incurrence of
future indebtedness by our subsidiaries whose assets were pledged, and on sales,
transfers or leases of their assets, and requires the subsidiaries to maintain
both a specified level of equity and a specified debt service coverage ratio.
16
We have a second line of credit with Sovereign Bank for $5.0 million
that is similar to the $18.0 million line of credit. This facility bears
interest at the same rate as the $18.0 million line of credit and also expires
in July 2005. Advances under this facility must be used to acquire real
property, loans on real property or to reduce indebtedness on property or loans.
The facility is secured by a pledge of approximately 425,000 of our RAIT common
shares and by a guaranty from the subsidiaries holding the assets securing the
$18.0 million line of credit. Credit availability is based on the value of the
pledged RAIT shares and was $5.0 million as of September 30, 2003, all of which
had been drawn at that date. The facility restricts us from making loans to our
affiliates other than:
- existing loans,
- loans in connection with lease transactions in an aggregate
not to exceed $50,000 in any fiscal year,
- loans to RAIT made in the ordinary course of business, and
- loans to our subsidiaries.
We have a line of credit with Commerce Bank for $5.0 million, all of
which had been drawn as of September 30, 2003. The facility is secured by our
pledge of 440,000 of our RAIT common shares. Credit availability is 50% of the
value of those shares, and was $5.0 million at September 30, 2003. Loans bear
interest, at our election, at either the prime rate reported in The Wall Street
Journal or specified LIBOR, plus 250 basis points, in either case with a minimum
rate of 5.5% and a maximum rate of 9.0%. The facility terminates in May 2005,
subject to extension. The facility requires us to maintain a specified net worth
and ratio of liabilities to tangible net worth, and prohibits our transfer of
the collateral.
We and certain of our real estate subsidiaries are the obligors under a
$6.8 million term note to Hudson United Bank. At September 30, 2003, $6.4
million was outstanding on this note which matures in October 2004. The note
bears interest at the prime rate reported in The Wall Street Journal, minus one
percent, and is secured by certain portfolio loans.
LEAF Financial and Lease Equity Appreciation Fund have entered into
revolving credit facilities with National City Bank and Commerce Bank that have
an aggregate borrowing limit of $20.0 million. Each facility bears interest at
the LIBOR plus 300 basis points at the time of borrowing. Borrowings under the
facilities are secured by an assignment of the leases being financed and the
underlying equipment being leased. Repayment of both facilities has been
guaranteed by us. The facility with National City Bank expires on December 31,
2003. At September 30, 2003, $2.5 million was outstanding on this facility with
current interest rates ranging from 4.10% to 4.18% per year. The facility with
Commerce Bank expires on May 27, 2004. At September 30, 2003, $4.7 million was
outstanding on this facility with a current interest rate of 4.10% per year. We
are a guarantor under both facilities.
Atlas Pipeline Partners has a $20.0 million revolving credit facility
administered by Wachovia Bank. Up to $3.0 million of the facility may be used
for standby letters of credit. Borrowings under the facility are secured by a
lien on all the property of Atlas Pipeline Partners' assets, including its
subsidiaries. The facility has a term ending in December 2005 and bears
interest, at Atlas Pipeline Partners' election, at the base rate plus the
applicable margin or the euro rate plus the applicable margin.
As used in the facility agreement, the base rate is the higher of:
- Wachovia Bank's prime rate or
- the sum of the federal funds rate plus 50 basis points.
17
The euro rate is the average of specified LIBORs divided by 1.00 minus
the percentage prescribed by the Federal Reserve Board for determining the
reserve requirement for euro currency funding. The applicable margin varies with
Atlas Pipeline Partners' leverage ratio from between 150 to 250 basis points,
for the euro rate option, or 0 to 50 basis points, for the base rate option.
Draws under any letter of credit bear interest as specified under the first
bullet point above. The credit facility requires Atlas Pipeline Partners to
maintain a specified net worth, ratio of debt to tangible assets and an interest
coverage ratio. In addition, the facility limits sales, leases or transfers of
assets, incurrence of other indebtedness and guarantees, and certain
investments. As of September 30, 2003, no amounts were outstanding under this
facility. Atlas Pipeline Partners expects that it will draw the full amount of
this facility as part of its financing of its acquisition of the Alaska Pipeline
Company.
As of September 30, 2003, we also had a $5.8 million term loan with The
Marshall Group. This loan was repaid in October 2003.
Senior Notes. As of September 30, 2003, we had outstanding $54.0
million of our 12% senior notes due 2004. Subsequent to our fiscal year end, we
repurchased $1.0 million of senior notes. The senior notes are payable interest
only until their maturity on August 1, 2004, but are subject to earlier
redemption at our option. We have called $40.0 million of senior notes for
redemption on December 22, 2003 (including $26.9 million repurchased in November
2003) and the balance of $13.0 million for redemption on January 20, 2004. See
"Business - General."
Employees
As of September 30, 2003, we employed 278 persons: 208 in energy, 41 in
equipment leasing, eight in real estate finance, three in financial services and
18 corporate employees.
18
Risk Factors
Statements made by us in written or oral form to various persons,
including statements made in filings with the SEC that are not strictly
historical facts are "forward-looking" statements that are based on current
expectations about our business and assumptions made by management. These
statements are subject to risks and uncertainties that exist in our operations
and business environment that could result in actual outcomes and results that
are materially different than predicted. The following includes some, but not
all, of those factors or uncertainties:
General
Interest rate increases will increase our interest costs under our
eight credit facilities. See Item 7A, "Quantative and Qualitative Disclosures
about Market Risk." This could have material adverse effects, including
reduction of net revenues for both our energy, real estate finance and equipment
leasing operations.
Risks Relating to Our Energy Business
Our future financial condition, results of operations and the value of
our natural gas and oil properties will depend upon market prices for natural
gas and oil. Natural gas and oil prices historically have been volatile and will
likely continue to be volatile in the future. Prices for natural gas and oil are
affected by many factors, over which we have no control, including:
- political instability or armed conflict in oil producing
regions or other market uncertainties;
- worldwide and domestic supplies of oil and gas;
- weather conditions;
- the level of consumer demand;
- the price and availability of alternative fuels;
- the availability of pipeline capacity;
- the price and level of foreign imports;
- domestic and foreign governmental regulations and taxes;
- the ability of the members of the Organization of Petroleum
Exporting Countries to agree to and maintain oil prices and
production controls; and
- the overall economic environment.
These factors and the volatility of the energy markets make it
extremely difficult for us to predict future oil and gas price movements with
any certainty. Price fluctuations can materially adversely affect us because:
- price decreases will reduce our energy revenues;
- price decreases may make it more difficult to obtain financing
for our drilling and development operations through sponsored
investment partnerships, borrowings or otherwise;
- price decreases may make some reserves uneconomic to produce,
reducing our reserves and cash flow;
- price decreases may cause the lenders under our energy credit
facility to reduce our borrowing base because of lower
revenues or reserve values, reducing our liquidity and,
possibly, requiring mandatory loan repayment;
- price increases may make it more difficult, or more expensive,
to drill and complete wells if they lead to increased
competition for drilling rigs and related materials;
- price increases may make it more difficult, or more expensive,
to execute our business strategy of acquiring additional
natural gas properties and energy companies.
19
Further, oil and gas prices do not necessarily move in tandem. Because
approximately 92% of our proved reserves are natural gas reserves, we are more
susceptible to movements in natural gas prices.
Well blowouts, cratering, explosions, uncontrollable flows of oil,
natural gas or well fluids, fires, formations with abnormal pressures, pipeline
ruptures or spills, pollution, releases of toxic gas and other environmental
hazards and risks are inherent operating hazards for us. The occurrence of any
of these hazards could result in substantial losses to us. In addition, we may
be liable for environmental damage caused by previous owners of properties
purchased or leased by us. As a result, we may incur substantial liabilities to
third parties or governmental entities. In accordance with customary industry
practices, we maintain insurance against some, but not all, of such risks and
losses. Pollution and environmental risks generally are not fully insurable. We
may elect to self-insure if we believe that insurance, although available, is
excessively costly relative to the risks presented. The occurrence of an event
that is not covered, or not fully covered, by insurance could reduce our
revenues and the value of our assets.
The amount of recoverable natural gas and oil reserves may vary
significantly from well to well. We may drill wells that, while productive, do
not produce sufficient net revenues to return a profit after drilling, operating
and other costs. The geologic data and technologies we use do not allow us to
know conclusively prior to drilling a well that natural gas or oil is present or
may be produced economically. The cost of drilling, completing and operating a
well is often uncertain, and cost factors can adversely affect the economics of
a project. Further, our drilling operations may be curtailed, delayed or
cancelled as a result of many factors, including:
- unexpected drilling conditions;
- title problems;
- pressure or irregularities in formations;
- equipment failures or accidents;
- adverse weather conditions;
- environmental or other regulatory concerns; and
- costs of, or shortages or delays in the availability of
drilling rigs and equipment.
We base our estimates of our proved natural gas and oil reserves and
future net revenues from those reserves upon analyses that rely upon various
assumptions, including those required by the SEC, as to natural gas and oil
prices, drilling and operating expenses, capital expenditures, taxes and
availability of funds. Any significant variance in these assumptions could
materially affect the estimated quantity of our reserves. As a result, our
estimates of our proved natural gas and oil reserves are inherently imprecise.
Actual future production, natural gas and oil prices, revenues, taxes,
development expenditures, operating expenses and quantities of recoverable
natural gas and oil reserves may vary substantially from our estimates or
estimates contained in the reserve reports. Our properties also may be
susceptible to hydrocarbon drainage from production by other operators on
adjacent properties. In addition, our proved reserves may be subject to downward
or upward revision based upon production history, results of future exploration
and development, prevailing natural gas and oil prices, mechanical difficulties,
governmental regulation and other factors, many of which are beyond our control.
You should not assume that the PV-10 values referred to in this report
represent the current market value of our estimated natural gas and oil
reserves. In accordance with SEC requirements, the estimates are based on prices
and costs as of the date of the estimates. Moreover, the 10% discount factor,
which the SEC requires in calculating future net cash flows for reporting
purposes, is not necessarily the most appropriate discount factor to calculate
risk-based value. The effective interest rate at various times and the risks
associated with the oil and gas industry generally will affect the
appropriateness of the 10% discount factor.
20
Our proved reserves will decline as reserves are produced unless we
acquire additional properties containing proved reserves, successfully develop
new or existing properties or identify additional formations with primary or
secondary reserve opportunities on our properties. If we are not successful in
expanding our reserve base, our future natural gas and oil production and
drilling activities, the primary source of our energy revenues, will decrease.
Our ability to find and acquire additional reserves depends on our generating
sufficient cash flow from operations and other sources of capital, principally
our sponsored drilling partnerships, all of which are subject to risks discussed
elsewhere in this section.
The growth of our energy operations has resulted from both our
acquisition of energy companies and assets and from our ability to obtain
capital funds through our sponsored drilling partnerships. If we are unable to
identify acquisitions on acceptable terms, or if our ability to obtain capital
funds through sponsored partnerships is impaired, we may be unable to increase
or maintain our inventory of properties and reserve base, or may be forced to
curtail drilling, production or other activities. This would likely result in a
decline in our revenues from our energy operations.
Under current federal tax laws, there are tax benefits to investing in
drilling investment partnerships such as ours, including deductions for
intangible drilling costs and depletion deductions. Changes to federal tax laws
that reduce or eliminate these benefits may make investment in our drilling
partnerships less attractive and, thus, reduce our ability to obtaining funding
from this significant source of capital. Moreover, the Jobs and Growth Tax
Relief Reconciliation Act of 2003 has reduced the maximum federal income tax
rate on long-term capital gains and qualifying dividends to 15% through 2008.
This change may make investment in our drilling partnerships relatively less
attractive than investments in assets likely to yield capital gains or
qualifying dividends.
We operate in a highly competitive environment, competing with major
integrated and independent energy companies for desirable oil and gas
properties, as well as for the equipment, labor and materials required to
develop and operate such properties. Many of our competitors have financial and
technological resources substantially greater than ours. We may incur higher
costs or be unable to acquire and develop desirable properties at costs we
consider reasonable because of this competition.
Under our agreements with Atlas Pipeline Partners, we are required to
pay transportation fees for natural gas produced by our drilling partnerships
and certain unaffiliated producers. Many of our transportation arrangements with
our existing drilling partnerships and unaffiliated producers require them to
pay us lesser fees than those we pay to Atlas Pipeline Partners. For the years
ended September 30, 2003 and 2002, the fees we paid to Atlas Pipeline
Partners, net of reimbursements and distributions to us from our general and
limited partner interests in it, exceeded the amount we received from producers
by $10.4 million and $6.5 million, respectively.
Subsidiaries of ours currently serve as general partners of 84 energy
investment partnerships. We intend to develop further energy investment
partnerships for which we will act as general partner. As a general partner,
each subsidiary is contingently liable for the obligations of these partnerships
to the extent that these obligations cannot be repaid from program assets or
insurance proceeds.
Federal, state and local authorities extensively regulate our drilling
and production activities, including the drilling of wells, the spacing of
wells, the use of pooling of oil and gas properties, environmental matters,
safety standards, production limitations, plugging and abandonment, and
restoration. These laws are under constant review for amendment or expansion,
raising the possibility of changes that may affect, among other things, the
pricing or marketing of oil and gas production. If we do not comply with these
laws, we may incur substantial penalties. The overall regulatory burden on the
industry increases the cost of doing business and, in turn, decreases
profitability.
Our operations are subject to complex and constantly changing
environmental laws adopted by federal, state and local governmental authorities.
We could face significant liabilities to the government and third parties for
discharges of natural gas, oil or other pollutants into the air, soil or water,
and we could have to spend substantial amounts on investigation, litigation and
remediation. For a discussion of the environmental laws that affect our
operations, see "Business - Energy - Environmental and Safety Regulations."
21
Risks Relating to Our Real Estate Financial and
Financial Leasing Services Businesses
The primary or sole source of recovery for our real estate loans is
typically the underlying real property. Accordingly, the value of our loans
depends upon the value of that real property. Many of the properties underlying
our portfolio loans, while income producing, do not generate sufficient revenues
to pay the full amount of debt service required under the original loan terms or
have other problems. There may be a higher risk of default with these loans as
compared to conventional loans. Loan defaults will reduce our current return on
investment and may require us to become involved in expensive and time-consuming
bankruptcy, reorganization or foreclosure proceedings.
Our loans, include those treated in our consolidated financial
statements as FIN 46 assets and liabilities, typically provide payment
structures other than equal periodic payments that retire a loan over its
specified term, including structures that defer payment of some portion of
accruing interest, or defer repayment of principal, until loan maturity. Where a
borrower must pay a loan balance in a large lump sum payment, its ability to
satisfy this obligation may depend upon its ability to obtain suitable
refinancing or otherwise to raise a substantial cash amount, which we do not
control. In addition, lenders can lose their lien priority in many
jurisdictions, including those in which our existing loans are located, to
persons who supply labor or materials to a property. For these and other
reasons, the total amount which we may recover from one of our loans may be less
than the total amount of the loan or our cost of acquisition.
Declines in real property values generally and/or in those specific
markets where the properties underlying our portfolio loans are located could
affect the value of and default rates under those loans. Properties underlying
our loans may be affected by general and local economic conditions, neighborhood
values, competitive overbuilding, casualty losses and other factors beyond our
control. The value of real properties may also be affected by factors such as
the cost of compliance with, and liability under environmental laws, changes in
interest rates and the availability of financing. Income from a property will be
reduced if a significant number of tenants are unable to pay rent or if
available space cannot be rented on favorable terms. Operating and other
expenses of properties, particularly significant expenses such as real estate
taxes, insurance and maintenance costs, generally do not decrease when revenues
decrease and, even if revenues increase, operating and other expenses may
increase faster than revenues.
Many of our portfolio loans, including those treated in our
consolidated financial statements as FIN 46 assets and liabilities, are junior
lien obligations. Subordinate lien financing poses a greater credit risk,
including a substantially greater risk of nonpayment of interest or principal,
than senior lien financing. If we or any senior lender forecloses on a loan, we
will be entitled to share only in the net foreclosure proceeds after payment to
all senior lenders. It is therefore possible that we will not recover the full
amount of a foreclosed loan or the amount of our unrecovered investment in the
loan.
At September 30, 2003, our allowance for possible losses was $1.4
million, which represents 3% of the book value of our loan portfolio. We cannot
assure you that this allowance will prove to be sufficient to cover future
losses, or that future provisions for loan losses will not be materially greater
than those we have recorded to date. Losses that exceed our allowance for
losses, or an increase in our provision for losses, could materially reduce our
earnings.
Our loans, including those treated in our consolidated financial
statements as FIN 46 assets and liabilities typically do not conform to standard
loan underwriting criteria. Many of our loans are subordinate loans. As a
result, our loans are relatively illiquid investments. We may be unable to vary
our portfolio in response to changing economic, financial and investment
conditions.
22
The existence of hazardous or toxic substances on a property will
reduce its value and our ability to sell the property in the event of a default
in the loan it underlies. Contamination of a real property by hazardous
substances or toxic wastes not only may give rise to a lien on that property to
assure payment of the cost of remediation, but also can result in liability to
us as a lender, or, if we assume ownership or management, as an owner or
operator, for that cost regardless of whether we know of, or are responsible
for, the contamination. In addition, if we arrange for disposal of hazardous or
toxic substances at another site, we may be liable for the costs of cleaning up
and removing those substances from the site, even if we neither own nor operate
the disposal site. Environmental laws may require us to incur substantial
expenses to remediate contaminated properties and may materially limit use of
these properties. In addition, future laws or more stringent interpretations or
enforcement policies with respect to existing laws may increase our exposure to
environmental liability.
Our income from our real estate operations includes accretion of
discount, which is a non-cash item. For a discussion of accretion of discount,
see "Business - Real Estate Finance - Accounting for Discounted Loans." For the
years ended September 30, 2003, 2002 and 2001, accretion of discount, net of
collection of interest, was $2.0 million, $3.2 million and $5.9 million,
respectively. We accrete income on a loan to a maximum amount equal to the
difference between our cost basis in the loan and the present value of the
estimated cash flows from the property underlying the loan. If the actual cash
flows from the property are less than our estimates, or if we reduce our
estimates of cash flows, our earnings may be adversely affected. Moreover, if we
sell a loan, or foreclose upon and sell the underlying property, and the amount
we receive is less than the amount of our carrying cost, we will recognize an
immediate charge to our allowance for losses or, if that amount is insufficient
to absorb the shortfall and provide for possible losses on remaining real estate
investments, our statement of operations.
In addition, the property owners have obtained senior lien financing
with respect to nine loans. The senior loans are with recourse only to the
properties securing them subject to certain standard exceptions, which we have
guaranteed. These exceptions relate principally to the following:
- fraud or intentional misrepresentation in connection with the
loan documents;
- misapplication or misappropriation of rents, insurance
proceeds or condemnation awards during continuance of an event
of default or, at any time, of tenant security deposits or
advance rents;
- payments of fees or commissions to various persons related to
the borrower or to us during an event of default, except as
permitted by the loan documents;
- failure to pay taxes, insurance premiums or specific other
expenses, failure to use property revenues to pay property
expenses, and commission of criminal acts or waste with
respect to the property;
- environmental violations; and
- the undismissed or unstayed bankruptcy or insolvency of
borrower.
We account for our investment in the Trapeza entities, described in
"Business-Financial Services," by the equity method of accounting. Accordingly,
we recognize our percentage share of any income or loss of these entities.
Because the Trapeza entities are investment companies for accounting purposes,
such income or loss will include a "mark-to-market" adjustment to reflect the
net changes in value, including unrealized appreciation or depreciation, in
investments and swap agreements. Such value will be impacted by changes in the
underlying quality of the Trapeza entities' investments, and by changes in
interest rates. To the extent that the Trapeza entities' investments are
securities denominated at a fixed rate of interest, increases in interest rates
will likely cause the value of the investments to fall and decreases in interest
rates will likely cause the value of the investments to rise. The Trapeza
entities' various interest rate hedges and swap agreements will also change in
value with changes in interest rates. Accordingly, our income or loss from our
Trapeza investments, and from future similar collateralized debt issuer
investments, may be volatile as interest rates change, and/or if the underlying
credit quality of their investments changes.
23
Before fiscal 2000, we entered into a series of standby commitments
with some participants in our loans which obligate us to repurchase their
participations or substitute a performing loan if the borrower defaults. At
September 30, 2003, the participations as to which we had standby commitments
had aggregate outstanding balances of $6.4 million. At September 30, 2003, we
also were contingently liable under guarantees of $1.2 million in mortgage loan
receivables connected with a discontinued operation and contingently liable
under guarantees of $1.9 in standby letters of credit issued in connection with
Atlas America and our lease of office space in New York City.
A real estate investment partnership in which we have a general partner
interest, has obtained senior lien financing with respect to four properties it
acquired. The senior liens are with recourse only to the properties securing
them subject to certain standard exceptions, which we have guaranteed. These
guarantees expire as the related indebtedness is paid down over the next ten
years. In addition, property owners have obtained senior lien financing with
respect to six of our loans. The senior liens are with recourse only to the
properties securing them subject to certain standard exceptions, which we have
guaranteed. These guarantees expire as the related indebtedness is paid down
over the next six years.
We believe the likelihood of our being required to pay any claims under
any of them is remote under the facts and circumstances pertaining to each of
them. An adverse change in these facts and circumstances could cause us to
determine that the likelihood that a particular contingency may occur is no
longer remote. In that event, we may be required to include all or a portion of
the contingency as a liability in our financial statements, which could result
in:
- violations of restrictions on incurring debt contained in our
senior notes or in agreements governing our other outstanding
debt; and
- prohibitions on additional borrowings under our credit lines.
In addition, if one or more of these contingencies were to occur, we
may not have sufficient funds to pay them and, in order to meet our obligations,
may have to sell assets at times and for prices that are disadvantageous to us.
Subsidiaries of ours currently serve as general partners of five public
equipment leasing partnerships, including one in the offering stage, two private
real estate investment partnerships, including one in the offering stage, and
five private investment partnerships that have invested and will invest in
issuers of debt obligations collateralized by trust preferred securities, one of
which is in the offering stage. We intend to develop further investment
partnerships for which we will act as general partner. As a general partner,
each subsidiary is contingently liable for the obligations of these partnerships
to the extent that their obligations cannot be repaid from partnership assets or
insurance proceeds.
ITEM 2. PROPERTIES
We maintain our executive office, real estate finance, leasing and
financial services operations in Philadelphia, Pennsylvania under leases for
18,000 square feet. These leases, which expire in May 2008, contains extension
options through 2033, and is located in an office building in which we have a
50% equity interest. We also maintain a 3,200 square foot office in New York,
New York under a lease agreement that expires in December 2006.
We own a 24,000 square foot office building in Pittsburgh,
Pennsylvania, a 17,000 square foot field office and warehouse facility in
Jackson Center, Pennsylvania and a field office in Deerfield, Ohio. We lease one
1,400 square foot field office in Ohio under a lease expiring in 2009 and one
3,100 square foot field office in Pennsylvania under a lease expiring in 2005.
In addition, we lease other field offices in Ohio and New York on a
month-to-month basis. We also rent 9,300 square feet of office space in
Uniontown, Ohio under a lease expiring in February 2006. All of these properties
are used for our energy operations.
24
Energy
Production. The following table sets forth the quantities of our
natural gas and oil production, average sales prices, average production costs
per equivalent unit of production and average exploration costs per equivalent
unit of production, for the periods indicated.
Average
Production Average Sales Price Production
---------------------- --------------------- Cost per
Fiscal Year Oil (Bbls) Gas (Mcf) per Bbl per Mcf (1) Mcfe (2)
- ----------- ---------- --------- ------- ----------- ----------
2003....... 160,048 6,966,899 $ 26.91 $ 4.92 $ .84
2002....... 172,750 7,117,276 $ 20.45 $ 3.56 $ .82
2001....... 177,437 6,342,667 $ 25.56 $ 5.04 $ .84
- ----------
(1) Our average sales prices before the effects of hedging was $5.08, $3.57
and $5.13 for the fiscal years ending in 2003, 2002 and 2001,
respectively.
(2) Production costs include labor to operate the wells and related
equipment, repairs and maintenance, materials and supplies, property
taxes, severance taxes, insurance, gathering charges and production
overhead.
Productive wells. The following table sets forth information as of
September 30, 2003 regarding productive natural gas and oil wells in which we
have a working interest:
Number of Productive Wells
--------------------------
Gross (1) Net (1)
--------- -------
Oil wells................................ 331 272
Gas wells................................ 4,324 2,338
--------- -------
4,655 2,610
========= =======
- ----------
(1) Includes our equity interest in wells owned by 84 investment
partnerships for which we serve as general partner and various joint
ventures. Does not include our royalty or overriding interests in 619
other wells.
Developed and Undeveloped Acreage. The following table sets forth
information about our developed and undeveloped natural gas and oil acreage as
of September 30, 2003. The information in this table includes our equity
interest in acreage owned by investment partnerships sponsored by us.
Developed Acreage Undeveloped Acreage
----------------- -------------------
Gross Net Gross Net
------- ------- ------- -------
Arkansas....................... 2,560 403 - -
Kansas......................... 160 20 - -
Kentucky....................... 924 462 12,106 6,053
Louisiana...................... 1,819 206 - -
Mississippi.................... 40 3 - -
Montana........................ - - 2,650 2,650
New York....................... 20,236 15,417 12,004 12,004
North Dakota................... 639 96 - -
Ohio........................... 115,709 96,600 41,498 37,989
Oklahoma....................... 4,323 468 - -
Pennsylvania................... 73,784 73,701 126,277 126,277
Texas.......................... 4,520 329 - -
West Virginia.................. 1,078 539 10,806 5,403
Wyoming........................ - - 80 80
------- ------- ------- -------
225,792 188,244 205,421 190,456
======= ======= ======= =======
25
The leases for our developed acreage generally have terms that extend
for the life of the wells, while the leases on our undeveloped acreage have
terms that vary from less than one year to five years. We paid rentals of
approximately $386,300 in fiscal 2003 to maintain our leases.
We believe that we hold good and indefeasible title to our properties,
in accordance with standards generally accepted in the natural gas industry,
subject to exceptions stated in the opinions of counsel employed by us in the
various areas in which we conduct our activities. We do not believe that these
exceptions detract substantially from our use of any property. As is customary
in the natural gas industry, we conduct only a perfunctory title examination at
the time we acquire a property. Before we commence drilling operations, we
conduct an extensive title examination and we perform curative work on defects
that we deem significant. We have obtained title examinations for substantially
all of our managed producing properties. No single property represents a
material portion of our holdings.
Our properties are subject to royalty, overriding royalty and other
outstanding interests customary in the industry. Our properties are also subject
to burdens such as liens incident to operating agreements, taxes, development
obligations under natural gas and oil leases, farm-out arrangements and other
encumbrances, easements and restrictions. We do not believe that any of these
burdens will materially interfere with our use of our properties.
Drilling activity. The following table sets forth information with
respect to the number of wells completed for the periods indicated, regardless
of when drilling was initiated.
Exploratory Wells Development Wells
------------------------------- ------------------------------
Productive Dry Productive Dry
--------------- ------------ ------------ ------------
Fiscal Year Gross Net Gross Net Gross Net Gross Net
- ----------- ----- --- ----- --- ----- --- ----- ---
2003............. - - - - 295.0 92.9 1 .33
2002............. - - - - 246.0 78.7 6 2.00
2001............. - - 1.0 .18 256.0 76.6 1 .27
Delivery Commitments. We are not obligated to provide fixed quantities
of oil in the future. At our option, we from time to time make short-term
delivery commitments for a portion of our natural gas. See Item 7A,
"Quantitative and Qualitative Disclosures of Market Risk-Energy-Commodity Price
Risk."
Natural Gas and Oil Reserve Information. The following tables summarize