ITEM 1. BUSINESS
(a) General Development of Business.
BACKGROUND AND FORMATION
Arden Realty, Inc. (the "Company"), through its controlling interest in Arden Realty Limited Partnership (the "Operating Partnership" or "OP"), is engaged in owning, acquiring, managing, leasing and renovating commercial properties in Southern California (the "Properties").
The Company was incorporated in Maryland in May 1996 and formed to continue and expand the real estate business of Arden Realty Group, Inc. and a group of affiliated entities (the "Arden Predecessors"). On October 9, 1996, the Company completed an initial public offering (the "IPO") of $.01 par value common stock (the "Common Stock"). Concurrent with consummation of the IPO, the Company and the Operating Partnership, together with the partners and members of the Arden Predecessors, engaged in certain formation transactions (the "Formation Transactions") which, among other things, resulted in the acquisition by the Company and Operating Partnership of 24 commercial properties from certain members of the Arden Predecessors.
(b) Financial Information about Industry Segments.
The Company currently is involved in only one industry segment, namely real estate. Therefore, all of the financial information contained herein relate to this industry segment.
(c) Narrative Description of the Business
BUSINESS
The Company is a self-administered and self-managed real estate investment trust ("REIT") engaged in owning, acquiring, managing, leasing and renovating commercial properties in Southern California. As of March 1, 1998, the Company owned a portfolio of 127 commercial properties containing approximately 16.4 million rentable square feet. All of the Properties are located in Southern California, with 69 in suburban Los Angeles County, 21 in Orange County, 20 in San Diego County, 12 in Riverside and San Bernardino Counties, three in Ventura County and two in Kern County. As of January 1, 1998, this portfolio of 127 properties was approximately 84.5% leased (87.0% leased if the four properties under renovation are excluded).
Included in the portfolio summary described above are 50 primarily office and R&D/industrial properties located in Southern California (the "LBA Portfolio"), aggregating approximately 5.2 million rentable square feet, that the Company acquired on March 1, 1998, for a purchase price of approximately $614.5 million. In connection with the acquisition of the LBA Portfolio, the Company also issued warrants to purchase 2.5 million shares of Common Stock at a price of $29.59 per share, subject to adjustment. The LBA Portfolio consists of 34 office properties containing approximately 3.6 million rentable square feet, 15 R&D/industrial properties containing approximately 1.5 million rentable square feet, and one retail property containing 144,225 rentable square feet. As of January 1, 1998, the office and R&D/industrial properties in the LBA Portfolio were 86.6% and 94.2% leased, respectively.
Including acquisitions through the LBA Portfolio closing, the Company is the largest publicly traded owner of office space in Southern California as measured by total rentable square feet owned.
BUSINESS AND GROWTH STRATEGIES
The Company's primary business objectives are to maximize growth in cash flow and to enhance the value of its portfolio in order to maximize total return to its stockholders. The Company believes it can achieve these objectives by continuing to implement its business strategies and by capitalizing on the external and internal growth opportunities described below. The Company also believes, based on its evaluation of market conditions, that a number of factors will enhance its ability to achieve its business objectives, including (i) the continuing improvement of the Southern California economy and (ii) the limited construction of new office properties in the Southern California region due to substantial building construction limitations in many submarkets, which provides opportunities to maximize occupancy rates, rental rates and overall portfolio value.
BUSINESS STRATEGIES
The Company's primary business strategies are to actively manage its portfolio and to acquire underperforming office and R&D/industrial properties, properties in need of renovation or properties which provide attractive yields with stable cash flow in submarkets where it can utilize its local market expertise and extensive real estate experience. When market conditions permit, the Company may also develop new properties in submarkets where it has local market expertise.
Based on its historical activities and its knowledge of the local marketplace, the Company believes that the Southern California region offers opportunities for well-capitalized, experienced owners of real estate with extensive local market expertise to take advantage of opportunities to acquire additional commercial properties at attractive prices and develop office and R&D/industrial properties, when feasible, at attractive returns. Through seven regional offices, the Company implements its business strategies by: (i) emphasizing tenant satisfaction and retention and employing intensive property marketing programs; (ii) utilizing a multidisciplinary approach to acquisition, management, leasing and renovation activities that is designed to coordinate decision-making and enhance responsiveness to market opportunities and tenant needs; and (iii) implementing cost control management and systems that capitalize on economies of scale arising from the size and location of the Company's portfolio. The Company believes that the implementation of these operating practices has led to the increased occupancy rates and rental revenue of its existing portfolio.
Aggressive Leasing. The concentration of many of the Properties within certain office submarkets and the Company's relationships with a broad array of tenants and brokers enable the Company to pursue aggressive leasing strategies, to effectively monitor the office space requirements of existing and potential tenants, and to offer tenants a variety of space alternatives across its portfolio. In an effort to realize cost savings and exercise more control over lease negotiations, as of December 31, 1997, the Company has implemented in-house leasing programs for approximately 80% of the Properties in selected submarkets in which it has a substantial market presence. The Company continues, however, to employ third-party broker listings in the submarkets in which it has a less significant market presence.
Integrated Decision-making and Responsiveness. In addition to the location and quality of the Properties, management generally credits its ability to maintain its occupancy levels to the coordination of its decision-making team. Acquisition, renovation, management and leasing activities are coordinated to enhance responsiveness to market opportunities and tenant needs. The acquisition, leasing and renovation teams work closely with the Company's senior management, from the initial meetings with prospective tenants or sellers and throughout the negotiation process. This integrated approach permits the Company to analyze the economic terms and costs (including tenant build-out and retrofitting costs) for each lease on a timely and efficient basis throughout lease negotiations. With respect to acquisitions, the Company can quickly analyze the costs of upgrades and lease-up potential. The Company is able to commit to leasing and acquisition terms quickly, facilitate timely deal execution and build-out of space for prospective tenants and minimize downtime between lease rollovers.
Cost Control Operating Efficiencies. The size and geographic location of the Company's portfolio permit it to enhance portfolio value by lowering operating costs and expenses, in comparison to single-site ownership and management. The Company seeks to capitalize on the economies of scale which result from the geographic focus of its portfolio, the ownership of multiple properties within certain submarkets and the maintenance of a centralized accounting system for cost control at each of the Properties.
GROWTH STRATEGIES
External Growth: Based on its own historical activities and its knowledge of the local marketplace, the Company believes that opportunities continue to exist to acquire additional commercial properties that: (i) provide attractive initial yields with significant potential for growth in cash flow; (ii) are in desirable locations within submarkets which the Company believes have economic growth potential; and/or (iii) are underperforming or need renovation, and therefore provide opportunities for the Company to increase the cash flow and value of such properties through renovation, active management and aggressive leasing. From January 1, 1997 through March 1, 1998, the Company acquired 93 commercial properties containing approximately 11.0 million rentable square feet for a total acquisition cost of approximately $1.4 billion (includes all purchase and closing costs and anticipated capital expenditures for, and carrying costs during renovation).
The Company intends to continue to acquire commercial properties within submarkets in Southern California which the Company believes present opportunities for long-term stable and rising rental rates due to employment growth, population movements within the region and restrictions on new development. The Company generally targets properties which are underperforming or need renovation and offer opportunities for the Company to implement its value-added strategy to increase cash flow.
The Company believes it has certain competitive advantages which enhance its ability to identify and capitalize on acquisition opportunities, including: (i) management's significant local market expertise, experience and knowledge of properties, submarkets and potential tenants within the Southern California region; (ii) management's long-standing relationships with tenants, real estate brokers and institutional and other owners of office and R&D/industrial properties; (iii) its fully integrated real estate operations which allow the Company to respond quickly to acquisition opportunities; (iv) its access to capital as a public company; (v) its ability to acquire properties in exchange for OP Units or Common Stock if the sellers so desire; and (vi) management's reputation as an experienced purchaser of commercial properties in Southern California which has the ability to effectively close transactions. The Company may also seek to take advantage of management's development expertise to develop office and R&D/industrial space in selected submarkets when market conditions support such development.
Internal Growth: The Company believes that opportunities exist to increase cash flow from its existing portfolio and that such opportunities will be enhanced as the Southern California commercial market continues to improve. The Company intends to pursue internal growth by: (i) continuing to maintain and improve occupancy rates through active management and aggressive leasing; (ii) realizing fixed contractual base rental increases or increases tied to indices such as the Consumer Price Index; (iii) re-leasing space as leases expire at increasing market rents which are expected to result over time from increased demand for commercial space in Southern California; (iv) controlling operating expenses through its cost control management and systems; (v) capitalizing on economies of scale arising from the size and geographic focus of its portfolio; and (vi) increasing revenue generated from parking facilities at certain Properties where the Company is currently offering free parking as an amenity or charging below market rates.
(i) Maintaining and improving occupancy rates: The Company believes that it has been successful in attracting, expanding and retaining a diverse tenant base by actively managing its Properties with an emphasis on tenant retention and satisfaction. The Company strives to be responsive to the needs of individual tenants through its on-site professional management staff and by providing tenants with alternative space within the Company's portfolio
to accommodate their changing space requirements. The Company's success in maintaining and improving occupancy rates is demonstrated, in part, by the number of existing tenants which have renewed or released their space, leased additional space to support their expansion needs, or moved to other space within the Company's portfolio. The Company also seeks to improve occupancies by aggressively marketing available space within its portfolio. In 1997, the Company signed 315 leases for approximately 1.1 million rentable square feet.
(ii) Re-leasing space as leases expire at increasing market rents: Although there can be no assurances in this regard, the Company believes that as the office space market in Southern California continues to improve, there will be increasing demand for office space and declining vacancies which are expected to result over time in increasing market rents. The Company believes it will have significant opportunities to increase cash flow during such periods of increasing market rents by renewing or re-leasing space as leases expire at the increased market rents.
(iii) Cost control management and systems: The Company seeks to lower operating expenses through cost control management that capitalizes on economies of scale opportunities resulting from the size and location of the Company's portfolio. The Company focuses on cost control in various areas of operations. For example, the Company is seeking to significantly lower its utility costs, which constitute over 25% of the operating costs of most of the Properties, through the portfolio-wide installation of energy enhancement technologies, which include lighting retrofit, replacement of heating, ventilation and air conditioning systems, and computer-driven energy management systems which monitor and react to the climatic requirements of individual Properties.
(iv) Capitalizing on economies of scale: In order to capitalize on economies of scale arising from the size and geographic focus of the Company's portfolio, the Company's property and asset managers are responsible for several Properties, which spreads administrative costs over such Properties and reduces per square foot administrative expense. In addition, the Company believes that parking operations, building and other services and tenant improvements purchased on a portfolio-wide basis will facilitate further economies of scale.
(v) Revenue from parking facilities: The Company owns or leases parking facilities which are attached or adjacent to many of the Properties. The Company currently provides free parking to tenants at several of the Properties as an amenity, and charges tenants at the remaining Properties at or below market rates for parking. If the demand for Southern California office space increases and occupancy rates rise, which the Company believes is the trend, the Company believes that there may be opportunities to generate additional revenue from the parking facilities associated with its Properties by charging for parking which is currently provided for free, increasing below market rates and maintaining its arrangements with a limited number of third-party operators of the Company's parking facilities.
RECENT DEVELOPMENTS From January 1, 1997, through March 1, 1998, the Company acquired 93 commercial properties containing approximately 11.0 million rentable square feet in Southern California for a Total Acquisition Cost (as defined below) of approximately $1.4 billion. The following table lists the acquisitions made by the Company during such period:
(1) "Total Acquisition Cost" includes all purchase costs, closing costs and anticipated capital expenditures for, and carrying costs during, renovation.
(2) At December 31, 1997 the Company owned a 75% interest in this property and exercised an option to purchase the remaining 25% interest for $27.5 million on March 25, 1998, resulting in a total acquisition cost of approximately $110.7 million.
(3) Property currently under renovation.
(4) The Company owns a 97.5% interest in the property.
(5) The Company acquired the LBA Portfolio on March 1, 1998 for a total acquisition cost of $619.9 million, including approximately $3.6 million related to warrants to purchase up to 2.5 million shares of the Company's common stock. See "Properties" under Item 2
ITEM 2. PROPERTIES
GENERAL
As of March 1, 1998 the Company's Properties consisted of 127 commercial properties containing approximately 16.4 million rentable square feet. The Properties consist primarily of suburban office and R&D/industrial properties and individually range from approximately 12,000 to 598,000 rentable square feet. All of the Properties are located in Southern California, with 69 located in suburban Los Angeles County, 21 in Orange County, 20 in San Diego County,12 in Riverside and San Bernardino counties, three in Ventura County, and two in Kern County. The Company believes that the Properties have desirable locations within established business communities and are well maintained. Of the Company's 127 Properties, 103 have been built since 1980 and 39 have been substantially renovated within the last five years. The average age of the buildings is approximately 14 years. The Properties offer an array of amenities including security, parking, conference facilities, on-site management, food services and health clubs.
The LBA Portfolio, which the Company acquired on March 1, 1998, is included in the portfolio summary described above. The LBA Portfolio consisted of 50 properties including 34 office properties containing approximately 3.6 million square feet, 15 R&D/industrial properties containing approximately 1.5 million rentable square feet, and one retail property containing 144,225 rentable square feet. All the properties in the LBA Portfolio are located in Southern California, with six in Los Angeles County, 15 in Orange County, 16 in San Diego County, 12 in Riverside and San Bernardino Counties and one in Ventura County. The properties included in the LBA Portfolio range from approximately 12,000 to 451,000 rentable square feet and have an average age of 11 years. Of the 50 properties included in the LBA Portfolio, 45 have been built since 1980 and 21 have been substantially renovated within the last five years.
Management believes that the location, quality of construction and building amenities, as well as the Company's reputation for providing a high level of tenant service, have enabled the Company to attract and retain a diverse tenant base. The Properties, including acquisitions through March 1, 1998, were 84.5% leased (87.0% leased if the four properties under renovation are excluded) to over 2,600 tenants as of January 1, 1998. As of January 1, 1998, no one tenant represented more than 1.5% of the aggregate Annualized Base Rent (as defined herein) of the Properties, including acquisitions through March 1, 1998, and only four tenants individually represented more than 1.0% of such aggregate Annualized Base Rent.
The Properties are leased to a variety of local, national and foreign businesses. Leases are typically structured for terms of three, five or 10 years. Most of the leases are full service, gross leases under which tenants typically pay for all real estate taxes and operating expenses above those for an established base year or expense stop. Leases typically contain provisions permitting tenants to renew at prevailing market rates. Under the lease, the landlord is generally responsible for structural repairs. Finally, tenants generally
pay directly (without regard to a base year or expense stop) for overtime use of air conditioning and for on site monthly employee and visitor parking.
Although the leases at the Properties primarily consist of gross leases, approximately 18% of the total portfolio leased square footage as of January 1, 1998 is leased pursuant to triple net leases with a number of tenants. In general, the triple net leases require the tenants to pay all real property taxes, insurance and expenses of maintaining the leased space or property and have renewal and termination provisions similar to those described above.
The Company's Properties, are regionally managed under active central control. All administration (including the formation and implementation of policies and procedures), leasing, capital expenditures and construction decisions are centrally administered at the Company's corporate office. The Company employs asset managers to oversee and direct the day-to-day operations of the Properties, as well as the on-site personnel, which may include a manager, assistant manager and other necessary staff. Asset managers communicate frequently with the Company's corporate offices to implement the Company's policies and procedures.
The on-site staffing of each property is dictated by the property's size, tenant profile, number of tenants and location. The Company contracts with third parties for cleaning services, day porters, engineers and any other personnel necessary to operate the Properties.
The following table sets forth certain information regarding the Company's 127 Properties as of January 1, 1998:
* Indicates LBA Portfolio property
(1) Annualized base rent is calculated as monthly contractual base rent under existing leases as of January 1, 1998, multiplied by 12; for those leases where rent has not yet commenced or which are in a free rent period, the first month in which rent is received is used to determine Annualized Base Rent. (2) At January 1, 1998, the Company owned a 75% interest in this property and on March 25, 1998 exercised its option to purchase the remaining 25% interest for $27.5 million, resulting in a total acquisition cost of approximately $110.7 million. (3) The land underlying these Properties and/or their parking structures is leased by the Company pursuant to long term ground leases. (4) The Company owns a 97.5% interest in the property. (5) Property is currently under renovation. (6) Above amounts for 2730 Wilshire exclude the 100%-occupied 12,740 square foot, 16-unit apartment complex which is also owned by the Company.
TENANT INFORMATION
The Company's 127 Properties are leased to over 2,600 tenants which are engaged in a variety of businesses, including financial services, entertainment, health care services, accounting, law, computer technology, education and publishing. The following table sets forth the Annualized Base Rent as of January 1, 1998 derived from the 20 largest tenants at these Properties:
LEASE DISTRIBUTIONS
The following table sets forth information relating to the distribution of the leases for the Company's 127 Properties, based on rentable square feet under lease, as of January 1, 1998:
LEASE EXPIRATIONS
The following table sets forth a summary schedule of the total lease expirations for the Company's 127 Properties for leases in place as of January 1, 1998, assuming that none of the tenants exercise renewal options or termination rights, if any, at or prior to the scheduled expirations:
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
The Company is not presently subject to any material litigation nor, to the Company's knowledge, is any litigation threatened against the Company, other than routine litigation arising in the ordinary course of business, some of which is expected to be covered by liability insurance and all of which collectively is not expected to have a material adverse effect on the consolidated financial statements of the Company.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of stockholders during the fourth quarter of the year ended December 31, 1997.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock began trading on the NYSE on October 4, 1996 under the symbol "ARI." On March 27, 1998, the last reported sales price per share of Common Stock on the NYSE was $28 7/16, and there were approximately 150 holders of record of the Common Stock. The table below sets forth the quarterly high and low closing sales price per share of Common Stock reported on the NYSE and the distributions declared per share by the Company with respect to each such period.
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(1) The Company paid a distribution of $.36 per share of Common Stock on January 15, 1997, to Stockholders of record on December 31, 1996. The distribution was for the period from October 9, 1996 through December 31, 1996 and is approximately equivalent to a quarterly distribution of $.40 per share and an annual distribution of $1.60 per share.
On March 17, 1998, the Company announced its first quarter 1998 dividend of $.42 per share, to be paid on April 30, 1998, to shareholders of record at the close of business on March 31, 1998.
Concurrent with consummation of the IPO and pursuant to the Formation Transactions, the Operating Partnership issued 2,889,071 OP Units to the partners and members of the Arden Predecessors and certain other "accredited" individuals in consideration for their contribution to the Operating Partnership of ownership interests in the Properties. In addition, the Operating Partnership issued 55,805 OP Units as partial consideration in the acquisition of one office property purchased by the Company subsequent to the IPO and prior to January 1, 1997. From January 1, 1997 through March 1, 1998, the Operating Partnership issued a total of 1,052,700 OP Units as partial consideration in the acquisition of three commercial properties, including 203,420 OP Units issued in connection with acquisition of the LBA Portfolio. Holders of the OP Units may redeem part or all of their OP Units for cash, or at the election of the Company, exchange such OP Units for shares of Common Stock on a one-for-one basis.
On July 23, 1997, the Company completed a secondary public offering (the "July 1997 Offering") of 13,750,000 shares of Common Stock. The July 1997 Offering price was $26.125 per share resulting in gross proceeds of approximately $313.5 million. Also on July 23, 1997, the underwriters exercised their overallotment option and, accordingly, the Company issued an additional 1,750,000 shares of common stock and received gross proceeds of approximately $45.7 million. The aggregate proceeds to the company, net of underwriters' discount and offering costs aggregating approximately $18.6 million were approximately $340.6 million.
On January 21, 1998, the Company filed a Registration Statement on Form S-3 with the Securities and Exchange Commission to offer in one or more series, its $.01 par value Common Stock, with an aggregate public offering price of up to $1.0 billion on terms to be determined at the time of the offerings.
On February 18, 1998, the Company completed an offering (the "February 18, 1998 Offering") of 881,950 shares of Common Stock. The shares from the February 18, 1998 Offering were issued to the trustee of a registered unit investment trust at an offering price of $28.3125 per share. Gross proceeds from this offering were approximately $25.0 million. The aggregate proceeds to the Company, net of
underwriters' discount and offering costs aggregating approximately $1.3 million were approximately $23.6 million.
On February 19, 1998, the Company completed a secondary public offering (the "February 19, 1998 Offering") of 20,000,000 shares of Common Stock. The February 19, 1998, offering price was $28.3125 per share resulting in gross proceeds of approximately $566.3 million. Also on February 19, 1998, the underwriters exercised their overallotment option and, accordingly, issued an additional 3,000,000 shares of common stock and received gross proceeds of approximately $84.9 million from the issuance of such shares. The aggregate proceeds to the Company from the issuance of these 23,000,000 shares of Common Stock, net of underwriters' discount and offering costs aggregating approximately $32.4 million, were approximately $618.8 million.
On February 23, 1998, the Company completed an offering (the "February 23, 1998 Offering") of 1,303,965 shares of Common Stock. The shares from the February 23, 1998 Offering were issued to the trustee of a registered unit investment trust at an offering price of $28.375 per share. Gross proceeds from this offering were approximately $37.0 million. The aggregate proceeds to the Company, net of underwriters' discount and offering costs aggregating approximately $1.9 million were approximately $35.1 million.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth selected consolidated/combined financial data for Arden Realty, Inc. and the Arden Predecessors (in thousands except per share amounts) and should be read in conjunction with the consolidated/combined financial statements included elsewhere in this Form 10-K.
ARDEN REALTY, INC. AND ARDEN PREDECESSORS (In thousands, except number of properties and percentages)
(1) The White Paper on Funds from Operations approved by the Board of Governors of the National Association of Real Estate Investment Trusts ("NAREIT") in March 1995 (the "White Paper") defines Funds from Operations as net income (loss) (computed in accordance with generally accepted accounting principles ("GAAP")), excluding gains (or losses) from debt restructuring and unusual items, plus real estate related depreciation and amortization. Management believes Funds from Operations is helpful to investors as a measure of the performance of an equity REIT because, along with cash flows from operating activities, financing activities and investing activities, it provides investors with an understanding of the ability of the Company to incur and service debt, to make capital expenditures and to fund other cash needs. The Company's computation of Funds from Operations may differ from the methodology for calculating Funds from Operations utilized by other equity REITs and, accordingly, may not be comparable to such other REITs. Funds from Operations should not be considered as an alternative to net income (determined in accordance with GAAP), as an indication of the Company's financial performance or as an alternative to cash flows from operating activities (determined in accordance with GAAP) as a measure of the Company's liquidity.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW The following discussion should be read in conjunction with the historical consolidated financial statements of the Company and the combined financial statements of the Arden Predecessors and related notes thereto included elsewhere in this Form 10-K.
Since its initial public offering in October 1996, the Company has pursued a strategy of acquiring underperforming commercial properties, properties in need of renovation and properties which provide attractive yields with stable cash flow, all in Southern California submarkets where it can utilize its local market expertise. The Company has also used its active in-house management, leasing and finance expertise to maximize growth in cash flow. In particular, through December 31, 1997 the Company has:
- - Raised approximately $433.5 million of equity in its initial public offering and approximately $359.2 million in a July 1997 secondary public offering. Proceeds to the Company from these offerings, net of underwriters' discount, advisory fee and offering costs aggregating approximately $54.8 million were approximately $737.9 million.
- - Completed $175.0 million of secured, non-recourse mortgage financing which bears interest at a fixed rate of 7.52% per annum.
- - Increased its borrowing capacity under lines of credit from $150 million at December 31, 1996 to $310 million at December 31, 1997, thereby providing flexibility in pursuing acquisitions and to fund tenant improvements and capital expenditures.
- - Acquired a total of 72 commercial properties with approximately 10.3 million rentable square feet, including two office properties aggregating approximately 182,587 rentable square feet that are undergoing major renovation.
- - Increased its total market capitalization from $599.0 million at December 31, 1996 to $1.1 billion at December 31, 1997.
The Company intends to continue focusing on maximizing growth in cash flow and enhancing the value of its portfolio of commercial properties. These objectives will be pursued by active management of its existing portfolio and by acquisitions of underperforming office and R&D/industrial properties, properties in need of renovation or properties which provide attractive yields with stable cash flows in submarkets where it can utilize its local market expertise. When market conditions permit, the Company may also develop new office or R&D/industrial properties in submarkets where it has local market expertise.
The Company's financial position and operating results are primarily comprised of its portfolio of commercial properties and income derived therefrom. Therefore, financial data from period to period will be affected by the timing of any significant property acquisitions. Due to the Company's and the Arden Predecessors' aggressive acquisition program, the Company expects there will be significant variability in financial data from period to period.
RECENT DEVELOPMENTS
In 1998, the Company has continued to identify and acquire commercial properties that meet its acquisition profile as described above. Through March 1, 1998, the Company acquired an additional 55 primarily office and R&D/industrial properties with approximately 6,123,300 rentable square feet for approximately $765.6 million (the "1998 Acquisitions"). Including the 1998 Acquisitions, the Company's portfolio of commercial properties consists of 127 properties containing approximately 16.4 million rentable square feet which are all located in Southern California. See "Acquisitions" under Item 1 of this Form 10-K for additional information regarding the 1998 Acquisitions. The Company funded the 1998 Acquisitions with proceeds from equity offerings (see discussion below), mortgage financing, draws on its lines of credit, and the issuance of OP Units.
Also on February 23, 1998, the Company completed the most recent of three 1998 equity offerings (the "1998 Offerings") resulting in the issuance of an aggregate of 25,185,915 shares of Common Stock with gross proceeds totaling approximately $713.2 million. Aggregate proceeds to the Company from the 1998 Offerings, net of underwriters' discount and offering costs aggregating approximately $35.7 million were approximately $677.5 million. Of these 1998 Offerings, 2,185,915 shares of common stock were issued to the trustees' of two unrelated registered unit investment trusts and the remaining 23,000,000 shares were issued in a secondary public offering. The Company used the net proceeds from the 1998 Offerings to fund the 1998 Acquisitions described above, to repay the outstanding balances on its lines of credit and for working capital.
RESULTS OF OPERATIONS
Comparison of the year ended December 31, 1997 to the year ended December 31, 1996. During 1997 the Company and the Arden Predecessors purchased 38 properties resulting in an increase in real estate investments of approximately $661 million.
The Company's management believes that in order for a meaningful analysis of the financial statements to be made, certain transactions which occurred in 1996 should be considered in a manner which makes each accounting period comparable. Accordingly, the revenue and expenses for the noncombined entities for the period from January 1, 1996 to October 8, 1996 have been included as though they were combined, with intercompany management fees relating to the noncombined entities of $704,000 eliminated in 1996 in the following discussion. The following section discusses the results of operations, as adjusted and in thousands.
YEAR ENDED DECEMBER 31, 1997 COMPARED TO THE YEAR ENDED DECEMBER 31, 1996
Rental revenue increased approximately $55.9 million or 90% in 1997 as compared to 1996. Rental revenue from properties acquired in 1996 increased approximately $24.6 million in 1997 as compared to the prior year, reflecting a full year of rental revenue from such properties. Rental revenue from properties acquired in 1997 was approximately $30.5 million. Rental revenue from properties owned for all of 1996 and 1997 increased approximately $843,000 in 1997 as compared to the prior year, primarily from increased occupancy.
Tenant reimbursements increased approximately $2.9 million or 93% in 1997 as compared to 1996. Tenant reimbursements from properties acquired in 1996 increased approximately $922,000 in 1997 as compared to the prior year. Tenant reimbursements from properties acquired in 1997 were approximately $1.4 million. Tenant reimbursements from properties owned for all of 1996 and 1997 increased approximately $527,000 in 1997 as compared to the prior year, primarily due to additional 1996 tenant reimbursement billings recognized in 1997.
Parking revenue, net of expense increased approximately $2.4 million or 49% in 1997 as compared to 1996. Parking revenue, net from properties acquired in 1996 increased approximately $1.1 million in 1997 as compared to the prior year. Parking revenue, net from properties acquired in 1997 was approximately $1.0 million. Parking revenue, net from properties owned for all of 1996 and 1997 increased approximately $262,000 in 1997 as compared to the prior year, primarily resulting from increased occupancy.
Revenue from other rental operations, consisting primarily of miscellaneous tenant charges such as after hours utility, heating and air conditioning charges, increased by approximately $1.1 million or 83% in 1997 as compared to the prior year. The increase associated with properties acquired in 1996 was $532,000 and such revenues from properties purchased in 1997 were $382,000. Such revenues from properties owned for all of 1996 and 1997 increased approximately $170,000 primarily due to a non-recurring early lease termination fee recognized in 1997.
Total property expenses in 1997 were $44.3 million, or 33% of total revenues from rental operations, compared with total property expenses of $24.8 million or 35% of total revenues from rental operations in 1996. The increase in total property expenses associated with properties acquired in 1996 was approximately $8.9 million, reflecting a full year of expenses from such properties. Expenses from properties acquired in 1997 were approximately $11.0 million. Expenses from properties owned for all of 1996 and 1997 decreased approximately $433,000 in 1997 as compared to the prior year. The decrease in total property expenses as a percent of revenues from rental operations was primarily due to benefits achieved from economies of scale across the entire portfolio.
General and administrative expenses were approximately $4.3 million or 3.2% of total revenues in 1997 as compared to $2.5 million or 3.5% of total revenues in 1996. General and administrative expenses as a percentage of total revenues decreased in 1997 compared to 1996 primarily due to benefits achieved from economies of scale across the entire portfolio.
Interest expense decreased approximately $13.6 million or 41% in 1997 as compared to 1996, primarily as a result of lower outstanding debt balances in 1997. The Company used the net proceeds of approximately $737.9 million from equity offerings in October 1996 and July 1997 to repay outstanding indebtedness and acquire additional commercial properties.
Depreciation and amortization expense increased $9.2 million or 83% in 1997, primarily due to 1996 and 1997 acquisitions.
Other income increased approximately $314,000 in 1997, primarily due to higher interest income from a mortgage note receivable acquired in September 1997.
Following is a comparison of property operating data for 17 properties which were owned for the entire twelve months ended December 31, 1997 and 1996 (in thousands):
Comparison of the year ended December 31, 1996 to the year ended December 31, 1995. During 1996 the Company and the Arden Predecessors purchased 16 properties resulting in an increase in real estate investments of approximately $266 million.
The Company's management believes that in order for a meaningful analysis of the financial statements to be made, certain transactions which occurred in 1996 should be considered in a manner
which makes each accounting period comparable. Accordingly, the revenue and expenses for the noncombined entities for the year ended December 31, 1995 and the period from January 1, 1996 to October 8, 1996 have been included as though they were combined, with intercompany management fees relating to the noncombined entities of $704,000 and $831,000 eliminated in 1996 and 1995, respectively, in the following discussion. The following section discusses the results of operations, as adjusted. (in thousands)
YEAR ENDED DECEMBER 31, 1996 COMPARED TO THE YEAR ENDED DECEMBER 31, 1995
Rental revenue increased approximately $37.7 million or 154% in 1996 as compared to 1995. Rental revenue from properties acquired in 1995 increased approximately $17.8 million in 1996 as compared to the prior year, reflecting a full year of rental revenue from such properties. Rental revenue from properties acquired in 1996 was $19.7 million. Rental revenue from properties owned for all of 1995 and 1996 increased approximately $254,000 in 1996 as compared to the prior year, primarily from increased occupancy.
Tenant reimbursements increased approximately $2.3 million or 274% in 1996 as compared to 1995. Tenant reimbursements from properties acquired in 1995 increased approximately $1.1 million in 1996 as compared to the prior year. Tenant reimbursements from properties acquired in 1996 were approximately $1.3 million. Tenant reimbursements from properties owned for all of 1995 and 1996 decreased approximately $109,000 in 1996 compared to 1995, primarily due to resetting base years in the expense recovery calculation for leases that were renewed or retenanted.
Parking revenue, net of expense increased approximately $3.4 million or 221% in 1996 as compared to 1995. Parking revenue, net from properties acquired in 1995 increased approximately $2.8 million in 1996 as compared to the prior year. Parking revenue, net from the properties acquired in 1996 was $544,000.
Parking revenue, net from properties owned for all of 1995 and 1996 increased approximately $16,000 in 1996 as compared to the prior year, primarily from increased occupancy.
Revenues from other rental operations, consisting primarily of miscellaneous tenant charges such as after hours utility, heating and air conditioning charges, increased by $375,000 or 40% in 1996 as compared to the prior year. The increase associated with properties acquired in 1995 was $538,000. Revenues from properties purchased in 1996 were $251,000. Revenues from other rental operations for properties owned for all of 1995 and 1996 decreased approximately $414,000 due to a non-recurring lease termination fee recognized in 1995.
In 1996, total property expenses were $24.8 million, or 35% of total revenues from rental operations, compared with total property expenses of $10.1 million or 37% of total revenues from rental operations in 1995. The increase in expenses associated with properties acquired in 1995 was $7.4 million, reflecting a full year of expenses from such properties. Expenses from properties acquired in 1996 were $7.4 million. Expenses from properties owned for all of 1995 and 1996 decreased approximately $181,000 in 1996 as compared to the prior year.
General and administrative expenses increased approximately $1.1 million or 79% in 1996 as compared to the prior year, resulting from higher management and administrative costs associated with the increased portfolio size and the operations of the Company as a public real estate investment trust.
Interest expense increased approximately $19.4 million or 141% in 1996 as compared 1995, primarily as a result of higher outstanding balances during 1996, which were used to fund property acquisitions.
Depreciation and amortization expense increased $6.7 million or 155% in 1996, primarily due to 1996 and 1995 acquisitions.
Other income increased $593,000 primarily due to an increase in interest income earned on higher restricted cash balances in 1996.
Following is a comparison of property operating data for eight properties which were owned for the entire twelve months ended December 31, 1996 and 1995 (in thousands):
LIQUIDITY AND CAPITAL RESOURCES
CASH FLOWS
Cash provided by operating activities increased by $19.1 million or 119%, to $35.1 million for the year ended December 31, 1997, as compared to $16.0 million for the year ended December 31, 1996 primarily due to operating results from the 1996 and 1997 acquisitions. Cash used in investing activities increased by $375.8 million, or 132.4%, to $659.7 million in 1997 compared to $283.8 in 1996 primarily due to the Company's aggressive property acquisition activity in 1997 and an increase in capital expenditures on properties owned. Cash provided by financing activities increased by $338.6 million, or 119.3%, to $622.2 million, as compared to $283.6 million for 1996. Cash provided by financing activities for the year ended December 31, 1997 consisted primarily of net proceeds from mortgage loans, unsecured lines of credit, and the issuance of 13,750,000 shares of common stock in a July 1997 secondary offering partially offset by distributions to shareholders and minority interests. Cash provided by financing activities for the year ended December 31, 1996 consisted primarily of net proceeds from the issuance of 21,674,500 shares of common stock in the Company's initial public offering, partially offset by net payments on mortgage loans and unsecured lines of credit.
CAPITAL COMMITMENTS
As of December 31, 1997 the Company had approximately $1.0 million outstanding in capital commitments related to tenant improvements, renovation costs, and general property related capital expenditures.
AVAILABLE BORROWINGS, CASH BALANCE AND CAPITAL RESOURCES
The Company has a $300 million unsecured line of credit (Amended Credit Facility) from a group of banks led by Wells Fargo. The Amended Credit Facility bears interest at a rate ranging between LIBOR plus 1.2% and LIBOR plus 1.45% (effective rate of 7.5% at December 31, 1997) depending on the leverage ratio of the Company. Once the Company achieves an investment grade unsecured debt rating, the interest rate may be lowered to between LIBOR Plus 0.9% and LIBOR plus 1.15% depending on such debt rating. Under certain circumstances, the Company has the option to convert the interest rate from LIBOR to the prime rate plus 0.5%. In addition, the Amended Credit Facility has a commitment fee ranging from .125% to .25% on the unused balance. The Amended Credit Facility matures on September 1, 2000. Proceeds from the Amended Credit Facility will be used, among other things, to provide funds for tenant improvements and capital expenditures and provide for working capital and other corporate purposes. As of December 31, 1997, the aggregate outstanding balance on the Amended Credit Facility was $230.4 million, and $7.0 million was available for additional borrowing. On February 19, 1998, the aggregate outstanding balance of $277.9 million on the Amended Credit Facility was repaid with proceeds from equity offerings of common stock.
The Company also has an unsecured line of credit with a total commitment of $10.0 million from City National Bank (the "City National Bank Credit Facility"). The City National Bank Credit Facility accrues interest at the City National Bank Prime Rate less 0.875% (effective rate of 7.6% at December 31, 1997), and is scheduled to mature on August 1, 1998. Proceeds from the City National Bank Credit Facility will be used, among other things, to provide funds for tenant improvements and capital expenditures and provide for working capital and other corporate purposes. As of December 31, 1997, the aggregate outstanding balance on the City National Bank Credit Facility was $10.0 million. On
February 19, 1998 the Company repaid the outstanding balance of $5.0 million on the City National Bank Credit Facility with proceeds from equity offerings of common stock.
As of December 31, 1997, the Company had $9.3 million in cash and cash equivalents, including $4.0 million in restricted cash, representing an interest bearing cash deposit required by one of the Company's mortgage loans payable.
On July 23, 1997, the Company completed a secondary public offering of 13,750,000 shares of Common Stock (the "July 1997 Offering"). The July 1997 Offering price was $26.125 per share resulting in gross proceeds of $359.2 million. The aggregate proceeds to the Company, net of underwriters' discount and offering costs aggregating approximately $18.6 million were approximately $340.6 million. Proceeds from the Company's July 1997 Offering were used to pay down the Company's Amended Credit Facility, City National Bank Credit Facility, and to acquire additional commercial properties.
On January 12, 1998, the Company filed a Form S-3 Registration Statement (the "Registration Statement") with the Securities and Exchange Commission to offer in one or more series, shares of its $.01 par value common stock with an aggregate public offering price of up to $1.0 billion. The Registration was declared effective on January 21, 1998.
Also on February 23, 1998, the Company completed the most recent of three 1998 equity offerings (the "1998 Offerings") resulting in the issuance of an aggregate of 25,185,915 shares of Common Stock with gross proceeds totaling approximately $713.2 million. Aggregate proceeds to the Company from these offerings, net of underwriters' discount and offering costs aggregating approximately $35.7 million were approximately $676.0 million. Of these 1998 offerings, 2,185,915 shares of common stock were issued to the trustees' of two unrelated registered unit investment trusts and the remaining 23,000,000 shares were issued in a secondary public offering. Net proceeds from the 1998 Offerings were used to repay the outstanding balances on the Amended Credit Facility and City National Bank Credit Facility and to fund a portion of the LBA Portfolio acquisition. The remaining proceeds were invested in short-term commercial paper and used for working capital.
As of March 27, 1998, the Company had $300.0 million available under its lines of credit and the capacity to issue up to $286.8 million of its common stock pursuant to the Registration Statement.
The Company expects to continue meeting its short-term liquidity and capital requirements generally through its working capital and net cash provided by operating activities. The Company believes that the net cash provided by operating activities will continue to be sufficient to pay any distributions necessary to enable the Company to continue qualifying as a REIT. The Company also believes that the foregoing sources of liquidity will be sufficient to fund its short-term liquidity needs for the foreseeable future, including recurring non-revenue enhancing capital expenditures, tenant improvements and leasing commissions.
The Company expects to meet certain long-term liquidity and capital requirements such as property acquisitions, scheduled debt payments, renovation costs, expansions and other non-recurring capital expenditures through long-term secured and unsecured indebtedness and the issuance of additional equity securities. The Company also expects to use the remaining funds available under the
Amended Credit Facility to fund acquisitions, development activities and capital improvements on an interim basis.
FUNDS FROM OPERATIONS
The Company considers Funds from Operations, as defined by NAREIT, to be a useful financial measure of the operating performance for an equity REIT. The Company believes that Funds from Operations 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. Funds from Operations does not represent net income or cash flows from operations as defined by generally accepted accounting principles ("GAAP") and it should not be considered as an alternative to these indicators in evaluating liquidity or operating performance of the Company.
The following table reflects the calculation of the Company's Funds from Operations for the year ended December 31, 1997 and for the period October 9, 1996 to December 31, 1996 and for the Arden Predecessors for the period January 1, 1996 to October 8, 1996 and for the year ended December 31, 1995:
The White Paper on Funds from Operations approved by the Board of Governors of the National Association of Real Estate Investment Trusts ("NAREIT") in March 1995 (the "White Paper") defines Funds from Operations as net income (loss) (computed in accordance with GAAP), excluding gains (or losses) from debt restructuring and unusual items, plus real estate related depreciation and amortization and after adjustments for unconsolidated partnerships and joint ventures. Management considers Funds from Operations an appropriate measure of performance of an equity REIT because it is predicated on cash flow analyses. The Company computes Funds from Operations in accordance with standards established by the White Paper which may differ from the methodology for calculating Funds from Operations utilized by other equity REITs and, accordingly, may not be comparable to such other REITs. Funds from Operations should not be considered as an alternative to net income (determined in accordance with GAAP) as an indicator of the Company's financial performance or to cash flow from operating activities (determined in accordance with GAAP) as a measure of the Company's liquidity, nor is it indicative of funds available to fund the Company's cash needs, including its ability to make distributions.
IMPACT OF YEAR 2000
The Year 2000 Issue is the result of computer programs being written using two digits rather than four to define the applicable year. Any of the Company's computer programs that have time-sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in a system failure or miscalculations causing disruptions of operations, including, among other things, a temporary inability to process transactions, send tenant invoices, or engage in similar normal business activities.
Based on a recent assessment, the Company determined that it will be required to modify or replace significant portions of its software so that its computer systems will function properly with respect to dates in the year 2000 and thereafter. The Company presently believes that with modifications to existing software and conversions to new software, the Year 2000 Issue will not pose significant operational problems for its computer systems. However, if such modifications and conversions are not made, or are not completed timely, the Year 2000 Issue could have a material impact on the operations of the Company.
The Company intends to initiate communications with all of its significant service providers, lenders, and large tenants to determine the extent to which the Company's interface systems are vulnerable to those third parties' failure to remediate their own Year 2000 Issues. However, there can be no guarantee that the systems of other companies on which the Company's systems rely will be timely converted and would not have an adverse effect on the Company's systems.
The Company will utilize both internal and external resources to reprogram, or replace, and test the software for the Year 2000 modifications. The Company anticipates completing the Year 2000 project prior to any anticipated impact on its operating systems. The Company can not presently estimate the total cost of the Year 2000 project, however, management does not anticipate such costs will have a material effect on the results of operations.
The Company's ability to complete the Year 2000 modifications prior to any anticipated impact on its operating systems is based on numerous assumptions of future events, including the continued availability of certain resources, third party modification plans and other factors. However, there can be no guarantee that this estimate will be achieved. Specific factors that might cause such material differences include, but are not limited to, the availability and cost of personnel trained in this area, the ability to located and correct all relevant computer codes, and similar uncertainties.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The financial statements and supplementary data required by Regulation S-X are included in this Report on Form 10-K commencing on page.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable.
PART III
Certain information required by Part III is omitted from this Report in that the Company will file a definitive proxy statement within 120 days after the end of its fiscal year pursuant to Regulation 14A for its Annual Meeting of Stockholders to be held on May 7, 1998 (the "Proxy Statement") and the information included therein is incorporated herein by reference.
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information contained in the section captioned "Proposal I; Election of Directors" of the Proxy Statement is incorporated herein by reference.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION The information contained in the section captioned "Executive Compensation" of the Proxy Statement is incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. The information contained in the section captioned "Principal and Management Stockholders" of the Proxy Statement is incorporated herein by reference.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information contained in the section captioned "Certain Relationships and Related Transactions" of the Proxy Statement is incorporated herein by reference.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS AND SCHEDULE, AND REPORTS ON FORM 8-K (a) (1 and 2) Financial Statements and Schedule
The following consolidated financial information is included as a separate section of this Annual Report on Form 10-K:
All other schedules are omitted since the required information is not present in amounts sufficient to require submission of the schedule or because the information required is included in the financial statements and notes thereto.
(3) Exhibits
EXHIBIT NUMBER DESCRIPTION
3.1 Amended and Restated Articles of Incorporation as filed as an exhibit to Registration Statement on Form S-11 (No. 333-8163) and incorporated herein by reference.
3.2 By-Laws of Registrant as filed as an exhibit to Registration Statement on Form S-11 (No. 333-8163) and incorporated herein by reference.
3.3 Specimen of certificate representing shares of Common Stock as filed as an exhibit to Registration Statement on Form S-11 (No. 333-8163) and incorporated herein by reference.
10.1 Amended and Restated Agreement of Limited Partnership of the Operating Partnership as filed as an exhibit to Registration Statement on Form S-11 (No. 333-8163) and incorporated herein by reference.
10.1.1 Agreement for Purchase and Sale by and among AEW/LBA Acquisition Co., LLC, a California limited liability company, AEW/LBA Acquisition Co. II, LLC, a California limited liability company, Cal Portfolio VI, L.L.C., a Delaware limited liability company, AEW/LBA Acquisition Co. IV, LLC, a California limited liability company, Spectrum Huntington Center, LLC, a California limited liability company, Spectrum Chicago Avenue, LLC, a California limited liability company, Spectrum Waples Street, LLC, a California limited liability company, Spectrum Lambert Plaza, LLC, a California limited liability company, and Arden Realty, Inc., a Maryland corporation as filed as an exhibit to Form 8-K filed on March 16, 1998 and incorporated herein by reference.
10.2 1996 Stock Option and Incentive Plan as filed as an exhibit to Registration Statement on Form S-11 (No. 333-8163) and incorporated herein by reference.
10.2.1 Closing Agreement dated March 2, 1998 as filed as an exhibit to Form 8-K filed on March 16, 1998 and incorporated herein by reference.
10.3 Form of Officers and Directors Indemnification Agreement as filed as an exhibit to Registration Statement on Form S-11 (No. 333-8163) and incorporated herein by reference.
10.3.1 Warrant Agreement dated as of March 2, 1998 by and among Arden Realty, Inc., a Maryland corporation and AEW/LBA Acquisition Co. II, LLC, a California limited liability company as filed as an exhibit to Form 8-K filed on March 16, 1998 and incorporated herein by reference.
10.4 Employment Agreement between the Company and Mr. Ziman as filed as an exhibit to Registration Statement on Form S-11 (No. 333-8163) and incorporated herein by reference.
10.5 Employment Agreement between the Company and Mr. Coleman as filed as an exhibit to Registration Statement on Form S-11 (No. 333-8163) and incorporated herein by reference.
10.6 Employment Agreement between the Company and Ms. Laing as filed as an exhibit to Registration Statement on Form S-11 (No. 333-8163) and incorporated herein by reference.
10.7 Miscellaneous Rights Agreement among the Company, the Operating Partnership, NAMIZ, Inc. and Mr. Ziman as filed as an exhibit to Registration Statement on Form S-11 (No. 333-8163) and incorporated herein by reference.
10.33 Credit Facility documentation consisting of First Amended and Restated Revolving Credit Agreement by and among the Operating Partnership and Chase Manhattan Bank, Lehman Brothers Realty Corporation and Wells Fargo Bank as filed as an exhibit to Registration Statement of Form S-11 (No.333-30059) and incorporated herein by reference.
10.34 Mortgage Financing documentation consisting of Loan Agreement by and between the Company's special purpose financing subsidiary and Lehman Brothers Realty Corporation (the Loan Agreement includes the Mortgage Note, Deed of Trust, and form of Tenant Estoppel Certificate and Agreement as exhibits) as filed as an exhibit to Registration Statement of Form S-11 (No. 333-30059) and incorporated herein by reference.
21.1 Subsidiary of Registrant as filed as an exhibit to Registration Statement on Form S-11 (No. 333-8163) and incorporated herein by reference.
23.1 Consent of Independent Auditors.
27 Financial Data Schedule
(b) Reports on Form 8-K
On October 15, 1997 the Company filed a report on Form 8-K relating to the acquisition of certain real estate properties. The Company filed the required financial statements and information under cover of Form 8-K/A on November 14, 1997.
On November 12, 1997 the Company filed a report on Form 8-K relating to the acquisition of certain real estate properties. The Company filed the required financial statements and information under cover of Form 8-K/A on November 24, 1997.
On December 18, 1997, the Company filed a report on Form 8-K relating to the acquisition of certain real estate properties.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on March 31, 1998.
ARDEN REALTY, INC.
By: /s/ Richard S. Ziman ------------------------------- Richard S. Ziman Chairman of the Board and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
REPORT OF INDEPENDENT AUDITORS
Board of Directors and Stockholders Arden Realty, Inc.
We have audited the accompanying consolidated balance sheets of Arden Realty, Inc. as of December 31, 1997 and 1996 and the related consolidated statements of operations, stockholders' equity, and cash flows of Arden Realty, Inc. for the year ended December 31, 1997 and for the period October 9, 1996 (commencement of operations) to December 31, 1996 and the related combined statements of operations, owners' equity and cash flows of the Arden Predecessors for the period January 1, 1996 to October 8, 1996 and for the year ended December 31, 1995. Our audits also included the financial statement schedule listed in the index at Item 14(a). These financial statements and the financial statement schedule are the responsibility of the management of Arden Realty, Inc. Our responsibility is to express an opinion on these financial statements and schedule 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 Arden Realty, Inc. at December 31, 1997 and 1996 and the consolidated results of its operations and its cash flows for the year ended December 31, 1997 and for the period October 9, 1996 to December 31, 1996 and the combined results of operations and cash flows of the Arden Predecessors for the period January 1, 1996 to October 8, 1996 and for the year ended December 31, 1995, in conformity with generally accepted accounting principles. Also, in our opinion, the financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
/s/ Ernst & Young LLP
Los Angeles, California January 29, 1998, except for Note 21, as to which the date is February 23, 1998
ARDEN REALTY, INC. CONSOLIDATED BALANCE SHEETS (in thousands, except share data)
See accompanying notes to financial statements.
ARDEN REALTY, INC. CONSOLIDATED STATEMENTS OF OPERATIONS AND ARDEN PREDECESSORS COMBINED STATEMENTS OF OPERATIONS (in thousands except share amounts)
See accompanying notes to financial statements.
ARDEN REALTY, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (in thousands, except share amounts)
ARDEN PREDECESSORS COMBINED STATEMENTS OF OWNERS' EQUITY (in thousands)
See accompanying notes to financial statements.
ARDEN REALTY, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS AND ARDEN PREDECESSORS COMBINED STATEMENTS OF CASH FLOWS (in thousands)
See accompanying notes to financial statements.
ARDEN REALTY, INC. AND ARDEN PREDECESSORS NOTES TO FINANCIAL STATEMENTS
1. DESCRIPTION OF BUSINESS
DESCRIPTION OF BUSINESS Arden Realty, Inc. (the "Company"), through its controlling interest in Arden Realty Limited Partnership (the "Operating Partnership"), and its other subsidiaries, is engaged in owning, acquiring, managing, leasing and renovating commercial properties (collectively, the "Properties") located in Southern California. The Company was formed in 1996 to continue and expand the real estate business of Arden Realty Group, Inc. and a group of affiliated entities (the "Arden Predecessors").
ORGANIZATION AND FORMATION OF THE COMPANY The Company was incorporated in Maryland in May 1996. On October 9, 1996, the Company completed an initial public offering (the "IPO") of 21,674,500 shares of $.01 par value common stock, at a price of $20.00 per share resulting in gross proceeds of $433.5 million. The aggregate proceeds to the Company from the IPO, net of underwriters' discount, advisory fee and offering costs aggregating approximately $36.2 million were approximately $397.3 million.
Concurrent with consummation of the IPO, the Company and the Operating Partnership, together with the partners and members of the Arden Predecessors (collectively, the "Participants"), engaged in certain formation transactions (the "Formation Transactions") as follows:
- - Pursuant to separate option agreements (the "Option Agreements"), the Company acquired for cash from certain Participants the interests owned by such Participants in certain of the Arden Predecessors and in certain of the Properties. The Company paid approximately $26.8 million from the net proceeds of the IPO for such interests, which represented 31.7% of the ownership interests in the Properties acquired by the Company.
- - The Company contributed (i) the interests in the Arden Predecessors and in the properties acquired pursuant to the Option Agreements and (ii) the net proceeds from the IPO (after payment of the cash consideration to certain Participants as described above) to the Operating Partnership in exchange for an 88.2% general partner interest in the Operating Partnership, representing the sole general partnership interest.
- - Pursuant to separate contribution agreements (the "Contribution Agreements"), the following additional contributions were made by Participants to the Operating Partnership in exchange for limited partner interests in the Operating Partnership ("OP Units"): (i) the remaining interests in the Arden Predecessors and in certain of the Properties (i.e., all interests not acquired by the Company pursuant to the Option Agreements) and (ii) certain assets, including management contracts relating to certain of the Properties and the contract rights to purchase two properties (303 Glenoaks and 12501 East Imperial Highway). The Participants making such contributions (a total of seven individuals and entities including Arden Realty Group, Inc., Richard Ziman, Victor Coleman, and Arthur Gilbert), received an aggregate of 2,889,071 OP Units, with a value of approximately $57.8 million based on the IPO price of the Company's common stock.
- - The Company, through the Operating Partnership, borrowed $57.0 million aggregate principal amount under a one year interim loan (the "1996 Interim Financing") which was non-recourse to the Company and the Operating Partnership and secured by cross-collateralized and cross-defaulted first mortgage liens on nine of the Properties.
- - Approximately $33.0 million of the net proceeds of the IPO were used by the Operating Partnership to purchase two properties, 303 Glenoaks and 12501 East Imperial Highway.
- - The Company used a portion of the proceeds of the IPO and the 1996 Interim Financing to repay approximately $370.0 million of mortgage debt secured by the Properties and indebtedness outstanding under lines of credit assumed by the Operating Partnership in the Formation Transactions.
The transfer of the Properties and operating interests of affiliates of the Company to the Operating Partnership for cash or OP Units has been accounted for at the historical cost of those interests, similar to a pooling of interests. All transfers by nonaffiliates have been accounted for at the fair value of the OP Units issued or cash consideration paid.
2. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION. The accompanying consolidated financial statements of Arden Realty, Inc. include the accounts of the Company, the Operating Partnership, and its other subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.
The minority interests at December 31, 1997 and December 31, 1996 represent limited partnership interests in the Operating Partnership of approximately 9.7% and 12.0%, respectively.
The Arden Predecessors were not a legal entity but rather a combination of partnerships and an affiliated real estate management corporation. The properties and entities were all managed by Messrs. Ziman and Coleman. In those instances where the financial interests held by Messrs. Ziman, Coleman, Gilbert and their affiliates were also controlling interests, the entities have been combined in the accompanying financial statements. Minority interests have been recorded for those entities that the affiliated Participants control but were not wholly-owned. Where controlling interests were not held by these affiliated Participants, or the Predecessor did not have unilateral right to refinance the debt on the property, the entities were accounted for as investments in noncombined entities utilizing the equity method of accounting.
RISKS AND UNCERTAINTIES The preparation of financial statements, in conformity with generally accepted accounting principles, requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
COMMERCIAL PROPERTIES The properties are stated at the lower of cost or estimated fair value. Write-downs to estimated fair value would be recognized when impairment indicators are present and a property's estimated undiscounted future cash flow, before interest charges, is less than its book value. In that situation, the Company would recognize an impairment loss to the extent the carrying amount exceeds the fair value of the property. Based on management's assessment, no write-downs to estimated fair value by the Company or the Arden Predecessors were necessary.
Repair and maintenance costs are charged to expense as incurred and significant replacements and betterments are capitalized.
Depreciation is calculated under the straight-line method using forty year lives for buildings and ten year lives for building improvements. Amortization of tenant improvements is calculated using the straight-line method over the term of the related lease.
CASH EQUIVALENTS Cash equivalents consist of highly liquid investments with original maturities of three months or less when acquired.
RESTRICTED CASH Restricted cash primarily consists of a cash deposit as required by one of the Company's mortgage loans payable.
PREPAID COSTS Costs associated with leasing properties are capitalized and amortized to expense on a straight-line basis over the related lease term. Costs associated with obtaining long-term financing are capitalized and amortized to interest expense over the term of the related loan.
REVENUE RECOGNITION Minimum rent, including rental abatements and contractual fixed increases attributable to operating leases, is recognized on a straight-line basis over the term of the related lease. Amounts expected to be received in later years are included in deferred rents. Property operating cost reimbursements due from tenants for common area maintenance, real estate taxes and other recoverable costs are recognized in the period the expenses are incurred.
INCOME TAXES Prior to October 9, 1996 the combined and noncombined entities that made up the Arden Predecessors consisted of a Subchapter S corporation, limited liability companies and partnerships. Taxable income for such entities was recorded on the separate tax returns of the membership unit holders and individual partners and, accordingly, no provision for income taxes was recorded in the accompanying financial statements of the Arden Predecessors.
The Company generally will not be subject to federal income taxes as long as it continues to qualify as a real estate investment trust ("REIT"). A REIT will generally not be subject to federal income taxation on that portion of income that qualifies as REIT taxable income and to the extent that it distributes such taxable income to its stockholders and complies with certain requirements. As a REIT, the Company is allowed to reduce taxable income by all or a portion of distributions to stockholders and must distribute at least 95% of its taxable income to qualify as a REIT. As dividends have eliminated taxable income, no Federal income tax provision has been reflected in the accompanying consolidated financial statements. State income tax requirements are essentially the equivalent of the Federal rules.
During 1997 and 1996, the Company declared dividends of $1.60 and $.36 per share, respectively. For federal income tax purposes $1.45 and $.28 per share was reported to shareholders as ordinary income for 1997 and 1996, respectively. A total of $.23 per share of the fourth quarter 1997 dividend will be reported to shareholders in 1998.
EARNINGS PER SHARE DATA Effective December 31, 1997, the Company adopted Statement of Financial Accounting Standards No. 128, Earnings Per Share ("SFAS No. 128"), which replaced primary and fully diluted earnings per share with basic and diluted earnings per share. Basic earnings per share is calculated on the weighted average shares of common stock outstanding during the period. Diluted earnings per share includes the effect of all potential common shares. The conversion of OP Units into common stock would have no effect on per share amounts as the OP Units share proportionately with the common stock shares in the results of the Operating Partnership. Earnings per share amounts for all periods presented have been restated in conformity with the requirements of SFAS No. 128 (Note 17).
RECLASSIFICATIONS Certain prior year amounts have been reclassified in order to conform to the current year presentation.
3. COMMERCIAL PROPERTIES The Company and the Arden Predecessors capitalize interest and taxes related to buildings under construction and renovation to the extent such assets qualify for capitalization. Total interest incurred and the amount capitalized was $20.6 million and $2.0 million, $1.3 million and $57,000, $24.3 million and $0 and $5.3 million and $8,000 for the year ended December 31, 1997, for the period October 9, 1996 to December 31, 1996, for the period January 1, 1996 to October 8, 1996 and the year ended December 31, 1995, respectively.
Twenty-three of the commercial properties with a carrying value of $429.4 million are encumbered by the Company's mortgage loans totalling $237.2 million (Note 8).
Office space in the properties is generally leased to tenants under lease terms which provide for the tenants to pay for increases in operating expenses in excess of specified amounts.
Future minimum lease payments to be received under noncancelable operating leases existing as of December 31, 1997, are as follows:
The above future minimum lease payments do not include specified payments for tenant reimbursements of operating expenses.
Arden Realty, Inc. leases the land underlying either the office buildings and/or parking structures of six of its buildings. Ground lease expense was approximately $1.6 million, $331,000, $806,000 and $19,000 for the year ended December 31, 1997, for the period from October 9, 1996 to December 31, 1996, for the period January 1, 1996 to October 8, 1996 and for the year ended December 31, 1995. Future minimum ground lease payments due under existing ground leases are as follows:
4. INVESTMENTS IN NONCOMBINED ENTITIES The Company's affiliates did not own controlling financial interests in certain of the Arden Predecessors. These investments were accounted for utilizing the equity method of accounting. Under such accounting method, the net equity investment of the Company's affiliates was reflected on the combined balance sheets, and the combined statements of operations included the affiliates' share of net income or loss from the entities. Subsequent to the IPO, the Company acquired the nonaffiliated Participants' interests and accordingly, consolidates the accounts of these properties. The affiliates' ownership interest in each entity was as follows:
AFFILIATES' ENTITY OWNERSHIP % ------ ----------- Bristol Encino Associates, LLC 20.9% 222 Harbor Associates, LLC 26.3% Beverly Ventura Associates, L.P. 50.0% 5000 Spring Associates Tenancy in Common 77.5%
Although the Company's affiliates owned a 77.5% interest in 5000 Spring Associates Tenancy-in-Common, they did not have unilateral right to refinance the property. As a result, this investment was accounted for utilizing equity accounting.
Condensed operating information is presented below for all noncombined entities.
CONDENSED COMBINED STATEMENTS OF OPERATIONS OF NONCOMBINED ENTITIES (in thousands)
The significant accounting policies used by the noncombined entities were similar to those used by the Arden Predecessors.
5. RENTS AND OTHER RECEIVABLES Rents and other receivables at December 31, 1997 include a $4.0 million note receivable from a corporation ("Forest City") which retained a 25% interest in World Savings Center, a 469,115 square foot office building in Los Angeles, California. The Company purchased a 75% interest in World Savings Center for $83.2 million in December 1997. The note bears interest at 7.25% per annum and required monthly payments of interest only. Subsequent to year end, the Company exercised its option to purchase the remaining 25% interest in World Savings Center from Forest City and retired this note receivable as partial consideration for such purchase.
6. PREPAID EXPENSES AND OTHER ASSETS Prepaid expenses at December 31, 1997 include a $20.0 million deposit made in connection with acquisition of the LBA Portfolio (Note 21). The deposit was funded with a draw on the Amended Credit Facility.
7. MORTGAGE NOTES RECEIVABLE In September 1997, the Company purchased two mortgage notes receivable, secured by a single commercial office property, with an aggregate balance of approximately $17.6 million, for approximately $14.4 million. The notes bear interest at the Eleventh District Cost of Funds plus 3.25% per annum (effective rate of 8.2% at December 31, 1997), require monthly payments of principal, interest, and additional net cash flow from the property, as defined, and mature on May 31, 2004.
8. MORTGAGE LOANS PAYABLE At December 31, 1996 the Company had $104.0 million outstanding under the 1996 Interim Financing, a mortgage loan due to Lehman Capital, a division of Lehman Brothers Holdings Inc. ("Lehman"). The loan was secured by nine fully cross-collateralized and cross-defaulted first trust deeds on real property bearing interest at LIBOR plus 1.5% on or before March 31, 1997 and LIBOR plus 2.0% for any subsequent period through maturity. Interest only payments were to be made monthly and all principal and unpaid interest was scheduled to mature on September 30, 1997.
In March 1997, the Company replaced the 1996 Interim Financing with a new mortgage loan (the "1997 Interim Financing") with a total commitment of $175.0 million from an affiliate of Lehman Brothers. The 1997 Interim Financing dated March 17, 1997 was scheduled to mature on September 30, 1997 and had a floating interest rate equal to LIBOR plus 1.5% on or before March 31, 1997 and LIBOR plus 2.0% for any subsequent period through maturity. The 1997 Interim Financing was secured by a fully cross-collateralized and cross-defaulted first mortgage liens on 12 of the Properties and required monthly payments of interest only, with all principal due at maturity.
On June 11, 1997, the Company refinanced, through a special purpose subsidiary, its 1997 Interim Financing with a new $175.0 million mortgage financing (the "Mortgage Financing") from an affiliate of Lehman Brothers. The Mortgage Financing is non-recourse and secured by fully cross-collateralized and cross-defaulted first mortgage liens on 18 of the Company's Properties (the "Mortgage Financing Properties") and has a twenty year term. The Mortgage Financing bears interest at a fixed rate of 7.52%, is anticipated to be repaid in seven years and requires monthly payments of interest only with all principal due in a balloon payment at maturity. If the Mortgage Financing is not repaid or refinanced within seven years, the interest rate increases by at least 2.0% and all excess cash flow from the Mortgage Financing Properties must be used to pay down principal. The Mortgage Financing documentation requires the Company to maintain a cash deposit of $4.0 million and to comply with certain customary financial covenants, ongoing operational restrictions, and certain cash management procedures. In addition, the Mortgage Financing prohibits prepayment for approximately three years from its origination.
In July 1997, the Company assumed a $5.0 million mortgage note payable in connection with the acquisition of 299 Euclid, a 73,400 square foot office building located in Pasadena, California. The note bears interest at 7.0% per annum, requires monthly payments of interest only, and matures on July 1, 2002.
In October 1997, the Company assumed a mortgage note payable of approximately $4.1 million (the "145 South Fairfax Mortgage Note") in connection with acquisition of 145 South Fairfax, a 54,429 square foot office building located in Los Angeles, California. The note bears interest at 8.93% per annum, requires monthly payments of principal and interest, and monthly impound payments for taxes, insurance and other operating purposes, and matures in January 2027. The 145 South Fairfax Mortgage Note prohibits prepayment prior to January 2007.
In October 1997, the Company assumed three mortgage notes payable, with an aggregate balance of approximately $8.1 million, in connection with the purchase of a 254,792 square foot six office property portfolio in
Thousand Oaks, California (the "Thousand Oaks Portfolio"). The notes bear interest ranging from 7.875% to 9% per annum, require monthly payments of principal and interest, and monthly impound payments for taxes and insurance, and mature on July 2015. The notes are secured by two of the properties in the Thousand Oaks Portfolio.
In December 1997, the Company borrowed $45.0 million, from an affiliate of Morgan Stanley (the "World Savings Mortgage Note"). The $45.0 million mortgage note payable is secured by the World Savings Center, bears interest at 9.21%, per annum, for the first three months and LIBOR plus 1.25% thereafter, requires monthly payments of interest only and matures on May 1, 1998.
Effective January 2, 1997, the Company entered into interest rate floor and cap transactions with a notional amount of $155.0 million to hedge the Company's exposure to variable interest rates. The Company entered into these agreements to convert floating rate liabilities to fixed rate liabilities. The agreements fixed the LIBOR portion of the interest rate on the Company's variable rate debt at 6.6% through March 2004. On July 23, 1997, the Company repaid all of its outstanding floating rate debt with proceeds from the July 1997 Offering (as defined in Note 10) and on October 22, 1997, the swap agreement was retired resulting in a loss on the derivative of $3.1 million. This loss was accrued in September 1997.
Following is a summary of scheduled principal payments for the Company's mortgage loans:
9. UNSECURED LINES OF CREDIT The Company had a line of credit, with a total commitment of $150.0 million from a group of banks led by Wells Fargo (the "Credit Facility"). The Credit Facility allowed the Company to borrow $75.0 million on an unsecured basis with the remainder to be secured by real property. The aggregate outstanding balance was $51.0 million (unsecured) at December 31, 1996. The line accrued interest at LIBOR plus 1.5% for secured borrowings, and LIBOR plus 1.75% for unsecured borrowings. The Credit Facility was amended in June 1997, as described below.
On May 5, 1997, the Company entered into a revolving credit agreement with Wells Fargo Bank (the "Wells Bridge Facility"). The Wells Bridge Facility was unsecured, with a total commitment of $110.0 million. The Company repaid the entire balance on the Wells Bridge Facility with a draw on the Amended Credit Facility as defined below.
On June 11, 1997, the Company amended the Credit Facility with a $300.0 million unsecured line of credit (the "Amended Credit Facility") from a group of banks led by Wells Fargo Bank (the "Lenders"). The interest rate of the Amended Credit Facility ranges between LIBOR plus 1.2% and LIBOR plus 1.45% depending on the leverage ratio of the Company. Once the Company achieves an unsecured investment grade debt rating, the interest rate may be lowered to between LIBOR plus 0.9% and LIBOR plus 1.15% depending on such debt rating. Under certain circumstances, the Company has the option to convert the interest rate from LIBOR to the prime rate plus 0.5%. The aggregate outstanding balance on the Amended Credit Facility was $230.4 million as of December 31, 1997 (see Note 21).
The Amended Credit Facility is subject to customary conditions to borrowing, contains representations, warranties and defaults customary in REIT financings, and contains financial covenants, including requirements for a minimum tangible net worth, maximum liabilities to asset values, and minimum interest, unsecured interest and fixed charge coverage ratios (all calculated as defined in the Amended Credit Facility documentation) and requirements to maintain a pool of unencumbered properties which meet certain defined characteristics and are approved by the Lenders. The Amended Credit Facility also contains restrictions on, among other things, indebtedness, investments, distributions, liens and mergers.
Pursuant to a separate agreement, Wells Fargo advanced $28.7 million to the Company (the "Secured Advance"). This advance, which was secured by two Properties, accrued interest at the Wells Fargo Prime Rate and matured on July 10, 1997 at which time the Company repaid the Secured Advance with a $28.7 million draw on the Amended Credit Facility.
The Company also has an unsecured line of credit with a total commitment of $10.0 million from City National Bank (the "City National Bank Credit Facility"). The City National Bank Credit Facility accrues interest at the City National Bank Prime Rate less 0.875%, and is scheduled to mature on August 1, 1998. The City National Bank Credit Facility is used, among other things, to provide funds for tenant improvements and capital expenditures and provide for working capital and other corporate purposes. At December 31, 1997, the aggregate outstanding balance on the City National Bank Credit Facility was $10.0 million. The City National Bank Prime Rate was 8.5% at December 31, 1997 (see Note 21).
10. STOCKHOLDERS' EQUITY An OP Unit and a share of common stock have essentially the same economic characteristics as they share equally in the total net income or loss and distributions of the Operation Partnership. OP Units may be redeemed for cash or, at the election of the Company, for shares of common stock on a one-for-one basis.
On March 28, 1997, the Operating Partnership issued 26,880 OP Units valued at approximately $763,000 in connection with the acquisition of the property located in Bakersfield, California.
On July 23, 1997, the Company completed a secondary public offering (the "July 1997 Offering") of 12,000,000 shares of Common Stock. The July 1997 Offering price was $26.125 per share resulting in gross proceeds of $313.5 million. Also, on July 23, 1997, the underwriters exercised their overallotment option and, accordingly, the Company issued an additional 1,750,000 shares of Common Stock and received gross proceeds of $45.7 million. The aggregate proceeds to the Company, net of underwriters' discount and offering costs aggregating $18.6 million, were approximately $340.6 million.
In December 1997, the Operating Partnership issued 822,400 OP Units valued at approximately $24.7 million in connection with the acquisition of a 469,115 square foot office property in Los Angeles.
In December 1997, 220,538 OP Units were exchanged for Common Stock.
11. FAIR VALUE OF FINANCIAL INSTRUMENTS The following disclosures of estimated fair value of financial instruments at December 31, 1997 were determined by management, using available market information and appropriate valuation methodologies. Considerable judgment is necessary to interpret market data and develop estimated fair value. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.
Cash equivalents, accounts payable, the line of credit and other financial instruments are carried at amounts which reasonably approximate their fair value amounts.
The mortgage notes payable of the Company have an estimated aggregate fair value which approximates its carrying value. Estimated fair value is based on interest rates currently available to the Company for issuance of debt with similar terms and remaining maturities.
12. NON-CASH INVESTING AND FINANCING ACTIVITIES Additional supplemental disclosures of non-cash investing and financing activities for the period October 9, 1996 to December 31, 1996 and for the year ended December 31, 1997 are as follows:
(1) The following summarizes the net assets contributed in 1996 in exchange for 2,889,071 OP Units (in thousands):
(2) In 1996, the Company purchased a 310,910 square foot multi-tenant office building for approximately $10.0 million in cash and the issuance of 55,805 OP Units valued at approximately $1.4 million.
(3) In March 1997, the Company purchased California Twin Center, a 155,189 square foot office building located in Bakersfield, California, for approximately $19.6 million with proceeds from the 1997 Interim Financing, and the issuance of 26,880 OP Units valued at approximately $763,000.
(4) In December 1997, the Company purchased a 75% interest in World Savings Center, a 469,115 square foot office building located in Los Angeles, California for approximately $83.2 million with proceeds from the Amended Credit Facility, World Savings Mortgage note payable, working capital, a $4.0 million note receivable and the issuance of 822,400 OP Units valued at approximately $24.7 million.
13. COMMITMENTS AND CONTINGENCIES
LITIGATION The Company's management does not believe there is any litigation threatened against the Company or the Arden Predecessors other than routine litigation arising out of the ordinary course of business, some of which is expected to be covered by liability insurance and all of which is not expected to have a material adverse effect on the consolidated financial statements of the Company or the combined financial statements of the Arden Predecessors.
CONCENTRATION OF CREDIT RISK The Company maintains its cash and cash equivalents at financial institutions. The combined account balances at each institution periodically exceed FDIC insurance coverage, and as a result, there is a concentration of credit risk related to amounts on deposit in excess of FDIC insurance coverage. Management believes that the risk is not significant.
14. RELATED PARTY TRANSACTIONS Included in other income are management fees of $95,000 for 1995 from various affiliated partnerships.
In March 1997, the Company purchased a 109,187 square foot office property from Arthur Gilbert, a minority interest common share owner for approximately $10.2 million.
15. PROPERTY ACQUISITIONS During 1997 the Company acquired 38 commercial properties containing approximately 4.9 million rentable square feet, all located in Southern California for a total cost, including the purchase price and closing costs, of approximately $641.5 million.
16. REVENUE FROM RENTAL OPERATIONS AND PROPERTY OPERATING EXPENSES Revenues from rental operations and property operating expenses are summarized as follows (in thousands):
17. EARNINGS PER SHARE
The following table set forth the computation of basic and diluted net income (loss) per share (in thousands, except per share amounts):
18. STOCK OPTION PLAN
The Company has elected to follow Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25) and related Interpretations in accounting for its employee and directors stock options because, as discussed below, the alternative fair value accounting provided for under FASB Statement No. 123, "Accounting for Stock-Based Compensation," requires use of option valuation models that were not developed for use in valuing employee stock options. Under APB 25, because the exercise price of employee and director stock options granted by the Company equals the market price of the underlying stock on the date of grant, no compensation expense is recognized.
The Company established a stock option plan for the purpose of attracting and retaining executive officers, directors and other key employees. As of December 31, 1997, and December 31, 1996, 1,353,334 and 1,500,000 of the Company's authorized shares have been reserved for issuance under such plan. On October 4, 1996 options to purchase an aggregate of 905,000 shares were granted at an exercise price equal to the Offering price of $20.00 per share. A total of 865,000 of the options will vest in three equal annual installments and 40,000 will vest in four equal annual installments from the grant date.
On December 2, 1996, and December 27, 1996, 10,000 and 15,000 options, respectively, were granted at exercise prices equal to $24.38 and $26.63, respectively (the market prices at the date of grant). All of the holders of these options have a ten year period to exercise and all options vest in three equal annual installments from the respective grant dates.
During 1997, the Company issued 556,000 options as described below:
All of the holders of the above options have a ten year period to exercise and all options were granted at exercise prices equal to the market prices at the date of the grant.
Pro forma information regarding net income and earnings per share is required by Statement 123, and has been determined as if the Company had accounted for its employee stock options under the fair value method of that Statement. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions for 1997 and 1996, respectively: Risk-free interest rate of 5.81% and 6.7%; dividend yield of 5.2% and 5.8%; volatility factor of the expected market price of the Company's common stock of .194 and .23; and a weighted average expected life of the options of eight and ten years.
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restriction and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's employee and director stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee and director stock options.
For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting periods. The Company's pro forma information follows (in thousands except earnings per share information):
A summary of the Company's stock option activity, and related information for the period October 9, 1996 to December 31, 1996 and for the year ended December 31, 1997 follows:
Exercise prices for options outstanding as of December 31, 1997 ranged from $20.00 to $32.25. The weighted average remaining contractual life of those options is 9.2 years.
19. EMPLOYEE RETIREMENT SAVINGS PLAN Effective June 12, 1997, the Company adopted a retirement savings plan pursuant to Section 401(k) of the Internal Revenue Code ("Code"), whereby participants may contribute a portion of their compensation to their respective retirement accounts, in an amount not to exceed the maximum allowed under the Code. The plan provides for matching contributions by the Company, which amounted to $71,000 for the year ended December 31, 1997. Plan participants are immediately vested in their contribution and are vested equally over four years in the matching contributions by the Company.
20. QUARTERLY RESULTS Following is a summary of the Company's revenues and expenses for the year ended December 31, 1997 and for the period October 9, 1996 to December 31, 1996. Revenues and expenses have fluctuated significantly from quarter to quarter primarily due to property acquisitions made during 1997 (unaudited).
21. SUBSEQUENT EVENTS:
COMMERCIAL PROPERTIES In January 1998, the Company purchased five office properties located in California including a 58,105 square foot office property in Newhall for approximately $8.5 million, a 167,045 square foot office property in San Diego ("Activity Business Center") for approximately $14.9 million, a 326,227 square foot office property located in Beverly Hills for approximately $65.1 million, a 49,639 square foot office property located in Westlake Village for approximately $7.3 million, and a 282,013 square foot office property in Los Angeles for approximately $29.6 million ("1100 Glendon"). These acquisitions were funded with existing working capital, draws from the Company's Amended Credit Facility, proceeds from the Bridge Loan, as defined below, and the assumption of two mortgage loans payable secured by the Activity Business Center and 1100 Glendon properties.
The Company assumed a mortgage note payable of approximately $8.2 million in connection with the acquisition of Activity Business Center, a 167,045 square foot office building located in San Diego, California. The note bears interest at 2.2% per annum plus the yield to maturity at the bid price of obligations of the United States Treasury maturing on April 30, 2006. The note requires monthly payments of principal and interest, monthly impound payments for taxes and insurance, and matures on May 1, 2006. The mortgage note prohibits prepayment prior to May 1, 2002.
The Company assumed a mortgage note payable of approximately $15.4 million in connection with the acquisition of 1100 Glendon, a 282,013 office building located in Los Angeles, California. The note bears interest at 8.09% per annum, requires monthly payments of principal and interest and matures on April 30, 2003.
The Company borrowed $60.0 million from Lehman Brothers Realty Corporation (the "Bridge Loan") in connection with the acquisition of 9100 Wilshire. The Bridge Loan is secured by three of the Company's properties, bears interest at LIBOR plus .75% per annum, requires monthly payments of interest, and matures on May 20, 1998.
On March 1, 1998, the Company acquired a portfolio of 50 primarily office and R&D/industrial properties (the "LBA Portfolio"), aggregating approximately 5.2 million rentable square feet for a purchase price of approximately $619.9 million, including $1.8 million of closing costs and approximately $3.6 million related to warrants to purchase 2.5 million shares of the Company's common stock, at a price of $29.59 per share, subject to adjustment. As partial consideration for this acquisition, the Operating Partnership issued 203,420 OP Units valued at approximately $5.8 million in connection with the acquisition of the LBA Portfolio. The LBA Portfolio consists of 34 office properties containing approximately 3.6 million rentable square feet, 15 R&D/industrial properties containing approximately 1.5 million rentable square feet, and one retail property containing 144,225 rentable square feet, all located in Southern California. The Company borrowed $200.0 million from Lehman Brothers Realty Corporation in connection with the acquisition of the LBA Portfolio. The $200.0 million mortgage loan is secured by 40 properties in the LBA Portfolio, bears interest at LIBOR plus 1.0% per annum, requires monthly payments of interest, and matures on July 1, 1998.
On March 25, 1998, the Company exercised its option to purchase the remaining 25% interest in World Savings Center for $27.5 million. In connection with this purchase, the Company assumed an additional $15.0 million of debt under the World Savings Mortgage Note.
STOCKHOLDERS' EQUITY On February 18, 1998, the Company completed an offering (the "February 18, 1998 Offering") of 881,950 shares of Common Stock. The shares from the February 18, 1998 Offering were issued to the trustee of a registered unit investment trust at an offering price of $28.3125 per share. Gross proceeds from this offering were approximately $25.0 million. The aggregate proceeds to the Company, net of underwriters' discount and offering costs aggregating $1.3 million were approximately $23.6 million.
On February 19, 1998, the company completed a secondary public offering (the "February 19, 1998 Offering") of 20,000,000 shares of Common Stock. The February 19, 1998 Offering price was $28.3125 per share resulting in gross proceeds of $566.3 million. Also on February 19, 1998, the underwriters exercised their overallotment option and, accordingly, issued an additional 3,000,000 shares of common stock and received gross proceeds of approximately $84.9 million. The aggregate proceeds to the Company, net of underwriters' discount and offering costs aggregating approximately $32.4 million, were approximately $618.7 million.
On February 23, 1998, the Company completed an offering (the "February 23, 1998 Offering") of 1,303,965 shares of Common Stock. The shares from the February 23, 1998 Offering were issued to the trustee of a registered unit investment trust at an offering price of $28.375 per share. Gross proceeds from this offering were approximately $37.0 million. The aggregate proceeds to the Company, net of underwriters' discount and offering costs aggregating approximately $1.9 million were approximately $35.1 million.
The Company used the proceeds from the offerings in February 1998 to repay the aggregate outstanding balance of $283.0 million on its unsecured lines of credit and on the acquisition of the LBA Portfolio as described above. The remaining proceeds were used for working capital.
On March 1, 1998 the Operating Partnership issued 203,420 OP Units valued at $5.8 million in connection with the acquisition of the LBA Portfolio as described above.
On March 17, 1998, the Company declared a first quarter dividend of $.42 per share to shareholders of record on March 31, 1998.
ARDEN REALTY, INC. SCHEDULE III
COMMERCIAL PROPERTIES AND ACCUMULATED DEPRECIATION
DECEMBER 31, 1997 (IN THOUSANDS, EXCEPT SQUARE FOOT DATA)
ARDEN REALTY, INC.
SCHEDULE III - COMMERCIAL PROPERTIES AND ACCUMULATED DEPRECIATION (CONTINUED)
The changes in real estate for each of the periods in the three years ended December 31, 1997 are as follows.
The changes in accumulated depreciation, exclusive of amounts relating to equipment, autos, and furniture and fixtures for each of the periods in the three years ended December 31, 1997 are as follows:
(1) The non-combined entities were consolidated as a result of the Company purchasing the controlling interests as part of the Formation Transactions