ITEM 1. BUSINESS
General Development and Description of Business
Glenborough Realty Trust Incorporated (the "Company") is a self-administered and self-managed real estate investment trust ("REIT") engaged primarily in the ownership, operation, management, leasing and acquisition of various types of income-producing properties. As of December 31, 1996, the Company owned and operated 54 income-producing properties (the "Properties," and each a "Property") and held three mortgage receivables. The Properties are comprised of 14 industrial Properties, 21 retail Properties, 3 multifamily Properties, 5 hotel Properties and 11 office Properties, located in 17 states. Included in the 54 income-producing properties are three properties in which the Company holds a participating first mortgage interest, not fee title. The properties consist of one retail Property, one industrial Property and one Hotel which are owned by AFP Partners. See Item 2
ITEM 2. PROPERTIES
The Location and Type of the Company's Properties
The Company's 54 Properties are diversified by type (office, industrial, retail, multifamily and hotel) and are located in four geographic regions and 17 states within the United States comprising numerous local markets. The following table sets forth the location, type and size of the Properties (by rentable square feet and/or units) along with average occupancy for the year ended December 31, 1996.
For the years ended December 31, 1995 and 1994, rental revenue from the two Properties leased to Navistar International contributed approximately 10% of the combined total rental revenue of the GRT Predecessor Entities. For the year ended December 31, 1996, no tenant contributed 10% or more of the rental revenue of the Company. A complete listing of Properties owned by the Company at December 31, 1996 is included as part of Schedule III in Item 14.
Office Properties
The Company owns eleven office Properties with total rentable square footage of 641,923. The leases for the office Properties have terms ranging from one to ten years. The office leases generally require the tenant to reimburse the Company for increases in building operating costs over a base amount. Many of the leases provide for rent increases that are either fixed or based on a consumer price index ("CPI"). As of December 31, 1996, the office Properties were approximately 93% leased.
The following table sets forth, for the periods specified, the total rentable area, aggregate average occupancy, average effective base rent per leased square foot and total effective annual base rent.
OFFICE PROPERTIES HISTORICAL RENT AND OCCUPANCY
(1) Total Effective Annual Base Rent divided by average occupancy in square feet. As used herein, "Effective Base Rent" represents base rent less concessions. (2) Total Effective Annual Base Rent adjusted for any free rent given for the period.
The following table sets forth the contractual lease expirations for leases for the office Properties as of December 31, 1996.
OFFICE PROPERTIES LEASE EXPIRATIONS
(1) Annual base rent expiring during each period, divided by total annual base rent (both adjusted for contractual increases). (2) This figure is based on square footage actually leased (which excludes vacant space), which accounts for the difference between this figure and "Total Rentable Area" in the preceding table (which includes vacant space). (3) This figure is based on square footage actually leased and incorporates contractual rent increases arising after 1996, and thus differs from "Total Effective Annual Base Rent" in the preceding table, which is based on 1996 rents. (4) Includes leases that have initial terms of less than one year.
Industrial Properties
The Company owns 14 industrial Properties aggregating 2,026,368 square feet. During June 1996, the Company sold two other industrial properties, which had 97,200 square feet. The industrial Properties are designed for warehouse, distribution and light manufacturing, ranging in size from 37,200 square feet to 474,426 square feet. As of December 31, 1996, seven of the industrial Properties were leased to multiple tenants, seven were leased to single tenants, and all seven of the single-tenant Properties are adaptable in design to multi-tenant use. As of December 31, 1996, the warehouse Properties were approximately 99% leased.
Four of the single-tenant Properties have eight years remaining on leases whose original terms were 20 years and include rent increases every three years based on all or a percentage of the change in the CPI. Under these leases the tenants are required to pay for all of the Properties' operating costs, such as common area maintenance, property taxes, insurance, and all repairs including structural repairs. These four Properties are leased to Navistar International Transportation Corporation ("Navistar"), but two of the leases have been assumed by Case Equipment Corporation ("Case"). Navistar has options under its leases to purchase either or both of the Properties on March 1, 1999, and 2002. The option price is equal to the lesser of (i) the greater of the appraised value or a specified option floor price; or (ii) a price derived by
applying a specified capitalization rate to a specified rental amount. The Case leases give the tenant a purchase option exercisable on March 1, 1999, and 2002 for an amount equal to the greater of the appraised value or a specified minimum price. Management believes, based on discussions with both tenants, that neither tenant has any present intention to exercise any option to purchase.
The remaining warehouse Properties have leases whose terms range from one to eight years. Most of the leases are "triple net" leases whereby the tenants are required to pay their pro rata share of the Properties' operating costs, common area maintenance, property taxes, insurance, and non-structural repairs. Some of the leases are "industrial gross" leases whereby the tenant pays as additional rent its pro rata share of common area maintenance and repair costs and its share of the increase in taxes and insurance over a specified base year cost. Many of these leases call for fixed or CPI-based rent increases.
The Company holds fee title to all of the industrial Properties except a 41,657 square-foot warehouse facility in Seattle known as Sea Tac II. This property is owned by a partnership managed by one of the Associated Companies. The Company holds a participating first mortgage interest in Sea Tac II. In accordance with GAAP, the Company accounts for the property as though it held fee title, as substantially all risks and rewards of ownership have been transferred to the Company as a result of the terms of the mortgage.
The following table sets forth, for the periods specified, the total rentable area, aggregate average occupancy, average effective base rent per leased square foot and total effective annual base rent for the Industrial Properties.
INDUSTRIAL PROPERTIES HISTORICAL RENT AND OCCUPANCY
(1) Total Effective Annual Base Rent divided by average occupancy in square feet. (2) Total Effective Annual Base Rent adjusted for any free rent given for the period. (3) Includes the TRP Properties. For these Properties, occupancy rates are presented as of December 31, 1996, and base rents are presented on an annualized basis based on results since the acquisition as this information is not available for the year ended December 31, 1996.
The following table sets forth the contractual lease expirations for leases for the industrial Properties as of December 31, 1996.
INDUSTRIAL PROPERTIES LEASE EXPIRATIONS
(1) Annual base rent expiring during each period, divided by total annual base rent (both adjusted for contractual increases). (2) This figure is based on square footage actually leased (which excludes vacant space), which accounts for the difference between this figure and "Total Rentable Area" in the preceding table (which includes vacant space). (3) This figure is based on square footage actually leased (which excludes vacant space) and incorporates contractual rent increases arising after 1996, and thus differs from "Total Effective Annual Base Rent" in the preceding table, which is based on 1996 rents. (4) Includes leases that have initial terms of less than one year.
Retail Properties
The retail portfolio consists of 21 Properties with a total of 630,700 square feet. As of December 31, 1996, the occupancy of the retail Properties was 97%. Five of the retail Properties, representing 543,950 square feet or 86% of the total rentable area, are anchored community shopping centers. The anchor tenants of these centers are national or regional supermarkets and drug stores.
Ten of the retail Properties are leased to QuikTrip Corporation on long-term leases expiring after 2008. QuikTrip is a regional convenience store operator with over 300 stores in six states. The leases require the tenant to pay for all Property costs and provide for periodic fixed increases of base rent. Under such leases, the tenant has one five-year option to renew at specified rental rates.
Six of the retail Properties are located in the Atlanta metropolitan area and are leased to tenants in the automotive care industry.
The leases for the retail Properties (excluding the above described QuikTrip leases) generally include fixed or CPI-based rent increases and some include provisions for the payment of additional rent based on a percentage of the tenants' gross sales that exceed specified amounts. Retail tenants also typically pay as additional rent their pro rata share of the Properties' operating costs including common area maintenance, property taxes, insurance and non-structural repairs. Some leases contain options to renew at market rates or specified rates.
The Company holds fee title to all of the retail Properties except the Park Center community center. Park Center is owned by a partnership managed by one of the Associated Companies. The Company holds a participating first mortgage interest in Park Center. In accordance with GAAP, the Company accounts for Park Center as though it held fee title, as substantially all risks and rewards of ownership have been transferred to the Company as a result of the terms of the mortgage.
The following table sets forth, for the periods specified, the total rentable area, aggregate average occupancy, average effective base rent per leased square foot and total effective annual base rent for the retail properties.
RETAIL PROPERTIES HISTORICAL RENT AND OCCUPANCY
(1) Total Effective Annual Base Rent divided by average occupancy in square feet. (2) Total Effective Annual Base Rent adjusted for any free rent given for the period. (3) Includes the Carlsberg Properties and the TRP Properties. For these Properties, occupancy rates are presented as of December 31, 1996, and base rents are presented on an annualized basis based on results since the acquisition as this information is not available for the year ended December 31, 1996. (4) Average effective base rent per leased square foot declined in 1996 due to the acquisition of properties with lower base rents.
The following table sets forth the contractual lease expirations for the retail Properties as of December 31, 1996.
RETAIL PROPERTIES LEASE EXPIRATIONS
(1) Annual base rent expiring during each period, divided by total annual base rent (both adjusted for contractual increases). (2) This figure is based on square footage actually leased (which excludes vacant space), which accounts for the difference between this figure and "Total Rentable Area" in the preceding table (which includes vacant space). (3) This figure is based on square footage actually leased (which excludes vacant space) and incorporates contractual rent increases arising after 1996, and thus differs from "Total Effective Annual Base Rent" in the preceding table which is based on 1996 rents. (4) Includes leases that have initial terms of less than one year.
Tenant Improvements and Leasing Commissions
The following table summarizes by year the capitalized tenant improvement and leasing commission expenditures incurred in the renewal or re-leasing of previously occupied space since January 1, 1992.
CAPITALIZED TENANT IMPROVEMENTS AND LEASING COMMISSIONS
(1) The significant increase in capitalized tenant improvements and commissions in 1995 over the previous year is primarily the result of re-leasing 15,491 sq. ft. at Regency Westpointe. The re-lease is for a term of ten years. There were no commissions paid in this transaction. Tenant improvements totaled $405,000. This tenant occupies 43% of Regency Westpointe. (2) The significant increase in capitalized tenant improvements and commissions in 1996 over the previous years is primarily the result of tenant improvements provided in connection with a lease extension of space for the principal tenant of the UCT Property. The lease was extended 10 years and expires in 2010.
Multifamily Properties
The Company owns three multi-family Properties, aggregating 642 units, and 542,710 square feet of space. All of the units are rented to residential tenants on either a month-to-month basis or for terms of one year or less. As of December 31, 1996, the multifamily properties were approximately 95% leased.
The following table sets forth, for the periods specified, total units, average occupancy, monthly average effective base rent per unit and total effective annual base rent for the multifamily Properties.
MULTIFAMILY PROPERTIES HISTORICAL RENT AND OCCUPANCY
(1) Total Effective Annual Base Rent divided by average occupied unit. (2) Total Effective Annual Base Rent adjusted for any free rent given for the period. (3) Includes the TRP Properties. For these Properties, occupancy rates are presented as of December 31, 1996, and base rents are presented on an annualized basis based on results since the acquisition as this information is not available for the year ended December 31, 1996. (4) Average effective monthly base rent per unit declined in 1996 due to the acquisition of properties with lower base rents.
Hotels
Overview. The Hotel portfolio consists of five hotels (the "Hotels," and each a "Hotel") ranging from 64 to 157 rooms each. Four of the Hotels are all-suite Hotels which consist primarily of one-bedroom suites, but each also includes some studio suites and two-bedroom suites. All of the Hotels are currently operating under license agreements with Country Lodging by Carlson, Inc. The four all-suite Hotels are marketed as Country Suites by Carlson ("Country Suites") and the fifth Hotel is marketed as Country Inns and Suites by Carlson. Country Lodging is part of the Carlson Companies, based in Minneapolis, Minnesota. The Carlson Companies own, operate and franchise Radisson Hotels, TGI Friday's Restaurants, Country Kitchen Restaurants and the Carlson Travel Agency Network. Currently there are a total of more than 85 Country Inns and Suites, with 30 additional under construction.
The Company holds fee title to four of the five Hotels. The fifth Hotel, the Country Suites in Irving, Texas is owned by a partnership managed by one of the Associated Companies. The Company holds a participating first mortgage interest in the Property. In accordance with GAAP, the Company accounts for the Property as though it holds fee title, as substantially all risks and rewards of ownership have been transferred to the Company as a result of the terms of the mortgage. The hotels owned in fee title are currently leased to GHG (see "The Percentage Leases," discussed below). The Irving, Texas hotel is managed by GHG under terms of a pre-existing contract.
The following table contains, for the periods indicated, occupancy, average daily rate ("ADR") and revenue per available room ("REVPAR") information for the Company's Hotels as well as comparative information for all U.S. Hotels and all Country Lodging hotels.
(1) Source: Smith Travel Research and Country Hospitality. (2) Source: Country Hospitality. Data for all years is limited to U.S. properties. (3) The San Antonio Hotel opened in 1995. (4) Information supplied for historical comparison only as this hotel was not acquired by the Company until August 1996. Source: Unaudited operating statements provided by previous owner of the hotel. (5) Information represents a full year of operations including operations prior to the Company's acquisition of the hotel in August 1996.
THE PERCENTAGE LEASES
In order for the Company to qualify as a REIT, neither the Company nor the Operating Partnership can operate the Hotels. Therefore, the Operating Partnership has leased four of the Hotels to GHG each for a term of five years pursuant to percentage leases ("Percentage Leases"), which provide for rent equal to the greater of the Base Rent (as defined in the Percentage Leases) or a specified percentage of room revenues (the "Percentage Rent"). Each Hotel is separately leased to GHG. GHG's ability to make rent payments will, to a large degree, depend on its ability to generate cash flow from the operations of the Hotels. Each Percentage Lease contains the provisions described below.
Each Percentage Lease has a non-cancelable term of five years, subject to earlier termination upon the occurrence of certain contingencies described in the Percentage Lease. The lessee under the Percentage Lease has one five-year renewal option at the then current fair market rent.
During the term of each Percentage Lease, the lessee is obligated to pay the greater of Base Rent or Percentage Rent. Base Rent accrues and is required to be paid monthly in advance. Percentage Rent is calculated by multiplying fixed percentages by room revenues for each of the four Hotels owned by the Company. The applicable percentage changes when revenue exceeds a specified threshold, and the threshold may be adjusted annually in accordance with changes in the applicable CPI. Percentage Rent accrues and is due quarterly.
The table below sets forth the annual Base Rent and the Percentage Rent formulas for each of the four Hotels owned by the Company.
(1) Hotel was acquired in August 1996, therefore, rent incurred for the year ended December 31, 1996 was less than a full year's rent.
Other than real estate and personal property taxes, casualty insurance, a fixed capital improvement allowance and maintenance of underground utilities and structural elements, which are the responsibility of the Company, the Percentage Leases require the lessee to pay rent, insurance, salaries, utilities and all other operating costs incurred in the operation of the Hotels.
Under the Percentage Leases, the Company is required to maintain the underground utilities and the structural elements of the improvements, including exterior walls (excluding plate glass) and roof. In addition, the Company must fund periodic capital improvements to the buildings and grounds, and the periodic repair, replacement and refurbishment of furniture, fixtures and equipment, up to the following amounts per quarter for the first year of the Percentage Lease: Arlington-$25,000; Ontario-$22,750, Tucson-$28,500, and San Antonio-$10,500. These amounts increase annually in accordance with the CPI. These obligations carry forward to the extent not expended, and any unexpended amounts will remain the property of the Company upon termination of the Percentage Leases. Except for capital improvements and maintenance of structural elements and underground utilities, GHG will be required, at its expense, to maintain the Hotels in good order and repair, except for ordinary wear and tear, and to make non-structural, foreseen and unforeseen, and ordinary and extraordinary, repairs which may be necessary and appropriate to keep the Hotels in good order and repair. GHG will not be permitted to sublet all or any part of the Hotels or to assign its interest under any of the Percentage Leases, other than to an affiliate, without the prior written consent of the Company. No assignment or subletting will release GHG from any of its obligations under the Percentage Leases.
If the Company enters into an agreement to sell or otherwise transfer a Hotel, the Company has the right to terminate the Percentage Lease with respect to such Hotel upon paying GHG the fair market value of its leasehold interest in the remaining term of the Percentage Lease to be terminated.
GHG is the licensee under the franchise licenses on the Hotels. The franchise agreements are assignable to the Company, another lessee, or a new owner, with a payment of $2,500 per Hotel.
Mortgage Loans Receivable
Although the Company does not intend to engage in the business of making real estate loans, the Company holds three notes receivable, secured by first priority real property liens, which had a total outstanding principal balance of $10,678,000 and a net carrying value of $9,905,000 at December 31, 1996. The financial statement carrying value of the Hovpark loan at December 31, 1996 is $6,700,000, the estimated fair value of the underlying collateral. Effective February 1, 1997, as a result of repayment of principal by the borrower, the principal balance of this loan was reduced to $500,000 and the maturity was extended to February 1, 2009. As of February 28, 1997, all payments are current. In connection with the Grunow loan, the Company entered into an Option Agreement which provides the Operating Partnership the option to purchase the Grunow Medical building based upon an agreed upon formula. See Note 6 in Item 14 for further discussion. The following table summarizes these three mortgages.
SUMMARY OF MORTGAGE LOANS RECEIVABLE
(1) This loan is currently secured by a pledge of partnership interests in the borrower.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
BLUMBERG. On February 21, 1995, a class action complaint was filed in the Superior Court of the State of California in and for San Mateo County in connection with the Consolidation. The plaintiff is Anthony E. Blumberg, an Investor in Equitec B, on behalf of himself and all others (the "Blumberg Action") similarly situated. The defendants are GC (formerly known as Glenborough Realty Corporation), Glenborough Realty Corporation ("GRC"), Robert Batinovich, the Partnerships and the Company.
The complaint alleged breaches by the defendants of their fiduciary duty and duty of good faith and fair dealing to investors in the Partnerships. The complaint sought injunctive relief and compensatory damages. The complaint alleged that the valuation of GC was excessive and was done without appraisal of GC's business or assets. The complaint further alleged that the interest rate for the Notes to be issued to investors in lieu of shares of Common Stock, if they so elected was too low for the risk involved and that the Notes would likely sell, if at all, at a substantial discount from their face value (as a matter entirely distinct from the litigation and subsequent settlement, the Company, as it had the option to, paid in full the amounts due plus interest in lieu of issuing Notes).
On October 9, 1995 the parties entered into an agreement to settle the action. The defendants, in entering into the settlement agreement, did not acknowledge any fault, liability or wrongdoing of any kind and continue to deny all material allegations asserted in the litigation. Pursuant to the settlement agreement, the defendants will be released from all claims, known or unknown, that have been, could have been, or in the future might be asserted, relating to, among other things, the Consolidation, the acquisition of the Company's shares pursuant to the Consolidation, any misrepresentation or omission in the Registration Statement on Form S-4, filed by the Company on September 1, 1994, as amended, or the prospectus contained therein ("Prospectus/Consent Solicitation Statement"), or the subject matter of the lawsuit. In return, the defendants agreed to the following: (a) the inclusion of additional or expanded disclosure in the Prospectus Consent Solicitation Statement, and (b) the placement of certain restrictions on the sale of the stock by certain insiders and the granting of stock options to certain insiders following consummation of the Consolidation. Plaintiff's counsel indicated that it would request that the court award it $850,000 in attorneys' fees, costs and expenses. In addition, plaintiffs' counsel indicated it would request the court for an award of $5,000 payable to Anthony E. Blumberg as the class representative. The defendants agreed not to oppose such requests.
On October 11, 1995, the court certified the class for purposes of settlement, and scheduled a hearing to determine whether it should approve the settlement and class counsel's application for fees. A notice of the proposed settlement was distributed
to the members of the class on November 15, 1995. The notice specified that, in order to be heard at the hearing, any class member objecting to the proposed settlement must, by December 15, 1995, file a notice of intent to appear, and a detailed statement of the grounds for their objection.
Objections were received from a small number of class members. The objections reiterated the claims in the original Blumberg complaint, and asserted that the settlement agreement did not adequately compensate the class for releasing those claims. One of the objections was filed by the same law firm that brought the BEJ Action described below.
At a hearing on January 17, 1996, the court heard the arguments of the objectors seeking to overturn the settlement, as well as the arguments of the plaintiffs and the defendants in defense of the settlement. The court granted all parties a period of time in which to file additional pleadings. On June 4, 1996, the court granted approval of the settlement, finding it fundamentally fair, adequate and reasonable to the respective parties to the settlement. However, the objectors gave notice of their intent to appeal the June 4 decision, and filed their opening brief with the court of appeals on November 15, 1996. The Company and the other defendants filed their answering brief on January 17, 1997.
BEJ EQUITY PARTNERS. On December 1, 1995, a second class action complaint relating to the Consolidation was filed in Federal District Court for the Northern District of California (the "BEJ Action"). The plaintiffs are BEJ Equity Partners, J/B Investment Partners, Jesse B. Small and Sean O'Reilly as custodian f/b/o Jordan K. O'Reilly, who as a group held limited partner interests in the California limited partnerships known as Outlook Properties Fund IV, Glenborough All Suites Hotels, L.P., Glenborough Pension Investors, Equitec Income Real Estate Investors-Equity Fund 4, Equitec Income Real Estate Investors C and Equitec Mortgage Investors Fund IV, on behalf of themselves and all others similarly situated. The defendants are GRC, GC, the Company, GPA, Ltd., Robert Batinovich and Andrew Batinovich. The Partnerships are named as nominal defendants.
This action alleges the same disclosure violations and breaches of fiduciary duty as were alleged in the Blumberg Action. The complaint sought injunctive relief, which was denied at a hearing on December 22, 1995. At that hearing, the court also deferred all further proceedings in this case until after the scheduled January 17, 1996 hearing in the Blumberg Action. Following several stipulated extensions of time for the Company to respond to the complaint, the Company filed a motion to dismiss the case. The Company has since withdrawn its motion to dismiss the case, and the plaintiffs have agreed to apply for an order from the court staying all proceedings in this action pending final resolution of the Blumberg action.
It is management's position that the BEJ Action, and the objections to the settlement of the Blumberg Action, are without merit, and management intends to pursue a vigorous defense in both matters. However, given the inherent uncertainties of litigation, there can be no assurance that the ultimate outcome in these two legal proceedings will be in the Company's favor.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The company did not submit any matters to a vote of security holders in the fourth quarter of the year ended December 31, 1996.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
Market Information
On January 31, 1996, the Company's Common Stock began trading on the NYSE at $12.00 per share under the symbol "GLB". On December 31, 1996, the closing price was $17.625. On February 26, 1997, the last reported sales price per share of the Company's Common Stock on the NYSE was $19.00. The following table sets forth the high and low sales price per share of the Company's Common Stock for the periods indicated, as reported on the NYSE composite tape.
(1) Although the Consolidation occurred on December 31, 1995 and the Company began paying distributions on its Common Stock based on earnings in the first quarter of 1996, the Common Stock did not begin trading on the NYSE until January 31, 1996. (2) High and low stock prices through February 26, 1997.
Holders
The approximate number of holders of record of the shares of the Company's common stock was 5,355 as of February 26, 1997.
Distributions
Since the Consolidation, the Company has paid regular quarterly distributions to holders of its Common Stock. During the year ended December 31, 1996, the Company declared and/or paid the following quarterly distributions:
(1) Distributions for the fourth quarter of 1996 were paid on February 19, 1997.
The Company intends to declare regular quarterly distributions to its stockholders. Federal income tax law requires that a REIT distribute annually at least 95% of its REIT taxable income. Future distributions by the Company will be at the discretion of the Board of Directors and will depend upon the actual Funds from Operations of the Company, its financial condition, capital requirements, the annual distribution requirements under the REIT provisions of the Internal Revenue Code, applicable legal restrictions and such other factors as the Board of Directors deems relevant. The Company intends to continue its policy of paying quarterly distributions, but there can be no assurance that distributions will continue or be paid at any specific level.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
Set forth below are selected financial data for:
Glenborough Realty Trust Incorporated: Consolidated balance sheet data is presented as of December 31, 1996 and 1995. Consolidated operating data is presented for the year ended December 31, 1996, and As Adjusted consolidated operating data is presented for the years ended December 31, 1995 and 1994, and assumes the Consolidation and related transactions occurred on January 1, 1994.
The GRT Predecessor Entities: Combined operating data is presented for the years ended December 31, 1995, 1994, 1993 and 1992. The combined balance sheet data is presented as of December 31, 1994, 1993 and 1992.
This selected financial data should be read in conjunction with financial statements of Glenborough Realty Trust Incorporated, including the notes thereto, included in Item 14.
(1) Certain revenues which are included in the historical combined amounts for 1995 and prior are not included on an as adjusted basis. These revenues are included in three unconsolidated Associated Companies, GHG, GC and GIRC, on an as adjusted basis, from which the Company receives lease payments and dividend income. (2) Historical 1996 and as adjusted 1994 net losses reflect $7,237 of Consolidation and litigation costs incurred in connection with the Consolidation. As adjusted 1994 data give effect to the Consolidation and related transactions as if such transactions had occurred on January 1, 1994, whereas historical 1996 data reflect such transactions in the periods they were expensed. The Consolidation and litigation costs were expensed on January 1, 1996, the Company's first day of operations. Net loss in 1992 includes a non-recurring writedown of $4,282 on GPI's investment in the master agreement that resulted from GPI's in-substance foreclosure on the AFP Partners' properties. (3) As adjusted net income per share is based upon as adjusted weighted average shares outstanding of 5,753,709 for 1995 and 1994.
(4) Consists of distributions declared for the period then ended. (5) EBIDA represents and is computed as earnings before interest expense, depreciation, amortization, loss provisions and minority interests. The Company believes that in addition to cash flows and net income, EBIDA is a useful financial performance measurement for assessing the operating performance of an equity REIT because, together with net income and cash flows, EBIDA provides investors with an additional basis to evaluate the ability of a REIT to incur and service debt and to fund acquisitions and other capital expenditures. To evaluate EBIDA and the trends it depicts, the components of EBIDA, such as rental revenues, rental expenses, real estate taxes and general and administrative expenses, should be considered. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." Excluded from EBIDA are financing costs such as interest as well as depreciation and amortization, each of which can significantly affect a REIT's results of operations and liquidity and should be considered in evaluating a REIT's operating performance. Further, EBIDA does not represent net income or cash flows from operating, financing and investing activities as defined by generally accepted accounting principles and does not necessarily indicate that cash flows will be sufficient to fund cash needs. It should not be considered as an alternative to net income as an indicator of the Company's operating performance or to cash flows as a measure of liquidity. (6) Funds from Operations represents income (loss) from operations before minority interests and extraordinary items plus depreciation and amortization except amortization of deferred financing costs and loss provisions. In 1996, consolidation and litigation costs were also added back to net income to determine FFO. Management generally considers FFO to be a useful financial performance measure of the operating performance of an equity REIT because, together with net income and cash flows, FFO provides investors with an additional basis to evaluate the ability of a REIT to incur and service debt and to fund acquisitions and other capital expenditures. FFO does not represent net income or cash flows from operations as defined by GAAP and does not necessarily indicate that cash flows will be sufficient to fund cash needs. It should not be considered as an alternative to net income as an indicator of the Company's operating performance or to cash flows as a measure of liquidity. FFO does not measure whether cash flow is sufficient to fund all of the Company's cash needs including principal amortization, capital improvements and distributions to stockholders. FFO also does not represent cash flows generated from operating, investing or financing activities as defined by GAAP. Further, FFO as disclosed by other REITs may not be comparable to the Company's calculation of FFO. (7) Cash available for distribution ("CAD") represents net income (loss) (computed in accordance with GAAP), excluding extraordinary gains or losses or loss provisions, plus depreciation and amortization including amortization of deferred financing costs, less lease commissions and capital expenditures. CAD should not be considered an alternative to net income as a measure of the Company's financial performance or to cash flow from operating activities (computed in accordance with GAAP) as a measure of the Company's liquidity, nor is it necessarily indicative of sufficient cash flow to fund all of the Company's cash needs. (8) CAD for the year ended December 31, 1995 excludes approximately $6,782 that represents the net proceeds received from the prepayment of the Finley mortgage loan and the repayment of the wrap note payable. (9) Debt to total market capitalization is calculated as total debt at period end divided by total debt plus the market value of the Company's outstanding common stock, on a fully converted basis, based upon the closing price of the Common Stock of $17.625 on December 31, 1996.
FUNDS FROM OPERATIONS
The Company believes that FFO is a measure of cash flow which, when considered in conjunction with other measures of operating performance, affects the value of equity REITs such as the Company. FFO means income (loss) from operations before minority interests and extraordinary items plus depreciation and amortization, except amortization of deferred financing costs and loss provisions. In the first quarter of 1996, consolidation and litigation costs that were charged to net income have also been added back to determine FFO.
FFO is not necessarily indicative of cash flow available to fund cash needs and is not the same as cash flow from operations as defined by GAAP, and should not be considered as an alternative to net income (loss) as an indicator of the Company's operating performance, or as an alternative to cash flows from operating, investing and financing activities as a measure of liquidity or ability to make distributions. Management generally considers FFO to be a useful financial performance measure of the operating performance of an equity REIT because, together with net income and cash flows, FFO provides investors with an additional basis to evaluate the ability of a REIT to incur and service debt and to fund acquisitions and other capital expenditures. FFO does not represent net income or cash flows from operations as defined by GAAP and does not necessarily indicate that cash flows will be sufficient to fund all of the Company's cash needs including principal amortization, capital improvements and distributions to stockholders. FFO also does not represent cash flows generated from operating, investing or financing activities as defined by GAAP. FFO as disclosed by other REITs may not be comparable to the Company's calculation of FFO.
In February 1995, NAREIT established new guidelines for calculating FFO that clarify previous guidelines. The primary change from the old definition to the new definition is the treatment of amortization of deferred financing fees. Under the new definition, the amortization of deferred financing fees is no longer added back to net income in calculating FFO. The new guidelines were effective beginning in 1996.
Beginning with the first quarter of 1996, the Company calculates its FFO based upon the new NAREIT definition and, accordingly, does not add back amortization of deferred financing fees and costs. The change does not affect the Company's CAD.
The following table sets forth the Company's calculation of FFO and CAD for the three months ended March 31, June 30, September 30 and December 31, 1996 and the year ended December 31, 1996 (dollars in thousands):
(1) Reflects the adjustments to FFO required to reflect the FFO of the Associated Companies allocable to the Company. The Company's investments in the Associated Companies are accounted for using the equity method of accounting. (2) The distributions for the three months ended December 31, 1996, were paid on February 19, 1997.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the selected data in Item 6 and the Consolidated Financial Statements of Glenborough Realty Trust Incorporated and the GRT Predecessor Entities, including the notes thereto, included in Item 14.
BACKGROUND
The Company commenced operations on December 31, 1995 through the merger of eight public limited partnerships and a management company with and into the Company. A portion of the Company's operations is conducted through the Operating Partnership in which the Company holds a 1% interest as the sole general partner and an approximate 91% limited partner interest. The Company intends to elect treatment as a REIT when it files its tax return for the year ended December 31, 1996.
The statements of operations, equity and cash flows for the years ended December 31, 1995, 1994 and 1993 of the GRT Predecessor Entities include the historical operations of GC and the Partnerships. These statements have been adjusted to reflect the consolidation of two joint ventures which were, in aggregate, wholly owned by the Partnerships. The statements of operations, equity and cash flows for the years ended December 31, 1995, 1994 and 1993 of the GRT Predecessor entities are included as the Consolidation of these entities to form the Company did not occur until December 31, 1995.
Certain components of the Company's results of operations are not comparable to those of the GRT Predecessor Entities. The primary reason for the difference is the segregation in 1996 of the operations (management fees and reimbursements, as well as related expenses) of the Associated Companies, all of which were combined in the GRT Predecessor Entities 1995 financial statements. Effective January 1, 1996, the Company owns 100% of the preferred stock in each of the Associated Companies and accounts for its interests under the equity method. Also, contributing to the comparability difference is the change in the operational structure of three original hotel properties, not including the San Antonio Hotel which was acquired in 1996 and the Irving, Texas Hotel, (the "Hotels"). The Hotels were wholly owned by the GRT Predecessor Entities and, thus, the operations of the Hotels were included in the financial statements of the GRT Predecessor Entities. In order for the Company to qualify as a REIT, neither the Company nor the Operating Partnership can operate the Hotels. Under the current structure, the Company owns the Hotels but leases them to GHG. The Company includes only the related lease payments earned from GHG in its statement of operations. When comparing historical year ended December 31, 1996 to historical years ended December 31, 1995 and 1994, the decreases in fees and reimbursements, property operating expenses and general and administrative expenses are the primary components affected by these changes in structure.
RESULTS OF OPERATIONS
COMPARISON OF THE HISTORICAL YEAR ENDED DECEMBER 31, 1996 TO THE AS ADJUSTED YEAR ENDED DECEMBER 31, 1995.
Set forth below is a discussion comparing the historical results of operations for the year ended December 31, 1996 to the results of operations for the year ended December 31, 1995 adjusted to reflect the Consolidation as if the Consolidation had occurred on January 1, 1994.
Following is a table of net operating income by property type, for comparative purposes, presenting the results for the year ended December 31, 1996 and the as adjusted year ended December 31, 1995.
RESULTS OF OPERATIONS BY PROPERTY TYPE HISTORICAL YEAR ENDED DECEMBER 31, 1996 AND AS ADJUSTED YEAR ENDED DECEMBER 31,
- --------------- (1) Eliminating entry represents internal market level property management fees included in operating expenses to provide comparison to industry performance.
Rental Revenues. Rental Revenues increased by $4,448,000, or 33%, to $17,943,000 for the year ended December 31, 1996 from $13,495,000 for the as adjusted year ended December 31, 1995. The increase consisted of increases in revenues from the Office, Industrial, Retail, Multi-Family and Hotel properties of $2,625,000, $127,000, $380,000, $737,000 and $579,000, respectively. Moreover, of this increase, $4,442,000 represents rental revenues generated from the acquisition in 1996 of 22 properties (the "1996 Acquisitions"). The increase was offset by the elimination of revenues from the All American Industrial Properties due to the sale of such properties in June 1996. These properties represented annual revenues of approximately $600,000.
Fees and Reimbursements. Fees and reimbursements revenue consists primarily of asset management fees paid to the Company by a controlled partnership and increased slightly to $311,000 in 1996 from $260,000 in 1995.
Interest and Other Income. Interest and other income consists primarily of interest on mortgage loans receivable and increased slightly to $1,080,000 in 1996 from $982,000 in 1995.
Equity in Earnings of Associated Companies. Equity in earnings of Associated Companies decreased slightly from $1,691,000 in 1995 to $1,598,000 in 1996, primarily resulting from the acquisition of the UCT Property and Bond Street Properties by the Company from entities controlled by the Associated Companies. Prior to the acquisition by the Company of these Properties, the partnerships owning these Properties paid all their fees and reimbursed all their related salary costs to GC.
Property Operating Expenses. Property operating expenses increased by $1,182,000, or 29%, to $5,266,000 in the year ended December 31, 1996 from $4,084,000 for the as adjusted year ended December 31, 1995. Of this increase, $1,722,000 represents expenses of the 1996 Acquisitions, offset in part by the reduction in expenses resulting from the sale of the All American Industrial properties.
General and Administrative Expenses. General and administrative expenses increased $410,000, or 42%, from $983,000 in 1995 to $1,393,000 in 1996. The increase is due in part to increased overhead costs resulting from the 1996 Acquisitions, including a portion of the transaction costs relating to the 1996 Acquisitions.
Interest Expense. Interest expense increased by $1,146,000, or 41%, to $3,913,000 in the year ended December 31, 1996 from $2,767,000 in the as adjusted year ended December 31, 1995. Substantially all of the
increase was the result of higher average borrowings during 1996 as compared to 1995. The increased borrowings in 1996 were used to finance the cash portion of the 1996 Acquisitions.
Depreciation and Amortization. Depreciation and amortization increased $921,000, or 25%, to $4,575,000 in 1996 from $3,654,000 in 1995. The increase was primarily due to depreciation and amortization associated with the 1996 Acquisitions.
Gain on Sale of Rental Properties. Gain on sale of rental properties of $321,000 during 1996 resulted from the sale of the All American Industrial Properties held in the Company's industrial portfolio.
Consolidation Costs. Consolidation costs in 1996 consist of the costs associated with preparing, printing and mailing the Prospectus/Consent Solicitation Statement and other documents related to the Consolidation, and all other costs incurred in the forwarding of the Prospectus/Consent Solicitation Statement to investors.
Litigation Costs. Litigation costs consist of the legal fees incurred in connection with defending two class action complaints filed by investors in certain of the GRT Predecessor Entities as well as an accrual for the proposed settlement in one case.
Loss on Debt Refinancing. Loss on debt refinancing of $186,000 during the year ended December 31, 1996 resulted from the write-off of unamortized loan fees when the $10,000,000 Imperial Bank line of credit was paid off with proceeds from the Wells Fargo Bank Line of Credit.
COMPARISON OF THE AS ADJUSTED YEAR ENDED DECEMBER 31, 1995 TO THE AS ADJUSTED YEAR ENDED DECEMBER 31, 1994
Set forth below is a discussion comparing the as adjusted results of operations for the year ended December 31, 1995 to the as adjusted results of operations for the year ended December 31, 1994, each adjusted to reflect the Consolidation as if the Consolidation had occurred on January 1, 1994.
Rental Revenues. Rental revenues increased $628,000, or 5%, to $13,495,000 in 1995 from $12,867,000 in 1994. The increase was primarily due to a net increase in occupancy at certain commercial properties and a small increase in lease payments from the hotel properties.
Fees and Reimbursements. Fees and reimbursements remained unchanged from 1994 to 1995 and consist primarily of asset management fees paid to the Company by a controlled partnership.
Interest and Other Income. Interest and other income decreased $127,000, or 11%, to $982,000 in 1995 from $1,109,000 in 1994. The decrease was primarily due to a decrease in interest earned on cash balances.
Equity in Earnings of Associated Companies. Equity in earnings of Associated Companies increased slightly to $1,691,000 in 1995 from $1,649,000 in 1994. As Adjusted amounts for both 1995 and 1994 include the effect of the Rancon contracts as if such contracts commenced on January 1, 1994, as well as the loss of certain other contracts which occurred in 1994 as if such losses occurred prior to January 1, 1994. The portfolio of properties and partnerships managed or controlled by the Associated Companies was otherwise unchanged from 1994 to 1995.
Property Operating Expenses. Property operating expenses increased by $411,000, or 11%, to $4,084,000 in 1995 from $3,673,000 in 1994. The increase was primarily due to expenses related to increased occupancy at certain commercial properties.
General and Administrative. General and administrative expenses increased slightly to $983,000 in 1995 from $954,000 in 1994. The number of properties owned by the Company remained consistent.
Interest Expense. Interest expense remained unchanged from 1994 to 1995.
Depreciation and Amortization. Depreciation and amortization expense increased $212,000, or 6%, in 1995 to $3,654,000 from $3,442,000 in 1994. The increase was due to the depreciation and amortization of newly capitalized costs.
Loss Provision. During the year ended December 31, 1995, the Company had recorded a loss provision of $863,000 to reduce the carrying value of its mortgage loan receivable secured by the Eatontown, New Jersey property to its estimated realizable value, which is equal to the value used for consolidation purposes, in anticipation of a renegotiation of the terms of the note upon its maturity on November 1, 1996. For the year ended December 31, 1994, the Company had recorded a loss provision of $533,000 to reduce its investment in Glenborough Partners to estimated fair market value.
COMPARISON OF THE HISTORICAL YEAR ENDED DECEMBER 31, 1996 TO THE HISTORICAL YEAR ENDED DECEMBER 31, 1995.
Rental Revenue. Rental Revenue increased by $2,489,000, or 16%, to $17,943,000 in 1996 from $15,454,000 in 1995. Of this increase, $4,442,000 represents rental revenues generated from the 1996 Acquisitions. The increase in 1996 revenues was offset by the elimination of revenues from the All American Industrial Properties due to the sale of such properties in June 1996. The increase in rental revenues was also offset by a decrease in hotel revenues due to the change in the operational structure of the Hotels. As discussed above, three of the original Hotels were owned and operated by the GRT Predecessor entities prior to 1996 and accordingly, the revenues of the Hotels are included in the 1995 statement of operations. However, under the current structure, the Company owns the Hotels but leases them to GHG and accordingly, the 1996 statement of operations reflects only the lease payments due under the operating leases. For the year ended December 31, 1996, each of the four originally owned hotels increased their ADR (Average Daily Rate) and REVPAR (Revenue Per Available Room).
Fees and Reimbursements and Equity in Earnings of Associated Companies. Fees and reimbursements revenue decreased to $311,000 for the year ended December 31, 1996 from $16,019,000 for the year ended December 31, 1995; equity in earnings of the Associated Companies increased to $1,598,000 for the year from the year ended December 31, 1996 from zero for the year ended December 31, 1995. As previously discussed, the primary reason for the difference between 1996 and 1995 results is the segregation in 1996 of the operations of the Associated Companies, and the resulting recognition of earnings from them using the equity method by the Company. In 1995, the earnings of the Associated Companies were consolidated with the partnerships participating in the Consolidation.
Interest and Other Income. Interest and other income decreased $1,618,000, or 60%, in 1996 to $1,080,000 from $2,698,000 in 1995. This decrease resulted primarily from the lower note receivable balance in 1996, primarily as a result of the early prepayment of a note receivable in April 1995 and the early repayment in January and June of 1995 of three of the four notes received from the sale of the Laurel Cranford buildings. Also, in 1996, cash balances decreased primarily as a result of the prepayment of the investor notes payable, payment of declared dividends and the payment of costs associated with the Consolidation.
Property Operating Expenses. Property operating expenses decreased $3,310,000, or 39%, to $5,266,000 in 1996 from $8,576,000 in 1995. Of the decrease, $4,993,000 is primarily the result of the change in the operational structure of the hotels, as previously discussed. The decrease was offset by an increase of $1,722,000 associated with the operating expenses of the 1996 Acquisitions.
General and Administrative. General and administrative expenses decreased to $1,393,000 in 1996 from $15,947,000 in 1995. The decrease is due primarily to the segregation in 1996 of the operations of the Associated Companies, as previously discussed.
Interest Expense. Interest expense increased $1,784,000, or 84%, to $3,913,000 in 1996 from $2,129,000 in 1995. Substantially all of the increase was the result of higher average borrowings during 1996 as compared to 1995. The increased borrowings were used to finance the 1996 Acquisitions.
Depreciation and Amortization. Depreciation and amortization remained relatively constant, decreasing to $4,575,000 in 1996 from $4,762,000 in 1995. Depreciation and amortization in 1995 includes the amortization of the management contracts, which are now reflected in the results of the Associated Companies in 1996. Depreciation and amortization in 1996 includes depreciation and amortization related to the 1996 Acquisitions.
COMPARISON OF THE HISTORICAL YEAR ENDED DECEMBER 31, 1995 TO THE HISTORICAL YEAR ENDED DECEMBER 31, 1994
Rental Revenue. Rental Revenue increased by $1,657,000, or 12%, to $15,454,000 in 1995 from $13,797,000 in 1994. This increase was primarily due to a net increase in occupancy at certain commercial properties, the acquisition of the Summerbreeze apartment complex and a significant increase in hotel revenues due to overall increases in occupancy and average daily room rates.
Fees and Reimbursements. Fees and reimbursements increased by $2,692,000, or 20%, to $16,019,000 in 1995 from $13,327,000 in 1994. The increase was primarily due to an increase in property and asset management fees and related expense reimbursements due to the acquisition of the Rancon and RGI management contracts.
Interest and Other Income. Interest and other income decreased $859,000, or 24%, to $2,698,000 in 1995 from $3,557,000 in 1994. Substantially all of the decrease resulted from the early repayment of the Finley Square note receivable in April 1995 and the early repayment in January and June of 1995 of three of the four notes from the sale of the Laurel Cranford buildings.
Property Operating Expenses. Property operating expenses increased $1,794,000, or 26%, to $8,576,000 in 1995 from $6,782,000 in 1994. The increase was primarily due to the higher expenses related to increased occupancy rates and to the acquisition of the Summerbreeze apartment complex in January 1995.
General and Administrative. General and administrative expenses, including salaries, increased $2,493,000, or 19%, to $15,947,000 in 1995 from $13,454,000 in 1994. Substantially all of this increase resulted from expenses incurred by Glenborough Realty Corporation in concluding its business as a stand alone corporation prior to merging with the Company. Such expenses will not be incurred again by the Company or the Associated Companies. In the same period, general and administrative cost reductions resulting from property sales in 1994 were offset by increased general and administrative costs associated with the Rancon and RGI management contracts acquired in 1995.
Interest Expense. Interest expense increased $989,000, or 87%, to $2,129,000 in 1995 from $1,140,000 in 1994. Substantially all of the increase was the result of increased debt levels primarily related to the financing of the acquisition of the Rancon management contracts and a first deed of trust on the Summerbreeze apartment complex acquired in 1995.
Depreciation & Amortization. Depreciation and amortization increased by $721,000, or 18%, to $4,762,000 in 1995 from $4,041,000 in 1996, due primarily to the acquisition of the Rancon and RGI management contracts on January 1, 1995.
LIQUIDITY AND CAPITAL RESOURCES
The Company expects to meets its short-term liquidity requirements generally through its working capital and cash generated by operations. As of December 31, 1996, the Company had no material commitments for capital improvements other than certain expansion related improvements estimated at approximately $1,750,000 at its existing shopping center in Tampa, Florida. Other planned capital improvements consist of tenant improvements, expenditures necessary to lease and maintain the Properties and expenditures for furniture and fixtures and building improvements at the Hotel Properties. The Company believes that its cash generated by operations will be adequate to meet both operating requirements and to make distributions in accordance with REIT requirements in both the short and the long-term. In addition to cash generated by operations, the Line of Credit provides for working capital advances. However, there can be no assurance that the Company's results of operations will not fluctuate in the future and at times affect (i) its ability to meet its operating requirements and (ii) the amount of its distributions.
The Company expects to meet certain of its long-term liquidity requirements, such as scheduled debt maturities and possible acquisitions, through a combination of short and long-term borrowings and the issuance of debt and equity securities of the Company.
Mortgage loans payable and secured bank lines increased from $33,685,000 at December 31, 1995 to $75,891,000 at December 31, 1996. This increase was primarily due to new borrowings in 1996 to fund the
1996 Acquisitions. The $10,000,000 Imperial Bank line of credit that existed at December 31, 1995 was replaced with the $50,000,000 Line of Credit provided by Wells Fargo Bank that is secured by first mortgages on certain of the Company's properties. The proceeds from the Line of Credit were used to retire the $10,000,000 Imperial line of credit and to fund the 1996 Acquisitions. The Line of Credit had an outstanding balance of $21,307,000 at December 31, 1996. In addition to increased borrowings under the Line of Credit, approximately $25,000,000 of new debt was assumed in connection with the 1996 Acquisitions and a $6,120,000 term loan was obtained to partially finance a 1996 Acquisition.
In October 1996, the Company completed a public equity offering of 3,666,000 shares of Common Stock at an offering price of $13.875 per share. The net proceeds from the offering of approximately $47.8 million were used to fund certain of the 1996 Acquisitions and to repay outstanding indebtedness.
At December 31, 1996, the Company's total indebtedness included fixed-rate debt of $44,657,000, or 59% of the Company's aggregate indebtedness, and floating-rate indebtedness of $31,234,000, or 41% of the Company's aggregate indebtedness. The Company's total market capitalization as of December 31, 1996 was $257,528,000 resulting in a ratio of debt to total market capitalization of approximately 29.5%.
In January 1997, the Company filed a shelf registration statement (the "January 1997 Shelf Registration Statement") with the Securities and Exchange Commission to register $250.0 million of equity securities. The January 1997 Shelf Registration Statement was declared effective by the Securities and Exchange Commission on February 25, 1997.
INFLATION
Substantially all of the leases at the retail Properties provide for pass-through to tenants of certain operating costs, including real estate taxes, common area maintenance expenses, and insurance. Leases at the multifamily Properties generally provide for an initial term of one month or one year and allow for rent adjustments at the time of renewal. Leases at the office properties typically provide for rent adjustment and pass-through of certain operating expenses during the term of the lease. All of these provisions permit the Company to increase rental rates or other charges to tenants in response to rising prices and therefore, serve to minimize the Company's exposure to the adverse effects on inflation.
FORWARD LOOKING STATEMENTS; FACTORS THAT MAY AFFECT OPERATING RESULTS
This Report on Form 10-K contains forward looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities and Exchange Act of 1934, including statements regarding the Company's expectations, hopes, intentions, beliefs and strategies regarding the future. Forward looking statements include statements regarding potential acquisitions, the anticipated performance of future acquisitions, recently completed acquisitions and existing properties, and statements regarding the Company's financing activities. All forward looking statements included in this document are based on information available to the Company on the date hereof, and the Company assumes no obligation to update any such forward looking statements. It is important to note that the Company's actual results could differ materially from those stated or implied in such forward looking statements. Some of the factors that could cause actual results to differ materially are set forth below.
LITIGATION RELATED TO CONSOLIDATION
Recent business reorganizations sponsored by others involving the conversion of partnerships into corporations have given rise to a number of investor lawsuits. These lawsuits have included claims against the general partners of the participating partnerships, the partnerships themselves and related persons involved in the structuring of or benefiting from the conversion or reorganization, as well as claims against the surviving entity and its directors and officers. The lawsuits have included, among others, claims that the structure of the reorganizations, as well as the manner in which they were submitted for investor approval, involved violations of federal and state securities laws, common law fraud and negligent misrepresentations, breaches of fiduciary duty, unfair and deceptive trade practices, negligence and waste, breaches of the partnership documents of the participating partnerships, failure to comply with applicable reporting requirements, violations of the rules of the NASD on suitability and fair practices, and violations of the Racketeer Influenced and Corrupt Organizations Act. Two lawsuits have been filed contesting the fairness of the Consolidation, one in California state court and one in federal court. A settlement of the state court action has been approved by the court, but objectors to the settlement have appealed that approval. The Company and the other defendants in the state court action have filed a responsive brief and the appeal is now pending. Plaintiffs in the federal court action have agreed voluntarily to take the action off calendar pending resolution of the state court action.
From time to time the Company is involved in other litigation arising out of its business activities. It is possible that this litigation and the other litigation previously described could result in significant losses in excess of amounts reserved, which could have an adverse effect on the Company's results of operations and the financial condition of the Company.
CHAPTER 11 REORGANIZATION OF PARTNERSHIP CONSOLIDATION BY SENIOR MANAGEMENT
Robert and Andrew Batinovich, two of the senior officers of the Company, were also senior members of a management team that formed a publicly registered limited partnership in 1986 to consolidate a number of predecessor partnerships. That public partnership was involved in litigation with its primary creditor and in order to prevent foreclosure filed a petition for reorganization under Chapter 11 of the United States Bankruptcy Code in May of 1992. The public partnership, the primary subsidiary of which is GPA, Ltd., which owns an approximately 14% limited partner interest in the Operating Partnership along with other substantial real estate assets, settled the litigation and obtained confirmation of a plan of reorganization in January 1994. Investors in the Offered Securities should consider that the consolidation of partnerships into GPA, Ltd.'s parent partnership did not achieve all of the objectives stated at the time and should further consider the relevance of that fact to their investment in the Offered Securities of the Company.
RISKS ASSOCIATED WITH ACQUISITIONS
Acquisitions Could Adversely Affect Operations or Stock Value
Consistent with its growth strategy, the Company is continually pursuing and evaluating potential acquisition opportunities, and is from time to time actively considering the possible acquisition of specific properties, which may include properties managed or controlled by one of the Associated Companies or owned by affiliated parties. It is possible that one or more of such possible future acquisitions, if completed, could adversely affect the Company's funds from operations or cash available for distribution, in the short term or the long term or both, or increase the Company's debt, or be perceived negatively among investors such that such an acquisition could be followed by a decline in the market value of the Common Stock.
Expansion Risk
The Company is experiencing a period of rapid expansion, which management expects will continue in the near future. This growth has increased the operating complexity of the Company as well as the level of responsibility for both existing and new management personnel. The Company's ability to manage its expansion effectively will require it to continue to update its operational and financial systems and to expand, train and manage its employee base. The Company's inability to effectively manage its expansion could have an adverse effect on the Company's results of operations and financial condition.
Conflict of Interest
The Company has acquired, and from time to time may acquire, properties from partnerships that Robert Batinovich, the Company's Chief Executive Officer, and Andrew Batinovich, the Company's Chief Operating Officer, control, and in which they and members of their families have substantial interests. It is also possible that the Company may enter into transactions to acquire other properties controlled by these individuals or in which they or members of their families have substantial interests in the future. These transactions involve or will involve conflicts of interest. These transactions may provide substantial economic benefits such as the payments or unit issuances, relief or deferral of tax liabilities, relief of primary or secondary liability for debt, and reduction in exposure to other property-related liabilities. Despite the presence of appraisals or fairness opinions or review by parties who have no interest in the transactions, the transactions will not be the product of arm's-length negotiation and there can be no assurance that these transactions will be as favorable to the Company as transactions that the Company negotiates with unrelated parties or will not result in undue benefit to Robert and Andrew Batinovich and members of their families. Neither Robert Batinovich nor Andrew Batinovich has guaranteed that any properties acquired from entities they control or in which they or their families have a significant interest will be as profitable as other investments made by the Company or will not result in losses.
Assumption of General Partner Liabilities
The Company and its predecessors have acquired a number of their properties by acquiring partnerships that own the properties or by first acquiring general partnership interests and at a later date acquiring the properties, and the Company may pursue acquisitions in this manner in the future. When the Company uses this acquisition technique, a subsidiary of the Company becomes a general partner. As a general partner the Company's subsidiary becomes generally liable for the debts and obligations of the partnership, including debts and obligations that may be contingent or unknown at the time of the acquisition. In addition, the Company's subsidiary assumes obligations under the partnership agreements, which may include obligations to make future contributions for the benefit of other partners. The Company undertakes detailed due diligence reviews to ascertain the nature and extent of obligations that its subsidiary will assume when it becomes a general partner, but there can be no assurance that the obligations assumed will not exceed the Company's estimates or that the assumed liabilities will not have an adverse effect on the Company's results of operations or financial condition. In addition, an Associated Company may enter into management agreements pursuant to which it assumes certain obligations as manager of properties. There can be no assurance that these obligations will not have an adverse effect on the Associated Companies' results of operations or financial condition, which could adversely affect the value of the Company's preferred stock interest in those companies.
Risks Relating to Tender Offers
The Company may, as part of its growth strategy, acquire properties and portfolio of properties through tender offer acquisitions of interests in public and private partnerships. Tender offers often result in competing tender offers, as well as litigation initiated by limited partners in the subject partnerships or by competing bidders. Due to the inherent uncertainty of litigation, the Company could be subject to adverse judgments in substantial amounts. As the Company has not yet attempted an acquisition through the tender offer process, and because of competing offers and possible litigation, there can be no assurance that, if undertaken, the
Company would be successful in acquiring properties through a tender offer or that the tender offer process would not result in litigation and a significant judgment adverse to the Company.
CERTAIN TAX RISKS
Consequences of Failure to Qualify as a REIT
The Company intends to elect to be treated as a REIT under the Code commencing with its taxable year ending December 31, 1996. No assurance can be given, however, that the Company will be able to operate in a manner which would permit it to qualify to make this election. Qualification as a REIT involves the satisfaction of numerous requirements (some on an annual and quarterly basis) established under highly technical and complex Code provisions for which only limited judicial or administrative interpretation exists, and involves the determination of various factual matters and circumstances not entirely within the Company's control. The Company will receive nonqualifying management fee income and will own nonqualifying preferred stock in the Associated Companies. As a result, the Company may approach the income and asset test limits imposed by the Code and could be at risk of not satisfying those tests. In order to avoid exceeding the asset test limit, for example, the Company may have to reduce its interest in the Associated Companies. The Company is relying on the opinion of its tax counsel regarding its ability to qualify as a REIT. This legal opinion is not binding on the IRS. See "Federal Income Tax Consequences -- Taxation of the Company."
If the Company were to fail to qualify as a REIT in any taxable year, the Company would be subject to federal income tax (including any applicable alternative minimum tax) on its taxable income at corporate rates. Moreover, unless entitled to relief under certain statutory provisions, the Company would also be disqualified from treatment as a REIT for the four taxable years following the year during which qualification is lost. This treatment would reduce the net earnings of the Company available for investment or distribution to stockholders because of the additional tax liability to the Company for the years involved. In addition, distributions to stockholders would no longer be required to be made. See "Federal Income Tax Consequences -- Failure to Qualify."
Even if the Company qualifies as a REIT, it will be subject to certain federal, state and local taxes on its income and property. See "Federal Income Tax Consequences -- Taxation of the Company."
Consequences of Failure of the Operating Partnership to Qualify as a Partnership
The Company expects that the Operating Partnership, which is organized as a limited partnership, will qualify for treatment as such under the Code. If the Operating Partnership, or any of the other partnerships owned by the Operating Partnership, fails to qualify for treatment as a partnership under the Code, the Company would cease to qualify as a REIT, and both the Company and the Operating Partnership would be subject to federal income tax (including any alternative minimum tax on the Company's income, at corporate rates). See "Federal Income Tax Consequences -- Failure to Qualify."
Possible Changes in Tax Laws
Income tax treatment of REITs may be modified, prospectively or retroactively, by legislative, judicial or administrative action at any time. No assurance can be given that legislation, regulations, administrative interpretations or court decisions will not significantly change the tax laws with respect to the qualification as a REIT or the federal income tax consequences of this qualification. In addition to any direct effects the changes might have, the changes might also indirectly affect the market value of all real estate investments, and consequently the ability of the Company to realize its investment objectives.
RISKS RELATING TO REAL ESTATE
Environmental Matters
All of the Properties presently owned by the Company have been subject to Phase I environmental assessments by independent environmental consultants. Some of the Phase I environmental assessments recommended further investigations in the form of Phase II environmental assessments, including soil and
groundwater sampling, and all of these investigations have been completed by the Company or are in the process of being completed. Certain of the Properties owned by the Company have been found to contain ACMs. The Company believes that these materials have been adequately contained and that an ACM operations and maintenance program has been implemented or is in the process of being implemented for the Properties found to contain ACMs.
Some, but not all, of the properties owned by partnerships managed by the Associated Companies have been subject to Phase I environmental assessments by independent environmental consultants. The Associated Companies determine on a case-by-case basis whether to obtain Phase I environmental assessments on these properties and whether to undertake further investigation or remediation. Certain of these properties contain ACMs. In each case the responsible Associated Company believes that these materials have been adequately contained and that an ACM operations and maintenance program has been implemented for the properties found to contain ACMs.
Six of the Properties owned by the Company are leased in whole or in part to an operator of auto care centers which include oil change and tune-up facilities, and ten of the Properties are leased to operators of convenience stores which sell petroleum-based fuels. These Properties and other of the Properties contain, and/or may have contained in the past, underground storage tanks for the storage of petroleum products and/or other hazardous or toxic substances which create a potential for release of petroleum products and/or other hazardous or toxic substances. Some of the Properties owned by the Company are adjacent to or near properties that have contained in the past or currently contain, underground storage tanks used to store petroleum products or other hazardous or toxic substances. Several of the Properties have been contaminated with petroleum products or other hazardous or toxic substances from on-site operations or operations on adjacent or nearby properties. In addition, certain of the Properties are on, adjacent to or near properties upon which others have engaged or may in the future engage in activities that may release petroleum products or other hazardous or toxic substances.
Although tenants of the Properties owned by the Company generally are required by their leases to operate in compliance with all applicable federal, state and local environmental laws, ordinances and regulations and to indemnify the Company against any environmental liability arising from the tenants' activities on the Properties, the Company could nevertheless be subject to environmental liability relating to its management of the Properties or strict liability by virtue of its ownership interest in the Properties and there can be no assurance that the tenants would satisfy their indemnification obligations under the leases. There can be no assurance that any environmental assessments of the Properties owned by the Company, properties being considered for acquisition by the Company, or the properties owned by the partnerships managed by the Associated Companies have revealed all potential environmental liabilities, that any prior owner or prior or current operator of such properties did not create an environmental condition not known to the Company or that an environmental condition does not otherwise exist as to any one or more of such properties that could have an adverse effect on the Company's results of operations and financial condition, either directly (with respect to properties owned by the Company), or indirectly (with respect to properties owned by partnerships managed by an Associated Company) by adversely affecting the financial condition of the Associated Company and thus the value of the Company's preferred stock interest in the Associated Company. Moreover, there can be no assurance that (i) future environmental laws, ordinances or regulations will not have an adverse effect on the Company's results of operations and financial condition or (ii) the current environmental condition of such properties will not be affected by tenants and occupants of such properties, by the condition of land or operations in the vicinity of the properties (such as the presence of underground storage tanks), or by third parties unrelated to the Company.
Risks Related to Ownership and Financing of Real Estate
The Company is subject to risks generally incidental to the ownership of real estate, including changes in general economic or local conditions, changes in supply of or demand for similar or competing properties in an area, the impact of environmental protection laws, changes in interest rates and availability of financing which may render the sale or financing of a property difficult or unattractive, changes in tax, real estate and zoning laws, and the creation of mechanics' liens or similar encumbrances placed on the property by a lessee or other
parties without the Company's knowledge and consent. Should any of these events occur, there could be an adverse effect on the Company's results of operations and financial condition.
Availability of Real Estate for Acquisitions
The Company's growth is dependent upon acquisitions. There can be no assurance that properties will be available for acquisition or, if available, that the Company will be able to purchase such properties on favorable terms. If such acquisitions are not available it could have a negative impact on the growth of the Company, which could have an adverse effect on the performance of the Company's Common Stock.
Competition for Acquisition of Real Estate
The Company faces competition from other businesses, individuals, fiduciary accounts and plans and other entities in the acquisition, operation and sale of its properties. Some of the Company's competitors are larger and have greater financial resources than the Company. This competition may result in a higher cost for properties the Company wishes to purchase.
Competition for Tenants
The Company is subject to the risk that when space becomes available at its properties the leases may not be renewed, the space may not be let or relet, or the terms of the renewal or reletting (including the cost of required renovations or concessions to tenants) may be less favorable to the Company. Although the Company has established annual property budgets that include estimates of costs for renovation and reletting expenses that it believes are reasonable in light of each property's situation, no assurance can be given that these estimates will sufficiently cover these expenses. If the Company is unable to promptly lease all or substantially all of the space at its properties, if the rental rates are significantly lower than expected, or if the Company's reserves for these purposes prove inadequate, then there could be an adverse effect on the Company's results of operations and financial condition.
Tenants' Defaults
The ability of the Company to manage its assets is subject to federal bankruptcy laws and state laws affecting creditors' rights and remedies available to real property owners. In the event of the financial failure or bankruptcy of a tenant, there can be no assurance that the Company could promptly recover the tenant's premises from the tenant or from a trustee or debtor-in-possession in any bankruptcy proceeding filed by or against that tenant, or that the Company would receive rent in the proceeding sufficient to cover its expenses with respect to the premises. In the event of the bankruptcy of a tenant, the Company will be subject to the provisions of the federal bankruptcy code, which in some instances may restrict the amount and recoverability of claims held by the Company against the tenant. If any tenant defaults on its obligations to the Company, there could be an adverse effect on the Company's results of operations and financial condition.
Management, Leasing and Brokerage Risks; Lack of Control of Associated Companies
The Company is subject to the risks associated with the property management, leasing and brokerage businesses. These risks include the risk that management contracts or service agreements may be terminated, that contracts will not be renewed upon expiration or will not be renewed on terms consistent with current terms, and that leasing and brokerage activity generally may decline. Acquisition of properties by the Company from the Associated Companies could result in a decrease in revenues to the Associated Companies and a corresponding decrease in dividends received by the Company from the Associated Companies. Each of these developments could have an adverse effect on the Company's results of operations and financial condition.
To qualify for and to maintain the Company's status as a REIT while realizing income from the Company's third-party management business, the capital stock of Glenborough Hotel Group, a Nevada corporation ("GHG"), Glenborough Corporation, a California corporation ("GC") and Glenborough Inland Realty Corporation, a California corporation ("GIRC," and collectively with GHG and GC, the "Associated Companies") (which conduct the Company's third-party management, leasing and brokerage businesses) is divided into two classes. All of the voting common stock of the Associated Companies, representing 5% of the
total equity of GC and GIRC, and 25% of the total equity of GHG, is held by individual stockholders. Nonvoting preferred stock representing the remaining equity of each Associated Company is held entirely by the Company. Although the Company holds a majority of the equity interest in each Associated Company, the Company is not able to elect directors of any Associated Company and, consequently, the Company has no ability to influence the day-to-day decisions of each entity.
Uninsured Loss
The Company or in certain instances tenants of the properties carry comprehensive liability, fire and extended coverage with respect to the Company's properties, with policy specification and insured limits customarily carried for similar properties. There are, however, certain types of losses (such as from earthquakes and floods) that may be either uninsurable or not economically insurable. Further, certain of the properties are located in areas that are subject to earthquake activity and floods. Should a property sustain damage as a result of an earthquake or flood, the Company may incur losses due to insurance deductibles, co-payments on insured losses or uninsured losses. Should an uninsured loss occur, the Company could lose some or all of its capital investment, cash flow and anticipated profits related to one or more properties, which could have an adverse effect on the Company's results of operations and financial condition.
Illiquidity of Real Estate
Real estate investments are relatively illiquid and, therefore, will tend to limit the ability of the Company to vary its portfolio promptly in response to changes in economic or other conditions. In addition, the Internal Revenue Code of 1986, as amended (the "Code"), and individual agreements with sellers of properties place limits on the Company's ability to sell properties, which may adversely affect returns to holders of Common Stock. Eighteen of the properties owned by the Operating Partnership were acquired on terms and conditions under which they be disposed of only in a like-kind exchange or other non-taxable transaction.
Potential Liability Under the Americans With Disabilities Act
As of January 26, 1992, all of the Company's properties were required to be in compliance with the Americans With Disabilities Act (the "ADA"). The ADA generally requires that places of public accommodation be made accessible to people with disabilities to the extent readily achievable. Compliance with the ADA requirements could require removal of access barriers and non-compliance could result in imposition of fines by the federal government, an award of damages to private litigants and/or a court order to remove access barriers. Because of the limited history of the ADA, the impact of its application to the Company's properties, including the extent and timing of required renovations, is uncertain. Pursuant to certain lease agreements with tenants in certain of the "single-tenant" Properties, the tenants are obligated to comply with the ADA provisions. If the Company's costs are greater than anticipated or tenants are unable to meet their obligations, there could be an adverse effect on the Company's results of operations and financial condition.
ADDITIONAL CAPITAL REQUIREMENTS
The Company's future growth depends in large part upon its ability to raise additional capital on satisfactory terms or at all. There can be no assurance that the Company will be able to raise sufficient capital to achieve its objectives. If the Company were to raise additional capital through the issuance of additional equity securities or securities convertible into or exercisable for equity securities, the interests of holders of the Offered Securities, could be diluted. Likewise, the Company's Board of Directors is authorized to cause the Company to issue Preferred Stock in one or more classes or series and to determine the distributions and voting and other rights of the Preferred Stock. Accordingly, the Board of Directors may authorize the issuance of Preferred Stock with voting, distribution and other similar rights which could be dilutive to or otherwise adversely affect the interests of holders of the Offered Securities. If the Company were to raise additional capital through debt financing, the Company will be subject to the risks described below, among others.
LIMITATION ON OWNERSHIP OF COMMON STOCK MAY PRECLUDE ACQUISITION OF CONTROL
Provisions of the Company's Articles of Incorporation are designed to assist the Company in maintaining its qualification as a REIT under the Code by preventing concentrated ownership of the Company which
might jeopardize REIT qualification. Among other things, these provisions provide that (a) any transfer or acquisition of Common Stock that would result in the disqualification of the Company as a REIT under the Code will be void, and (b) if any person attempts to acquire shares of Common Stock that after the acquisition would cause the person to own or to be deemed to own, by operation of certain attribution rules set out in the Code, an amount of Common Stock in excess of a predetermined limit, which, pursuant to Board action, currently is 8.8% of the outstanding shares of Common Stock (the "Ownership Limitation" and as to the Common Stock, the transfer of which would cause any person to actually own Common Stock in excess of the Ownership Limitation, the "Excess Shares"), the transfer shall be void and the Common Stock subject to the transfer shall automatically be transferred to an unaffiliated trustee for the benefit of a charitable organization designated by the Board of Directors of the Company until sold by the trustee to a third party or purchased by the Company. Robert Batinovich and individuals or entities whose ownership of Common Stock is attributed to Robert Batinovich in determining the number of shares of Common Stock owned by him for purposes of compliance with Section 856 of the Code (the "Attributed Owners"), are exempt from these restrictions, but are prohibited from acquiring shares of Common Stock if, after the acquisition, they would own in excess of 14% of the outstanding shares of Common Stock. This limitation on the ownership of Common Stock may have the effect of precluding the acquisition of control of the Company by a third party without the consent of the Board of Directors. If the Board of Directors waives the Ownership Limitation for any person, the Ownership Limitation shall be proportionally and automatically reduced with regard to all other persons such that no five persons may own more than 49% of the Common Stock (the aggregate Ownership Limitations as to all of these persons, as adjusted, the "Adjusted Ownership Limitation"). See "Description of Common Stock -- Restrictions on Ownership and Transfer of Common Stock" and "Federal Income Tax Consequences."
OTHER RISKS
Debt Financing
The Company intends to incur additional indebtedness in the future, including through borrowings under a credit facility, if a credit facility is available, to finance property acquisitions. As a result, the Company expects to be subject to risks associated with debt financing, including the risk that interest rates may increase, the risk that the Company's cash flow will be insufficient to meet required payments on its debt and the risk that the Company may be unable to refinance or repay the debt as it comes due. The Company's current $50 million secured revolving line of credit with Wells Fargo Bank, N.A. provides that distributions may not exceed 90% of funds from operations and that, in the event of a failure to pay principal or interest on borrowings thereunder when due (subject to any applicable grace period), the Company and its subsidiaries may not pay any distributions on the Common Stock or the Preferred Stock. If the Company is unable to obtain acceptable financing to repay indebtedness at maturity, the Company may have to sell properties to repay indebtedness or properties may be foreclosed upon, which could have an adverse effect on the Company's results of operations and financial condition.
Dependence on Executive Officers
The Company is dependent on the efforts of Robert and Andrew Batinovich, its President and Chief Executive Officer and its Executive Vice President, Chief Financial Officer and Chief Operating Officer, respectively, and of its other executive officers. The loss of the services of any of them could have an adverse effect on the results of operations and financial condition of the Company.
Board of Directors May Change Investment Policies
The descriptions in this Prospectus of the major policies and the various types of investments to be made by the Company reflect only the current plans of the Company's Board of Directors. The Company's Board of Directors may change the investment policies of the Company without a vote of the stockholders. If the Company changes its investment policies, the risks and potential rewards of an investment in the Company may also change. In addition, the methods of implementing the Company's investment policies may vary as new investment techniques are developed. See "Business and Properties -- Investment Policies."
Effect of Market Interest Rates on Price of Common Stock
One of the factors that may influence the market price of the shares of Common Stock in public markets will be the annual yield on the price paid for shares of Common Stock from distributions by the Company. An increase in market interest rates may lead prospective purchasers of the Common Stock to seek a higher annual yield from their investments. Such circumstances may adversely affect the market price of the Common Stock.
Shares Available for Future Sale
No prediction can be made as to the effect, if any, that future sales of shares of Common Stock or future conversions or exercises of securities into or for shares of Common Stock, or the availability of such securities for future sales, including shares of Common Stock issuable upon exchange of Operating Partnership units, will have on the market price of the Common Stock prevailing from time to time. Sales of substantial amounts of Common Stock, or the perception that such sales could occur, may adversely affect the prevailing market price for the Common Stock.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The response to this item is submitted as a separate section of this Form 10-K. See Item 14.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by Item 10 is incorporated by reference from the Company's definitive proxy statement for its annual stockholders' meeting to be held on May 15, 1997.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information required by Item 11 is incorporated by reference from the Company's definitive proxy statement for its annual stockholders' meeting to be held on May 15, 1997.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by Item 12 is incorporated by reference from the Company's definitive proxy statement for its annual stockholders' meeting to be held on May 15, 1997.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by Item 13 is incorporated by reference from the Company's definitive proxy statement for its annual stockholders meeting to be held on May 15, 1997.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON FORM 8-K
(b) Reports on Form 8-K (incorporated herein by reference)
On October 28, 1996, the Company filed a report on Form 8-K to make available additional ownership and operation information concerning the Company and the properties owned or managed by it as of September 30, 1996, in the form of a Supplemental Information package.
On November 1, 1996, the Company filed a report on Form 8-K to document the acquisition of the TRP Properties.
On December 4, 1996, the Company filed a report on Form 8-K to document the acquisition of the Carlsberg Properties.
On December 30, 1996, the Company filed reports on Form 8-K/A to document the acquisition of the TRP Properties and the acquisition of the Carlsberg Properties.
On February 5, 1997, the Company filed a report on Form 8-K to make available additional ownership and operation information concerning the Company and the properties owned or managed by it as of December 31, 1996, in the form of a Supplemental Information package.
On February 24, 1997, the Company filed reports on Form 8-K/A, Amendment No. 2, to document the acquisitions of the UCT, TRP and Carlsberg Properties.
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Shareholders of GLENBOROUGH REALTY TRUST INCORPORATED:
We have audited the accompanying consolidated balance sheets of GLENBOROUGH REALTY TRUST INCORPORATED, as of December 31, 1996 and 1995, the related consolidated statements of operations, stockholders' equity and cash flows for the year ended December 31, 1996, and the combined statements of operations, stockholders' equity and cash flows of the GRT Predecessor Entities for each of the two years in the period ended December 31, 1995. These consolidated and combined financial statements and the schedules referred to below are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated and combined financial statements and schedules based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of GLENBOROUGH REALTY TRUST INCORPORATED, as of December 31, 1996 and 1995, the consolidated results of its operations and its cash flows for the year ended December 31, 1996, and the combined results of operations and cash flows of the GRT Predecessor Entities for each of the two years in the period ended December 31, 1995, in conformity with generally accepted accounting principles.
Our audits were made for the purpose of forming an opinion on the basic consolidated and combined financial statements taken as a whole. The accompanying schedules listed in the index to financial statements and schedules are presented for the purpose of complying with the Securities and Exchange Commission's rules and are not a required part of the basic consolidated and combined financial statements. These schedules have been subjected to the auditing procedures applied in our audits of the basic consolidated and combined financial statements and, in our opinion, are fairly stated in all material respects in relation to the basic consolidated and combined financial statement taken as a whole.
ARTHUR ANDERSEN LLP
San Francisco, California January 27, 1997
GLENBOROUGH REALTY TRUST INCORPORATED CONSOLIDATED BALANCE SHEETS December 31, 1996 and 1995 (in thousands, except share amounts)
See accompanying notes to consolidated financial statements.
GLENBOROUGH REALTY TRUST INCORPORATED AND GRT PREDECESSOR ENTITIES CONSOLIDATED AND COMBINED STATEMENTS OF OPERATIONS For the years ended December 31, 1996, 1995 and 1994 (in thousands, except per share amounts)
See accompanying notes to consolidated financial statements.
GLENBOROUGH REALTY TRUST INCORPORATED AND GRT PREDECESSOR ENTITIES STATEMENTS OF EQUITY For the Years Ended December 31, 1996, 1995 and 1994 (in thousands)
See accompanying notes to consolidated financial statements.
GLENBOROUGH REALTY TRUST INCORPORATED AND GRT PREDECESSOR ENTITIES CONSOLIDATED AND COMBINED STATEMENTS OF CASH FLOWS For the years ended December 31, 1996, 1995 and 1994 (in thousands, except per share amounts)
(continued)
See accompanying notes to consolidated financial statements.
GLENBOROUGH REALTY TRUST INCORPORATED AND GRT PREDECESSOR ENTITIES CONSOLIDATED AND COMBINED STATEMENTS OF CASH FLOWS - CONTINUED For the years ended December 31, 1996, 1995 and 1994 (in thousands, except per share amounts)
See accompanying notes to consolidated financial statements.
GLENBOROUGH REALTY TRUST INCORPORATED AND GRT PREDECESSOR ENTITIES
Notes to Consolidated Financial Statements December 31, 1996 and 1995
NOTE 1. ORGANIZATION
Glenborough Realty Trust Incorporated (the "Company") was organized in the State of Maryland on August 26, 1994. It is the intent of the Company to qualify as a real estate investment trust ("REIT") under the Internal Revenue Code of 1986, as amended (the "Code"). The Company completed a Consolidation with certain public California limited partnerships and other entities (the "Consolidation") engaged in real estate activities (the "GRT Predecessor Entities") through an exchange of assets of the GRT Predecessor Entities for 5,753,709 shares of Common Stock of the Company. The Consolidation occurred on December 31, 1995, and the Company commenced operations on January 1, 1996.
To maintain the Company's qualification as a REIT, no more than 50% in value of the outstanding shares of the Company may be owned, directly or indirectly, by five or fewer individuals (defined to include certain entities), applying certain constructive ownership rules. To help ensure that the Company will not fail this test, the Company's Charter provides for certain restrictions on the transfer of the Common Stock to prevent further concentration of stock ownership.
The Company, through several subsidiaries, is engaged primarily in the ownership, operation, management, leasing, acquisition, expansion and development of various income-producing properties. The Company's major consolidated subsidiary, in which it holds a 1% general partner interest and a 90.79% limited partner interest, is Glenborough Properties, L.P. (the "Operating Partnership"). The Operating Partnership, directly and through various subsidiaries in which it and the Company own 100% of the ownership interests, controls a total of 54 real estate projects and 3 notes receivable.
The Company also holds 100% of the non-voting preferred stock of the following three Associated Companies (the "Associated Companies"):
- - Glenborough Corporation (formerly known as Glenborough Realty Corporation) ("GC") is the general partner of nine partnerships and provides asset and property management services for these nine partnerships and one partnership for which an affiliate serves as general partner (the "Controlled Partnerships"). It also provides property management services for a limited portfolio of property owned by unaffiliated third parties.
- - Glenborough Inland Realty Corporation ("GIRC") provides partnership administration, asset management, property management and development services under a long term contract to an additional group of unaffiliated partnerships which include seven public partnerships.
- - Glenborough Hotel Group ("GHG") leases the four Country Suites By Carlson hotels owned by the Company and operates them for its own account. It also operates three Country Suites By Carlson hotels owned by the Controlled Partnerships, and two resort condominium hotels.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION The accompanying financial statements present the consolidated financial position of the Company as of December 31, 1996 and 1995, the consolidated results of operations and cash flows of the Company for the year ended December 31, 1996, and the combined results of operations and cash flows of the GRT Predecessor Entities for the years ended December 31, 1995 and 1994, as the Consolidation transaction discussed in Note 1 above was not effective until December 31, 1995. All intercompany transactions, receivables and payables have been eliminated in consolidation and combination.
RECLASSIFICATION Certain 1995 balances have been reclassified to conform with the current year presentation.
GLENBOROUGH REALTY TRUST INCORPORATED AND GRT PREDECESSOR ENTITIES
Notes to Consolidated Financial Statements December 31, 1996 and 1995
USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the results of operations during the reporting period. Actual results could differ from those estimates.
NEW ACCOUNTING PRONOUNCEMENTS In March 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 121 (SFAS 121), "Accounting for Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed Of." The Company adopted SFAS 121 in the fourth quarter of 1995. SFAS 121 requires that an evaluation of an individual property for possible impairment must be performed whenever events or changes in circumstances indicate that an impairment may have occurred. There was no impact from the initial adoption of SFAS 121.
In 1996, the Company adopted the disclosure requirements of SFAS No. 123, "Accounting for Stock Based Compensation." SFAS No. 123 calls for a new method of recognizing the cost of compensating employees with stock options and similar instruments. At its option, the Company has elected not to adopt this method of accounting, but rather has provided additional required disclosures in Note 13 to the consolidated financial statements which indicate the impact such accounting would have on its reported results of operations if SFAS No. 123 had been fully implemented by the Company.
RENTAL PROPERTY Rental properties are stated at cost unless circumstances indicate that cost cannot be recovered, in which case, the carrying value of the property is reduced to estimated fair value. Estimated fair value: (i) is based upon the Company's plans for the continued operation of each property; (ii) is computed using estimated sales price, as determined by prevailing market values for comparable properties and/or the use of capitalization rates multiplied by annualized rental income based upon the age, construction and use of the building, and (iii) does not purport, for a specific property, to represent the current sales price that the Company could obtain from third parties for such property. The fulfillment of the Company's plans related to each of its properties is dependent upon, among other things, the presence of economic conditions which will enable the Company to continue to hold and operate the properties prior to their eventual sale. Due to uncertainties inherent in the valuation process and in the economy, it is reasonably possible that the actual results of operating and disposing of the Company's properties could be materially different than current expectations.
Depreciation is provided using the straight line method over the useful lives of the respective assets.
The useful lives are as follow:
Buildings and improvements 10 to 40 years Tenant Improvements Term of the related lease Furniture and Equipment 5 to 7 years
INVESTMENTS IN ASSOCIATED COMPANIES The Company's investments in the Associated Companies are accounted for using the equity method, as discussed further in Note 4.
INVESTMENTS IN MANAGEMENT CONTRACTS Investments in management contracts are recorded at cost and are amortized on a straight-line basis over the term of the contracts.
MORTGAGE LOANS RECEIVABLE The Company monitors the recoverability of its loans and notes receivable through ongoing contact with the borrowers to ensure timely receipt of interest and principal payments, and where appropriate, obtains financial
GLENBOROUGH REALTY TRUST INCORPORATED AND GRT PREDECESSOR ENTITIES
Notes to Consolidated Financial Statements December 31, 1996 and 1995
information concerning the operation of the properties. Interest on mortgage loans is recognized as revenue as it accrues during the period the loan is outstanding. Mortgage loans receivable will be evaluated for impairment if it becomes evident that the borrower is unable to meet its debt service obligations in a timely manner and cannot satisfy its payments using sources other than the operations of the property securing the loan. If it is concluded that such circumstances exist, then the loan will be considered to be impaired and its recorded amount will be reduced to the fair value of the collateral securing it. Interest income will also cease to accrue under such circumstances. Due to uncertainties inherent in the valuation process, it is reasonably possible that the amount ultimately realized from the Company's collection on these receivables will be different than the recorded amounts.
CASH EQUIVALENTS The Company considers short-term investments (including certificates of deposit) with a maturity of three months or less at the time of investment to be cash equivalents.
FAIR VALUE OF FINANCIAL INSTRUMENTS Statement of Financial Accounting Standards No. 107 requires disclosure about fair value for all financial instruments. Based on the borrowing rates currently available to the Company, the carrying amount of debt approximates fair value. Cash and cash equivalents consist of demand deposits and certificates of deposit with financial institutions. The carrying amount of cash and cash equivalents as well as the mortgage notes receivable described above, approximates fair value.
DEFERRED FINANCING AND OTHER FEES Fees paid in connection with the financing and leasing of the Company's properties are amortized over the term of the related notes payable or leases and are included in other assets.
MINORITY INTEREST Minority interest represents the 8.21% limited partner interests in the Operating Partnership not held by the Company.
REVENUES All leases are classified as operating leases. Rental revenue is recognized on a straight-line basis over the terms of the leases.
For the years ended December 31, 1995 and 1994, rental revenue from the two properties leased to Navistar International represented approximately 10% of the Company's total rental revenue. For the year ended December 31, 1996, no tenants represented 10% or more of rental revenue of the Company.
Fees and reimbursement revenue consists of property management fees, overhead administration fees, and transaction fees from the acquisition, disposition, refinance, leasing and construction supervision of real estate.
Revenues are recognized only after the Company is contractually entitled to receive payment, after the services for which the fee is received have been provided, and after the ability and timing of payments are reasonably assured and predictable.
INCOME TAXES The Company will make an election to be taxed as a REIT under Sections 856 through 860 of the Code. As a REIT, the Company generally will not be subject to Federal income tax to the extent that it distributes at least 95% of its REIT taxable income to its shareholders. REITs are subject to a number of organizational and operational requirements. If the Company fails to qualify as a REIT in any taxable year, the Company will be subject to Federal income tax (including any applicable alternative minimum tax) on its taxable income at regular corporate tax rates. Even if the Company qualifies for taxation as a REIT, the Company may be subject to certain state and local taxes on its income and property and to Federal income and excise taxes on its undistributed income.
GLENBOROUGH REALTY TRUST INCORPORATED AND GRT PREDECESSOR ENTITIES
Notes to Consolidated Financial Statements December 31, 1996 and 1995
Certain of the Company's predecessors were subject to income taxes, the provisions for which have been included in the accompanying combined results of operations of the GRT Predecessor Entities.
NOTE 3. RENTAL PROPERTY
The cost and accumulated depreciation of real estate investments as of December 31, 1996 and 1995 are as follows (in thousands):
In June 1996, the Company sold the two self-storage facilities held in its industrial portfolio. The sales price for these two facilities was $2,900. The sales generated a gain of $321 and cash proceeds of $2,882. From these proceeds, $790 was paid down on the Company's secured bank line. The sale was an all-cash sale and the Company has no continuing obligations or involvement with these properties. Accordingly, the Company recognized the sale of the two self-storage facilities under the full accrual method of accounting.
In July 1996, the Company acquired a 23-story, 272,443 square foot office building (the "UCT Property"), in St. Louis, Missouri. The total acquisition cost, including capitalized costs, was approximately $18,844, which consisted of $350 in the form of 23,333 partnership units in the Operating Partnership (based on a per unit value of $15.00), and the balance paid in cash. The cash portion was financed through advances under the Line of Credit.
In August 1996, the Company acquired a 64-room hotel property (the " the San Antonio Hotel"), which is located in San Antonio, Texas. The total acquisition cost, including capitalized costs, was approximately $2,805, which was paid in cash. The acquisition was financed with an advance on the Line of Credit.
In August 1996, the Company also expanded an existing shopping center in Tampa, Florida through a purchase-leaseback transaction with the anchor tenant. The Company's initial acquisition cost, including capitalized costs, was approximately $1,617, all of which was paid in cash which was financed through advances under the Line of Credit, and in addition the Company committed an additional $1,800 for future expansion and tenant improvements, which the Company expects will also be paid in cash. The cash portion was financed through advances under the Line of Credit.
In September 1996, the Company acquired a two-story, 40,595 square foot office building (the "the Bond Street Property"), in Farmington Hills, Michigan. The total acquisition cost, including capitalized costs, was approximately $3,185, which consisted of $391 in the form of 26,067 partnership units in the Operating Partnership (based on a per unit value of $15.00), and the balance paid in cash. The cash portion was financed through advances under the Line of Credit.
GLENBOROUGH REALTY TRUST INCORPORATED AND GRT PREDECESSOR ENTITIES
Notes to Consolidated Financial Statements December 31, 1996 and 1995
In October 1996, the Company acquired a portfolio of 12 properties, aggregating approximately 784,000 square feet and 538 multi-family units, together with associated management interests (the "TRP Properties"). The total acquisition cost, including capitalized costs, was approximately $43,798, which consisted of (i) approximately $16,300 of mortgage debt assumed, (ii) approximately $760 in the form of 52,387 partnership units in the Operating Partnership (based on a per unit value of $14.50), (iii) approximately $2,600 in the form of 182,000 shares of Common Stock of the Company (based on a per share value of $14.50) and (iv) the balance in cash. The cash portion was financed through advances under the Line of Credit. The TRP Properties consist of three office, six industrial, one retail and two multi-family Properties, located in six states..
In November 1996, the Company acquired from various partnerships and their general partner, a Southern California syndicator, a portfolio of six Properties (including one property on which the Company made a mortgage loan which included a purchase option), aggregating approximately 342,000 square feet, together with associated management interests (the "the Carlsberg Properties"). The total acquisition cost including the mortgage loan and capitalized costs, was approximately $23,152, which consisted of (i) approximately $8,900 of mortgage debt assumed, (ii) approximately $350 in the form of 24,844 shares of Common Stock of the Company (based on a per share value of $14.09) and (iii) the balance in cash. The cash portion was financed through advances under the Line of Credit. The Carlsberg Properties consist of five office Properties and one retail Property, located in two states. Concurrently with the Company's acquisition of the Carlsberg Properties, one of the Associated Companies assumed management of a portfolio of 13 additional properties with an aggregate of one million square feet under a venture with an affiliate of the seller.
The Company leases its commercial and industrial property under non-cancelable operating lease agreements. Future minimum rents to be received as of December 31, 1996 are as follows (in thousands):
NOTE 4. INVESTMENTS IN ASSOCIATED COMPANIES AND GLENBOROUGH PARTNERS
The Company's investments in the Associated Companies are accounted for using the equity method as the Company has significant ownership interests through its 100% preferred stock ownership but does not own any voting interests. The Company records earnings on its investments in the Associated Companies equal to its cash flow preference, to the extent of earnings, plus its pro rata share of remaining earnings, based on cash flow allocation percentages. Distributions received from the Associated Companies are recorded as a reduction of the Company's investments.
The Company's investment in Glenborough Partners ("GP") is accounted for using the cost method as the Company holds only a 3.9% limited partnership interest.
GLENBOROUGH REALTY TRUST INCORPORATED AND GRT PREDECESSOR ENTITIES
Notes to Consolidated Financial Statements December 31, 1996 and 1995
As of December 31, 1996 and 1995, the Company had the following investments in the Associated Companies and GP (in thousands):
Summary condensed balance sheet information as of December 31, 1996, and the condensed statements of operations for the year then ended are as follows (in thousands):
Balance Sheets as of December 31, 1996
Statements of Operations For the Year Ended December 31, 1996
NOTE 5. INVESTMENT IN MANAGEMENT CONTRACT
Investment in management contract included in the Company's balance sheet as of December 31, 1996 and 1995, represents the unamortized portion of the asset management agreement for the Glenborough Institutional Fund I partnership. The contract is being amortized on a straight-line basis over eleven years.
NOTE 6. MORTGAGE LOANS RECEIVABLE
The Company held a first mortgage loan with a principal balance of $7,563,000 and a carrying value of $6,700,000 at December 31, 1996, secured by an office and research complex in Eatontown, New Jersey. The loan had an original maturity date of November 1, 1996 with interest only payable monthly at the fixed rate of eight percent
GLENBOROUGH REALTY TRUST INCORPORATED AND GRT PREDECESSOR ENTITIES
Notes to Consolidated Financial Statements December 31, 1996 and 1995
(8%) per annum. The borrower was additionally obligated to pay cash flow equal to 75% of all annual net cash flow of the property until the Company received the equivalent of ten percent (10%) interest for the year in issue, and thereafter fifty percent (50%) of all additional net cash flow of the property (if any) for the year in issue. In 1995, due to the uncertainty surrounding the borrower's ability to payoff the note receivable upon its November 1996 maturity, the Company recorded a $863,000 loss provision on this mortgage loan receivable to reduce its carrying value to the estimated fair value of the underlying property. The terms of the note were renegotiated in December 1996 with the maturity date extended to February 1, 1997. The interest rate continued at 8% per annum. The borrower had the right to payoff the loan at a discount between January 10 and January 31, 1997. The discounted payoff was i) $6,863,000 in cash and ii) a note for $500,000 payable over a term of twelve years at six percent (6%) interest amortized over twenty-five years. On January 28, 1997, the borrower paid off the note at the above discounted terms, resulting in a gain to the Company of $658,000 of which $158,000 will be recognized in the Company's 1997 Statement of Operations and the remaining gain associated with the $500,000 note receivable will be recorded as income when cash is received.
At December 31, 1996, the Company held a first mortgage loan in the amount of $511,000 secured by an industrial property in Los Angeles, California. The terms of the note include interest accruing at eight percent (8%) per annum for the first twenty-four months (ending June 1996) and at nine percent (9%) per annum for the next sixty months until the note matures in June 2001. Monthly payments of principal and interest, computed based on a thirty year amortization schedule, commenced January 1995 and continue until maturity.
On November 19, 1996, the Operating Partnership entered into a Loan Agreement and Option Agreement with Carlsberg Properties, LTD. ("the Borrower"). The loan amount is for $3,600,000, of which $2,694,000 was initially disbursed to the Borrower and $906,000 was held by the Operating Partnership as leasing and interest reserves. At December 31, 1996, the loan balance was $2,694,000. The loan is secured by a 48,000 square foot medical building in Phoenix, Arizona (the "Secured Property"), and matures on November 19, 1999, with interest only payable monthly at the fixed rate of eleven percent (11%) per annum calculated on the full amount of the loan. The Option Agreement provides the Operating Partnership the option to purchase the Secured Property on either the second or third anniversary of the closing date of November 19, 1996, for the greater of i) the then outstanding loan balance plus $50,000 or ii) the value of the Secured Property as defined in the Option Agreement.
Contractually due principal payments of the mortgage loans receivable are as follows (in thousands):
NOTE 7. SECURED LIABILITIES
The Company had the following mortgage loans, bank lines, and notes payable outstanding as of December 31, 1996 and 1995 (in thousands):
GLENBOROUGH REALTY TRUST INCORPORATED AND GRT PREDECESSOR ENTITIES
Notes to Consolidated Financial Statements December 31, 1996 and 1995
Of the loans outstanding at December 31, 1995, the $10,000,000 line of credit was paid off with proceeds from the new line of credit discussed above. A $186,000 loss on debt refinancing resulted from the write-off of the
unamortized loan fees related to the $10,000,000 line of credit and is reflected as an extraordinary item on the accompanying 1996 Statement of Operations.
The required principal payments on the Company's debt for the next five years and thereafter are as follows (in thousands):
NOTE 8. INVESTOR NOTES PAYABLE
Included in the proxy to approve or disapprove the Consolidation, was the option to choose notes in lieu of shares of Common Stock. Upon successful completion of the Consolidation, notes in the amount of $2,483,000 were issued to the limited partners whose votes indicated such election. The notes were unsecured obligations of the Company, bearing a variable rate of interest payable quarterly until their maturity date, November 1, 2002. In January 1996, the Company paid the notes in full, along with accrued interest, thereon.
NOTE 9. PREPAID CONSOLIDATION COSTS
The prepaid consolidation costs included in the Company's December 31, 1995 consolidated balance sheet included accounting fees as well as the costs of mailing and printing the Prospectus/Consent Solicitation Statement, any supplements thereto or other documents related to the Consolidation, the costs of the Information Agent, Investor brochure, telephone calls, broker-dealer fact sheets, printing, postage, travel, meetings, legal and other fees related to the solicitation of consents, as well as reimbursement of costs incurred by brokers and banks in forwarding the Prospectus/Consent Solicitation Statement to Investors. The entire balance of prepaid consolidation costs was expensed in the accompanying 1996 Statement of Operations.
Prepaid litigation costs at December 31, 1995 included the legal fees incurred in connection with defending two class action complaints filed by investors in certain of the GRT Predecessor Entities as well as an accrual for the amount of the settlement that the plaintiff's counsel in one case was requesting be awarded by the court. The entire balance in prepaid litigation costs was expensed in the accompanying 1996 Statement of Operations (see Note 14).
NOTE 10. RELATED PARTY TRANSACTIONS
Fee and reimbursement income earned by the Company and the GRT Predecessor Entities from related partnerships totaled $311,000, $2,995,000 and $2,858,000 for the years ended December 31, 1996, 1995 and 1994, respectively, and consisted of asset management fees for the year ended December 31, 1996 and property management fees, asset management fees, reimbursements and related expenses for the years ended December 31, 1995 and 1994.
NOTE 11. CAPITAL CONTRIBUTION FROM GRT PREDECESSOR ENTITY SHAREHOLDERS
During the year ended December 31, 1994, the two major shareholders of GC contributed to GC cash of approximately $16 million, along with an obligation to return $17 million of November 1995 one year Treasury Bills that had an approximate market value of $16 million (included in other liabilities at December 31, 1994) at the time of the contribution. This investment was viewed as a hedge against the Company's exposure to rising interest
GLENBOROUGH REALTY TRUST INCORPORATED AND GRT PREDECESSOR ENTITIES
Notes to Consolidated Financial Statements December 31, 1996 and 1995
rates because of its floating rate debt. This position was closed in February 1995 at a total loss of approximately $116,000.
NOTE 12. PROVISION FOR LOSS ON INVESTMENTS IN REAL ESTATE, REAL ESTATE PARTNERSHIPS AND MORTGAGE LOANS RECEIVABLE
The loss provisions recorded during the years ended December 31 are as follows:
NOTE 13. STOCK COMPENSATION PLAN
In May 1996, the Company adopted an employee stock incentive plan (the "Plan") to provide incentives to attract and retain high quality executive officers and key employees. The Plan provides for options to purchase shares of the Company's Common Stock ("Stock") and for the sale or bonus grant of Stock to eligible individuals. The number of shares of Stock reserved for issuance under the Plan equals ten percent of the outstanding shares of Stock as of each December 31st for the ensuing twelve month period (199,567 as of December 31, 1996). The Company accounts for the fair value of the options and bonus grants in accordance with APB Opinion No. 25. As of December 31, 1996, 35,000 shares of bonus grants have been issued under the Plan. The fair value of the shares granted have been recorded as deferred compensation in the accompanying financial statements and will be charged to earnings ratably over the respective vesting periods which range from 2 to 5 years. As of December 31, 1996, 796,000 options to purchase shares of Stock have been granted. The exercise price of each option granted is equal to the per-share fair market value of the Stock on the date the option is granted. To date all options granted have been at the fair market value of the shares on the grant date, and as such, no compensation expense has been recognized as accounted for under APB Opinion No. 25. The options vest over periods between 1 and 6 years, and have a maximum term of 10 years.
In October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123 "Accounting for Stock-based Compensation" (FAS 123). As permitted by FAS 123, the Company will not change its method of accounting for stock options but has provided the additional required disclosures in the table below. The additional compensation expense that would have been recorded if the Company had adopted FAS 123 is not material.
GLENBOROUGH REALTY TRUST INCORPORATED AND GRT PREDECESSOR ENTITIES
Notes to Consolidated Financial Statements December 31, 1996 and 1995
A summary of the status of the Company's stock option plan as of December 31, 1996 and changes during the year then ended is presented below:
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions used for grants during 1996: expected distribution yield of 8.5%, expected volatility of 5.0%, risk-free interest rate of 6.3% and expected lives of 10, 7 and 5 years.
NOTE 14. COMMITMENTS AND CONTINGENCIES
Environmental Matters. The Company follows a policy of monitoring its properties for the presence of hazardous or toxic substances. The Company is not aware of any environmental liability with respect to the properties that would have a material adverse effect on the Company's business, assets or results of operations. There can be no assurance that such a material environmental liability does not exist. The existence of any such material environmental liability could have an adverse effect on the Company's results of operations and cash flow.
General Uninsured Losses. The Company carries comprehensive liability, fire, flood, extended coverage and rental loss insurance with policy specifications, limits and deductibles customarily carried for similar properties. There are, however, certain types of extraordinary losses which may be either uninsurable, or not economically insurable. Further, certain of the properties are located in areas that are subject to earthquake activity. Should a property sustain damage as a result of an earthquake, the Company may incur losses due to insurance deductibles, co-payments on insured losses or uninsured losses. Should an uninsured loss occur, the Company could lose its investment in, and anticipated profits and cash flows from, a property.
Litigation. Prior to the completion of the Consolidation, two lawsuits were filed in 1995 contesting the fairness of the Consolidation, one in California State court and one in federal court. The complaints in both actions alleged, among other things, breaches by the defendants of fiduciary duties and inadequate disclosures. The State court action was settled, and the settlement was approved by the State court despite objections by certain members of the class, who subsequently filed an appeal. Pursuant to the terms of the settlement in the State court action, pending the appeal the Company has paid one-third of the $855,000 settlement amount and the remaining two-thirds is being held in escrow. In the federal action, the court in December of 1995 deferred all further proceedings pending a ruling in the State court action. Following the State court decision approving the settlement, the defendants filed a motion to dismiss the federal court action. Given the inherent uncertainties of litigation, there can be no assurance that the ultimate outcomes of these actions will be favorable to the Company.
NOTE 15. PUBLIC STOCK OFFERING
In October 1996, the Company completed the October 1996 Offering of 3,666,000 shares of Common Stock. The 3,666,000 shares were sold at a per share price of $13.875 for total proceeds of $47,814,000 (net of 6% underwriting fee of $3,052,000). This additional capital was used to acquire the TRP Properties and to repay $24,000,000 of the outstanding balance under the Company's Line of credit with Wells Fargo which was then available to fund the
acquisition of the Carlsberg Properties. In addition, approximately $1,100,000 in other costs were incurred in connection with the offering.
Following is a proforma statement of operations of the Company giving effect to the 1996 offering and related acquisitions (including the acquisitions discussed in Note 3) as if they had been completed on January 1, 1996: ===========
NOTE 16. SUBSEQUENT EVENTS
In January 1997, the Company entered into a definitive agreement with two limited partnerships organized by affiliates of CIGNA Corp. to acquire a portfolio of six properties, aggregating approximately 616,000 square feet and 224 multi-family units (the "CIGNA Properties"). The total acquisition cost, including capitalized costs, is expected to be approximately $45.5 million, which will be paid entirely in cash from the proceeds of the Offering. The CIGNA Properties consist of two office properties, two office/R&D properties, a neighborhood shopping center and a multi-family property, located in four states. These acquisitions are subject to a number of contingencies, including approval of the acquisition by a majority in interest of the voting power of the limited partners of each of the selling partnerships, satisfactory completion of environmental and engineering due diligence and customary closing conditions. Accordingly, there can be no assurance that any or all of these acquisitions will be completed.
In February 1997, the Company entered into definitive agreements with various partnerships and their general partner, a Southern California syndicator, to acquire a portfolio of up to 11 properties, aggregating approximately 524,000 square feet, together with associated management interests (the "E&L Properties"). The total acquisition cost, including capitalized costs, is expected to be approximately $22.2 million, which will consist of (i) approximately $9.5 million of mortgage debt assumed, (ii) approximately $7.8 million in the form of approximately 412,000 partnership units in the Operating Partnership (based on an assumed per unit value of $19.00), (iii) approximately $650,000 in the form of approximately 34,000 shares of Common Stock of the Company (based on an assumed per share value of $19.00) to be issued in connection with the acquisition of the management interests relating to the E&L Properties, and (iv) the balance in cash. The cash portion of the acquisition cost will be funded
GLENBOROUGH REALTY TRUST INCORPORATED AND GRT PREDECESSOR ENTITIES
Notes to Consolidated Financial Statements December 31, 1996 and 1995
with proceeds of the Offering. The E&L Properties consist of one office and ten industrial properties, all located in Southern California. These acquisitions are subject to a number of contingencies, including the approval of the acquisition by a majority of the voting power of the limited partners of each of the selling partnerships, satisfactory completion of environmental and engineering due diligence and customary closing conditions. Accordingly, there can be no assurance that any or all of these acquisitions will be completed, and it is possible that fewer than all of these acquisitions may be completed.
In February 1997, the Company acquired a 163-suite hotel Property (the "Scottsdale Hotel"), which began operations in January 1996 and is located in Scottsdale, Arizona. The total acquisition cost, including capitalized costs, was approximately $12.1 million, which consisted of approximately $4.7 million of mortgage debt assumed, and the balance in cash. The cash portion was financed through advances under the Company's Line of Credit. Like four of the Company's other hotel Properties, the Scottsdale Hotel is marketed as a Country Suites by Carlson.
GLENBOROUGH REALTY TRUST INCORPORATED AND GRT PREDECESSOR ENTITIES
Notes to Consolidated Financial Statements December 31, 1996 and 1995
NOTE 17. UNAUDITED QUARTERLY RESULTS OF OPERATIONS
The following represents an unaudited summary of quarterly results of operations for the year ended December 31, 1996:
GLENBOROUGH REALTY TRUST INCORPORATED AND GRT PREDECESSOR ENTITIES
Notes to Consolidated Financial Statements December 31, 1996 and 1995
Per share amounts do not necessarily sum to per share amounts for the year as weighted average shares outstanding are measured for each period presented, rather than solely for the entire year.
GLENBOROUGH REALTY TRUST INCORPORATED
SCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION
December 31, 1996 (in thousands)
(continued)
(continued)
GLENBOROUGH REALTY TRUST INCORPORATED
SCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION - CONTINUED
December 31, 1996 (in thousands)
(1) Initial Cost and Date Acquired by Participating Partnerships, where applicable. (2) The Company holds a participating first mortgage interest in the property. In accordance with GAAP, the Company is accounting for the property as though it holds fee title. (3) The aggregate cost for Federal income tax purposes is $158,343. (4) Pledged as security for Wells Fargo Bank Line of Credit - $21,307. (5) Pledged as security for loan with an investment bank -- $19,744. (6) Bracketed amounts represent reductions to carrying value in prior years. (7) Pledged as security for Wells Fargo Bank Term Loan - $6,120. (8) Initial Cost represents original book value carried forward from the financial statements of the GRT Predecessor Entities.
GLENBOROUGH REALTY TRUST INCORPORATED SCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION - CONTINUED
December 31, 1996 (in thousands)
Reconciliation of gross amount at which real estate was carried for the years ended December 31:
GLENBOROUGH REALTY TRUST INCORPORATED
SCHEDULE IV - MORTGAGE LOANS RECEIVABLE, SECURED BY REAL ESTATE
December 31, 1996 (in thousands)
(1) Paid off on January 28, 1997 (2) The loan amount is $3,600,000, of which $2,694,000 was initially disbursed to the borrower and $906,000 was held by the Company as leasing and interest reserves.
GLENBOROUGH REALTY TRUST INCORPORATED
SCHEDULE IV - MORTGAGE LOANS RECEIVABLE, SECURED BY REAL ESTATE
December 31, 1996 (in thousands)
The following is a summary of changes in the carrying amount of mortgage loans for the years ended December 31, 1996, 1995 and 1994 (in thousands):
SIGNIFICANT SUBSIDIARIES
GHG and GIRC each independently qualify as a significant subsidiary, as defined in Rule 3-09 of Regulation S-X. Accordingly, the separate financial statements of GHG and GIRC have been included in the December 31, 1996 Form 10-K of the Company following the Company's Consolidated Financial Statements in Item 14.
GLENBOROUGH HOTEL GROUP
BACKGROUND
GHG was organized in the state of Nevada on September 23, 1991. GHG currently operates hotel properties owned by the Company under four separate percentage leases and manages three hotel properties owned by two partnerships whose managing general partner is Glenborough Corporation. The Company owns 100% of the 50 shares of non-voting preferred stock of GHG and three individuals, including Terri Garnick, an executive officer of the Company, each own 33 1/3% of the 1,000 shares of voting common stock of GHG.
GHG also owns approximately 80% of the common stock of RGI. RGI manages homeowners associations and rental pools for two beachfront resort condominium hotel properties and owns six rental units at one of the properties. GHG receives 100% of the earnings of RGI and consolidates their operations with its own.
GHG also owns 94% of the outstanding common stock of Atlantic Pacific Holdings, Ltd., the sole owner of 100% of the common stock of APAC. APAC was formed to underwrite certain insurable risks, however, it no longer underwrites any business and is expected to be liquidated in 1997. GHG accounts for its investment in APAC using the cost method due to its anticipated liquidation.
LIQUIDITY AND CAPITAL RESOURCES
GHG's primary source of funding is the cash generated by the operations of the four hotels leased from the Company and fees received for (i) managing three hotels owned by two partnerships and (ii) managing the homeowners associations and rental pools for the resort condominium hotel properties as discussed above.
The boards of directors of GHG declared and paid the following quarterly dividends for the year ending December 31, 1996:
(1) Dividends for the fourth quarter of 1996 were declared and paid in January 1997.
RESULTS OF OPERATIONS
Room revenue of $7,463,000 represents the revenue earned on the four hotels leased from the Company.
Fee revenue and salary reimbursements of $2,417,000 represents the fees earned for managing three hotels and two resort condominium hotels.
The primary expenses associated with the leased hotels are room expenses of $2,000,000, lease payments of $2,507,000, sales and marketing of $770,000 and other operating expenses of $1,036,000, including utilities, maintenance and insurance.
The only direct expenses incurred in connection with the management of the three hotels and two resort condominium hotel properties are salaries and benefits of $1,640,000.
General and administrative costs of $995,000 represent the overhead costs associated with administering the business of GHG. Such costs primarily consist of administrative salaries and benefits, rent, legal fees and accounting fees.
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Stockholders of GLENBOROUGH HOTEL GROUP
We have audited the accompanying consolidated balance sheet of GLENBOROUGH HOTEL GROUP as of December 31, 1996, and the related consolidated statements of income, stockholders' equity and cash flows for the year then ended. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of GLENBOROUGH HOTEL GROUP as of December 1996, and the results of its operations and its cash flows for the year then ended in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
San Francisco, California January 27, 1997
GLENBOROUGH HOTEL GROUP CONSOLIDATED BALANCE SHEET As of December 31, 1996 (in thousands, except share amounts)
See accompanying notes to consolidated financial statements
GLENBOROUGH HOTEL GROUP CONSOLIDATED STATEMENT OF INCOME For the year ended December 31, 1996 (in thousands)
See accompanying notes to consolidated financial statements
GLENBOROUGH HOTEL GROUP CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY For the year ended December 31, 1996 (in thousands, except shares)
See accompanying notes to consolidated financial statements
GLENBOROUGH HOTEL GROUP CONSOLIDATED STATEMENT OF CASH FLOWS For the year ended December 31, 1996 (in thousands)
See accompanying notes to consolidated financial statements
GLENBOROUGH HOTEL GROUP
Notes to Consolidated Financial Statements
December 31, 1996
NOTE 1. ORGANIZATION
Glenborough Hotel Group ("GHG") was organized in the state of Nevada on September 23, 1991. GHG currently operates hotel properties owned by Glenborough Realty Trust Incorporated ("GLB") under four separate percentage leases and manages three hotel properties owned by two partnerships whose managing general partner is Glenborough Corporation. GLB owns 100% of the 50 shares of non-voting preferred stock of GHG and three individuals, including Terri Garnick, an executive officer of GLB, each own 33 1/3% of the 1,000 shares of voting common stock of GHG.
GHG also owns approximately 80% of the common stock of Resort Group, Inc. ("RGI"). RGI manages homeowners associations and rental pools for two beachfront resort condominium hotel properties and owns six units at one of the properties. GHG receives 100% of the earnings of RGI and consolidates its operations with its own.
GHG also owns 94% of the outstanding common stock of Atlantic Pacific Holdings, Ltd., the sole owner of 100% of the common stock of Atlantic Pacific Assurance Company, Limited ("APAC"), a Bermuda corporation formed to underwrite certain insurable risks of certain of GLB's predecessor partnerships and related entities. APAC no longer underwrites any business and is expected to be liquidated in 1997. GHG accounts for its investment in APAC using the cost method due to its anticipated liquidation.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation - The accompanying financial statements present the consolidated financial position of GHG and RGI as of December 31, 1996 and the consolidated results of operations and cash flows of GHG and RGI for the year ended December 31, 1996. All intercompany transactions, receivables and payables have been eliminated in the consolidation.
Use of Estimates - The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the results of operations during the reporting period. Actual results could differ from those estimates.
Rental Property - Rental properties are stated at cost unless circumstances indicate that cost cannot be recovered, in which case, the carrying value of the property is reduced to estimated fair value.
Depreciation is provided using the straight line method over the useful lives of the respective assets.
Investments in Management Contracts - Investments in management contracts are recorded at cost and are amortized on a straight-line basis over the term of the contracts.
Cash Equivalents - GHG considers short-term investments (including certificates of deposit) with a maturity of three months or less at the time of investment to be cash equivalents.
NOTE 3. INVESTMENTS IN MANAGEMENT CONTRACTS, NET
Investments in management contracts reflects the unamortized portion of the management contracts RGI holds with the two beachfront resort condominium hotel properties for both management of the homeowners associations and the rental pool programs.
NOTE 4. RENTAL PROPERTY
Rental property and equipment represents the six condominium hotel units owned by RGI as well as furniture and fixtures in GHG's corporate offices. The six units owned by RGI participate in a resort rental program on an "at will"
GLENBOROUGH HOTEL GROUP Notes to Consolidated Financial Statements
December 31, 1996
basis, whereby there is no fixed term of participation. Such participation generated approximately $19,000 of cash flow after deductions for capital reserves for the year ended December 31, 1996.
NOTE 5. MORTGAGE LOAN
Mortgage loan of $61,000 represents the debt secured by the six condominium hotel units owned by RGI. Such debt bears interest at 7%, payable in monthly installments of principal and interest totaling $2,304, and matures June 30, 1999.
NOTE 6. THE PERCENTAGE LEASES
GHG is leasing the four hotels owned by GLB for a term of five years pursuant to individual percentage leases ("Percentage Leases") which provide for rent equal to the greater of the Base Rent (as defined in the lease) or a specified percentage of room revenues (the "Percentage Rent"). Each hotel is separately leased to GHG (the "lessee"). The lessee's ability to make rent payments will, to a large degree, depend on its ability to generate cash flow from the operations of the hotels. Each Percentage Lease contains the provisions described below.
Each Percentage Lease has a non-cancelable term of five years, subject to earlier termination upon the occurrence of certain contingencies described in the Percentage Lease. The lessee under the Percentage Lease has one five-year renewal option at the then current fair market rent.
During the term of each Percentage Lease, the lessee is obligated to pay the greater of Base Rent or Percentage Rent. Base Rent is required to be paid monthly in advance. Percentage Rent is calculated by multiplying fixed percentages by room revenues for each of the four hotels; the applicable percentage changes when revenue exceeds a specified threshold, and the threshold may be adjusted annually in accordance with changes in the applicable CPI. Percentage Rent is due quarterly.
The table below sets forth the annual Base Rent and the Percentage Rent formulas for each of the four hotels.
HOTEL LEASE RENT PROVISIONS
GLENBOROUGH HOTEL GROUP Notes to Consolidated Financial Statements
December 31, 1996
(1) The San Antonio hotel was acquired in August 1996, therefore, rent incurred for the year ended December 31, 1996 was less than a full year's base rent.
Other than real estate and personal property taxes, casualty insurance, a fixed capital improvement allowance and maintenance of underground utilities and structural elements, which are the responsibility of GLB, the Percentage Leases require the lessees to pay rent, insurance, salaries, utilities and all other operating costs incurred in the operation of the Hotels.
NOTE 7. INCOME TAXES
The 1996 provision for income taxes consists of the following (in thousands):
The deferred tax provision results from temporary differences in the recognition of depreciation and amortization expense for tax and financial reporting purposes. As such amounts will be deductible for tax purposes in future periods, a corresponding deferred tax asset has been and is included in prepaid expenses in the accompanying balance sheet.
NOTE 8. DECLARATION OF DIVIDENDS
The board of directors of GHG declared the following dividends:
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Shareholder of Atlantic Pacific Assurance Company Limited:
We have audited the accompanying balance sheets of Atlantic Pacific Assurance Company Limited (a Bermuda company) as of December 31, 1996 and 1995, and the related statements of income and retained earnings and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Atlantic Pacific Assurance Company Limited as of December 31, 1996 and 1995, and the results of its operations and its cash flows for the years then ended in conformity with accounting principles generally accepted in the United States.
ARTHUR ANDERSEN LLP
Hamilton, Bermuda February 15, 1997
ATLANTIC PACIFIC ASSURANCE COMPANY LIMITED
BALANCE SHEETS
AS OF DECEMBER 31, 1996 AND 1995
(Expressed in U.S. Dollars)
The accompanying notes are an integral part of these balance sheets.
ATLANTIC PACIFIC ASSURANCE COMPANY LIMITED
STATEMENTS OF INCOME AND RETAINED EARNINGS
FOR THE YEARS ENDED DECEMBER 31, 1996 AND 1995
(Expressed in U.S. Dollars)
The accompanying notes are an integral part of these statements.
ATLANTIC PACIFIC ASSURANCE COMPANY LIMITED
STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1996 AND 1995
(Expressed in U.S. Dollars)
The accompanying notes are an integral part of these statements.
ATLANTIC PACIFIC ASSURANCE COMPANY LIMITED
NOTES TO FINANCIAL STATEMENTS
AS OF DECEMBER 31, 1996 AND 1995
(Expressed in U.S. Dollars)
NOTE 1. INSURANCE BUSINESS
Atlantic Pacific Assurance Company Limited (the Company) was incorporated in Bermuda on November 3, 1987 and is a wholly owned subsidiary of Atlantic Pacific Holdings Limited (the Parent), which is incorporated in Bermuda.
The Parent was formerly owned by Equitec partnerships and the Company insured the risks of those partnerships. During 1994 and 1995, limited partnerships which were affiliated with Glenborough Realty Corporation acquired a majority of ownership in the Parent. On December 31, 1995, a majority of the Glenborough Realty Corporation limited partnerships were consolidated into a Real Estate Investment Trust (REIT). The REIT subsequently transferred its ownership in the Parent to Glenborough Hotel Group, a Nevada corporation of which the REIT owns 100% of the non-voting preferred stock.
The Company insured or assumed liability of the owners up to limits of $100,000 per occurrence for various automobile, general liability, and property exposure which covered physical loss or damage to all real and personal property; and up to $500,000 per occurrence for workers' compensation exposures. All policies under the program expired April 30, 1990, and none have been renewed.
NOTE 2. SIGNIFICANT ACCOUNTING POLICIES
These financial statements have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The significant accounting policies are summarized as follows:
a) Cash and cash equivalents
Cash and cash equivalents include amounts held in banks and time deposits having maturities within three months of the date of purchase by the Company. The carrying value of cash and cash equivalents approximates fair value because of the short maturity of these investments. As of December 31, 1996, all of the Company's cash and cash equivalents are on deposit with one financial institution.
b) Reserve for outstanding losses and loss related expenses
The reserve for outstanding losses and loss related expenses and the related provision for losses and loss related expenses includes estimates for losses pending settlement. Generally accepted accounting principles require that the reserve for outstanding losses and loss related expenses be recorded at the ultimate cost of settling losses, using past experience adjusted for current trends and any other factors that would modify past experience. The reserve for outstanding losses and loss related expenses are based on a May, 1991 independent actuarial study using industry reporting statistics. No new losses were reported during 1996 and 1995.
Although management believes that the amounts recorded are adequate, there can be no assurance that the ultimate settlement of losses will not vary significantly from the reserves provided. Future adjustments to the estimates recorded as of December 31, 1996, resulting from the continual review process and differences between estimates and ultimate settlements, will be reflected in the statements of income of future years when such adjustments become known.
c) Investment income
Interest income is accrued to the balance sheet date.
NOTE 3. LETTERS OF CREDIT
As of December 31, 1996, the Company has outstanding letters of credit of approximately $1,419,000 (1995 - $1,419,000) to secure the future payment of losses. Time deposits of a similar amount have been pledged to secure these letters of credit.
NOTE 4. RESERVE FOR OUTSTANDING LOSSES AND LOSS RELATED EXPENSES
As the Company has not renewed any policies since 1990, all activity in the reserve for outstanding losses and loss related expenses relates to years prior to and including 1990. There was no additional development on prior year claims in 1996 and 1995. Losses paid in 1996 were $654 (1995 - $320,444). No additional premiums are due as a result of the prior year effects.
NOTE 5. STATUTORY CAPITAL AND SURPLUS
The Company is registered under The Bermuda Insurance Act 1978 and Related Regulations (the Act) and is obliged to comply with various provisions of the Act regarding solvency and liquidity. These provisions have been met and the required minimum statutory capital and surplus as of December 31, 1996 is approximately $120,000 (1995 - $120,000). The Company's actual statutory capital and surplus as of that date is approximately $2,206,000 (1995 - $2,209,000) and accordingly, all retained earnings are available for distribution to the shareholder.
NOTE 6. TAXES
At the present time, no income, profit, capital or capital gain taxes are levied in Bermuda and, accordingly, no provision for such taxes has been recorded by the Company. In the event that such taxes are levied, the Company has received an undertaking from the Bermuda Government exempting it from all such taxes until March 28, 2016.
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Stockholders of GLENBOROUGH INLAND REALTY CORPORATION
We have audited the accompanying balance sheet of GLENBOROUGH INLAND REALTY CORPORATION as of December 31, 1996, and the related statements of income, stockholders' equity and cash flows for the year then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of GLENBOROUGH INLAND REALTY CORPORATION as of December 1996, and the results of its operations and its cash flows for the year then ended in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
San Francisco, California January 27, 1997
GLENBOROUGH INLAND REALTY CORPORATION BALANCE SHEET As of December 31, 1996 (in thousands, except share amounts)
The accompanying notes are an integral part of these statements.
GLENBOROUGH INLAND REALTY CORPORATION STATEMENT OF INCOME For the year ended December 31, 1996 (in thousands)
The accompanying notes are an integral part of these statements.
GLENBOROUGH INLAND REALTY CORPORATION STATEMENT OF STOCKHOLDERS' EQUITY For the year ended December 31, 1996 (in thousands, except shares)
The accompanying notes are an integral part of these statements.
GLENBOROUGH INLAND REALTY CORPORATION STATEMENT OF CASH FLOWS For the year ended December 31, 1996 (in thousands)
The accompanying notes are an integral part of these statements.
GLENBOROUGH INLAND REALTY CORPORATION
Notes to Financial Statements
December 31, 1996
NOTE 1. ORGANIZATION
Glenborough Inland Realty Corporation ("GIRC") was organized in the State of California on January 1, 1995. GIRC provides management services for certain partnerships sponsored by Rancon Financial Corporation ("RFC"), an unaffiliated corporation. These services include asset management, property development, Securities and Exchange Commission reporting, accounting, investor relations and property management services, and may in the future also include general partner services.
GLB owns 100% of the 19,000 shares of non-voting preferred stock of GIRC, and three individuals, including Frank Austin, an executive officer of GLB, each own 33 1/3% of the 1,000 shares of voting common stock of GIRC.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation - The accompanying financial statements present the financial position of GIRC as of December 31, 1996 and the results of operations and cash flows of GIRC for the year ended December 31, 1996.
Use of Estimates - The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the results of operations during the reporting period. Actual results could differ from those estimates.
Investments in Management Contracts - Investments in management contracts are recorded at cost and are amortized on a straight-line basis over the term of the contracts.
Cash Equivalents - GIRC considers short-term investments (including certificates of deposit) with a maturity of three months or less at the time of investment to be cash equivalents.
Income Taxes - Provision for income taxes in based on financial accounting income.
NOTE 3. INVESTMENTS IN MANAGEMENT CONTRACTS
Investments in management contracts reflects the unamortized portion of the management contracts GIRC holds with RFC for management of certain partnerships. The contracts are being amortized on a straight-line basis over ten years.
NOTE 4. NOTE RECEIVABLE
The note receivable of $80,000 represents a loan made by GIRC to Green Meadows Partners, Ltd., an affiliate of Glenborough Corporation. The note bears interest at the rate of eight percent (8%) per annum with a maturity date of August 22, 1997. All payments on this note are deferred until maturity.
NOTE 5. LINE OF CREDIT
The line of credit of $2,383,000 represents debt with a bank which has availability up to $2,700,000. Such debt bears interest at the variable rate of Prime or LIBOR plus 2.75% (8.25% at December 31, 1996). The debt requires monthly interest only payments and has a maturity date of December 31, 1998. The line of credit is secured by the Management, Administration and Consulting Agreement for the RFC partnerships.
NOTE 6. INCOME TAXES
The 1996 provision for income taxes consists of the following (in thousands):
The deferred tax provision results from a temporary difference in the recognition of amortization expense for tax and financial reporting purposes. The investments in management contracts are being amortized on a straight-line basis over 10 years for financial reporting purposes and 15 years for tax purposes. As such items will be deductible for tax purposes in future periods, the corresponding deferred tax asset has been recorded and is included in prepaid expenses in the accompanying balance sheet.
NOTE 7. DECLARATION OF DIVIDENDS
The board of directors of GIRC declared the following dividends:
SIGNATURES
Pursuant to the requirements of Section l3 or l5(d) of the Securities Exchange Act of l934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
GLENBOROUGH REALTY TRUST INCORPORATED
By: Glenborough Realty Trust Incorporated,
Date: March 5, 1997 /s/ Robert Batinovich --------------------- Robert Batinovich Chairman of the Board, President and Chief Executive Officer
Date: March 5, 1997 /s/ Andrew Batinovich --------------------- Andrew Batinovich Director, Executive Vice President, Chief Operating Officer and Chief Financial Officer (Principal Financial Officer)
Date: March 5, 1997 /s/ Terri Garnick ------------------ Terri Garnick Senior Vice President, Chief Accounting Officer, Treasurer (Principal Accounting Officer)
Date: March 5, 1997 /s/ Laura Wallace ----------------- Laura Wallace Director
EXHIBIT INDEX
Exhibit Number Exhibit Title - ------- ---------------------------------------------------------- 2.01 Articles and Plan of Merger dated December 28, 1995, by and among the Company and the Partnerships. (3)
2.02 Articles and Plan of Merger dated December 28, 1995, by and among the Company and Glenborough Corporation. (3)
3.01 Articles of Amendment and Restatement of Incorporation of Glenborough Realty Trust Incorporated. (1)
3.02 Bylaws of Glenborough Realty Trust Incorporated. (1)
3.10 Second Amended and Restated Agreement of Limited Partnership of Glenborough Properties, L.P. (5)
4.02 Form of Common Stock Certificate of the Company. (1)
10.01 First Amended and Restated Agreement of Limited Partnership of Glenborough Properties, L.P. (4)
10.02 Form of Indemnification Agreement for existing Officers and Directors of Glenborough Realty Trust Incorporated. (1)
10.04* Form of 1996 Employee Stock Incentive Plan. (4)
10.05* Form of 1995 Non-Employee and Director Stock Incentive Plan. (1)
10.06 Lease Agreements between Glenborough Properties, L.P. and Glenborough Hotel Group for Country Suites-Tucson, Country Suites-Ontario and Country Suites- Arlington. (2)
10.07* Employment Agreement between Glenborough Realty Trust Incorporated and Robert Batinovich. (2)
10.08* Employment Agreement between Glenborough Realty Trust Incorporated and Andrew Batinovich. (2)
10.14 Management, Administration and Consulting Agreement dated as of December 20, 1994 between Glenborough Inland Realty Corporation and the General Partners of nine Rancon Partnerships. (1)
10.15 Amendment to Management, Administration and Consulting Agreement dated March 30, 1995 between Glenborough Inland Realty Corporation and the General Partners of nine Rancon Partnerships. (1)
10.18 Agreement between Glenborough Corporation and Bear, Stearns & Co., Inc., dated October 7, 1994. (1)
10.19* Employment Agreement between Glenborough Realty Corporation and Robert Batinovich. (2)
10.20* Employment Agreement between Glenborough Realty Corporation and Andrew Batinovich. (2)
10.21* Employment Agreement between Glenborough Inland Realty Corporation and Robert Batinovich. (2)
EXHIBIT INDEX - CONTINUED
Exhibit Number Exhibit Title - ------- ------------------------------------------------- 10.22* Employment Agreement between Glenborough Inland Realty Corporation and Andrew Batinovich. (2)
10.23* Employment Agreement between Glenborough Hotel Group and Andrew Batinovich. (2)
10.24 Form of Indemnification Agreement for Existing Officers and Directors of Glenborough Hotel Group. (1)
10.25 Form of Indemnification Agreement for Existing Officers and Directors of Glenborough Realty Corporation. (1)
10.26 Form of Indemnification Agreement for Existing Officers and Directors of Glenborough Inland Realty Corporation. (1)
10.27 Registration Agreement between Glenborough Realty Trust Incorporated and GPA, Ltd. (2)
10.28 Lock Up Agreements. (2)
10.29 Subscription Agreement between Glenborough Properties, L.P. and GPA, Ltd. (2)
10.30 Form of Agreement for Purchase and Sale of Real Estate to be entered into by and between Glenborough Realty Trust Incorporated and Outlook Income Fund 9. (1)
10.31 Indemnification Agreement for Glenborough Realty Corporation and Glenborough Realty Trust Incorporated, with Robert Batinovich as indemnitor. (2)
10.32 Amendment to First Amended and Restated Agreement of Limited Partnership of Glenborough Properties, L.P. (6)
10.33 Agreement for contribution of Partnership Interests for the University Club Tower Property. (7)
10.34 Credit agreement with Wells Fargo Bank N.A. related to the $50,000,000 secured revolving line of credit. (8)
10.35 Credit agreement with Wells Fargo Bank N.A. related to the $6,120,000 2-year secured term loan. (9)
10.36 Purchase Agreement related to the acquisition of Carlsberg Plaza, one of the Carlsberg Properties. (10)
10.37 Purchase Agreement related to the acquisition of Dallidet Professional Center, one of the Carlsberg Properties. (11)
10.38 Purchase Agreement related to the acquisition of Hillcrest Office Building, one of the Carlsberg Properties. (12)
10.39 Purchase Agreement related to the acquisition of Tradewinds Office Building, one of the Carlsberg Properties. (13)
10.40 Purchase Agreement related to the acquisition of Sonora Plaza, one of the Carlsberg Properties. (14)
10.41 Loan Agreement between Glenborough Properties, L.P. and Carlsberg Properties, Ltd. for the $3,600,000 Grunow mortgage loan receivable. (15)
10.42 Option Agreement between Glenborough Properties, L.P. and Carlsberg Properties, Ltd. for the Grunow Medical Building. (16)
EXHIBIT INDEX - CONTINUED
Exhibit Number Exhibit Title - ------- ---------------------------------------------------------- 10.43 Contribution Agreement related to the acquisition of the TRP Properties. (17)
10.44 Agreement for Contribution of Partnership Interests related to the acquisition of the Bond Street Property. (18)
10.45 Second Amendment to First Amended and Restated Agreement of Limited Partnership of Glenborough Properties, L.P. (19)
10.46 Second Amendment to Agreement of Limited Partnership of GPA Bond, a California Limited Partnership. (20)
10.47 Lease Agreement between Glenborough Properties, L.P. and Glenborough Hotel Group for Country Suites - San Antonio. (21)
10.48 Purchase Agreement related to the purchase of the Scottsdale Hotel.
10.49 The First Amendment to the Agreement of Purchase of Sale related to the purchase of the Scottsdale Hotel.
23.1 Consent of Arthur Andersen LLP, independent public accountants.
27.1 Financial Data Schedule
* Indicates management contract or compensatory plan or arrangement.
(1) Incorporated by reference to the identically numbered exhibit to the Company's Registration Statement on Form S-4 (Registration No. 33-83506), which became effective October 26, 1995.
(2) Incorporated by reference to the identically numbered exhibit to the Company's Annual Report on Form 10-K for the year ended December 31, 1995.
(3) Incorporated by reference to the identically numbered exhibits to the Company's Current Report on Form 8-K which was filed on January 16, 1996.
(4) Incorporated by reference to the identically numbered exhibit to the Company's Registration Statement on Form S-11 (Registration No. 333-09411), which was filed on August 1, 1996.
(5) Incorporated by reference to the identically numbered exhibit to the Company's Current Report on Form 8-K which was filed on November 1, 1996.
(6) Incorporated by reference to Exhibit 10.02 to the Company's Registration Statement on Form S-11 (Registration No. 333-09411), which was filed on August 1, 1996.
(7) Incorporated by reference to Exhibit 10.39 to the Company's Registration Statement on Form S-11 (Registration No. 333-09411), which was filed on August 1, 1996.
(8) Incorporated by reference to Exhibit 10.31 to the Company's Registration Statement on Form S-11 (Registration No. 333-09411), which was filed on August 1, 1996.
(9) Incorporated by reference to Exhibit 10.30 to the Company's Registration Statement on Form S-11 (Registration No. 333-09411), which was filed on August 1, 1996.
(10) Incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K which was filed on November 1, 1996.
(11) Incorporated by reference to Exhibit 10.2 to the Company's Current Report on Form 8-K which was filed on November 1, 1996.
(12) Incorporated by reference to Exhibit 10.3 to the Company's Current Report on Form 8-K which was filed on November 1, 1996.
EXHIBIT INDEX - CONTINUED
(13) Incorporated by reference to Exhibit 10.4 to the Company's Current Report on Form 8-K which was filed on November 1, 1996.
(14) Incorporated by reference to Exhibit 10.5 to the Company's Current Report on Form 8-K which was filed on November 1, 1996.
(15) Incorporated by reference to Exhibit 10.6 to the Company's Current Report on Form 8-K which was filed on November 1, 1996.
(16) Incorporated by reference to Exhibit 10.7 to the Company's Current Report on Form 8-K which was filed on November 1, 1996.
(17) Incorporated by reference to Exhibit 99. to the Company's Current Report on Form 8-K filed on December 30, 1996.
(18) Incorporated by reference to Exhibit 10.01 to the Company's Quarterly Report on Form 10Q/A for the quarter ended September 30, 1996.
(19) Incorporated by reference to Exhibit 10.02 to the Company's Quarterly Report on Form 10Q/A for the quarter ended September 30, 1996.
(20) Incorporated by reference to Exhibit 10.03 to the Company's Quarterly Report on Form 10Q/A for the quarter ended September 30, 1996.
(21) Incorporated by reference to Exhibit 10.04 to the Company's Quarterly Report on Form 10Q/A for the quarter ended September 30, 1996.