ITEM 1 -- BUSINESS
The Company
Prime Retail, Inc. (the "Company") was organized as a Maryland corporation on July 16, 1993. The Company commenced operations upon completion of its initial public offering (the "Initial Public Offering") on March 22, 1994. The Company is a self-administered and self-managed real estate investment trust ("REIT"). Concurrent with the completion of the Initial Public Offering, the Company became the general partner of Prime Retail, L.P. (the "Operating Partnership") which owns interests in and provides development, leasing, marketing and management services for 28 upscale factory outlet centers and three community shopping centers (the "Properties") with a total of 7,217,000 and 424,000 square feet of gross leasable area ("GLA") at December 31, 1997, respectively. The Properties are located throughout the United States, generally near large metropolitan areas.
On November 1, 1994, the Company organized Prime Retail Services Limited Partnership and Prime Retail Services, Inc. (collectively referred to as the "Services Corporation"). The Services Corporation was formed primarily to operate business lines of the Company that are not directly associated with the collection of rents.
As used herein, unless the context otherwise requires, the term "Company" shall mean the Company and those entities owned or controlled by the Company.
On November 12, 1997 and as amended on February 1, 1998, the Company entered into a definitive merger agreement ("Merger Agreement") with Horizon Group, Inc. ("Horizon") for an aggregate consideration of approximately $945,200, including the assumption of $556,900 of Horizon debt and transaction costs. Upon completion of the transaction, the Company will own and operate 48 outlet centers totaling approximately 13,406,261 square feet of GLA. See Note 15 - - "Merger Agreement" of the Notes to the Consolidated Financial Statements for additional information.
The Company's executive offices are located at 100 East Pratt Street, Baltimore, Maryland 21202 (telephone 410-234-0782).
Tax Status
The Company has elected to be taxed as a REIT under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended (the "Code"). As a REIT, the Company generally will not be subject to federal income tax at the corporate level on income it distributes to its stockholders so long as it distributes at least 95% of its taxable income (excluding any net capital gain) each year. Since the Initial Public Offering the Company believes that it has complied with the tax regulations to maintain its REIT status. If the Company fails to qualify as a REIT in any taxable year, the Company will be subject to federal income tax (including any applicable alternative minimum tax) on its taxable income at regular corporate rates. Even if the Company qualifies as a REIT, the Company may be subject to certain state and local taxes on its income and property.
Business of the Company
The Company is engaged primarily in the ownership, development, construction, acquisition, leasing, marketing and management of factory outlet centers throughout the United States. Factory outlet centers have become an established segment of the retail industry, enabling value-oriented shoppers to purchase designer and brand-name products directly from manufacturers at discounts generally ranging from 25% to 50% below regular department and specialty store prices.
Since entering the factory outlet center business in 1988 (through the retail division of The Prime Group, Inc. ("PGI"), from whom the Company acquired certain Properties and management and development operations), the Company has become one of the leading developers and operators in the industry having successfully developed or acquired outlet centers containing approximately 7.2 million square feet of GLA at December 31, 1997, including approximately 1,221,000 square feet of GLA that was acquired and approximately 224,000 square feet of GLA that was developed and completed during 1997.
The Company pursues acquisition and development strategies designed to take advantage of growth opportunities in the factory outlet segment of the retail industry and to distinguish itself among its competitors. The Company strives to differentiate itself from competitors in the outlet center industry by owning and operating larger outlet centers with highly accessible locations, a larger and more diverse merchandising mix, extensive food and recreational amenities and quality architecture and landscaping, all designed to create an upscale environment in which to showcase merchandise and encourage shopping.
The average outlet center in the Company's portfolio contains 257,750 square feet of GLA at December 31, 1997, compared to an industry average of approximately 177,656 square feet as reported in January 1998 by Value Retail News ("VRN") an industry trade magazine whose Advisory Board and executive committee includes William H. Carpenter, Jr., President and Chief Operating Officer of theCompany. Management believes that the considerable size of its outlet centers, coupled with the Company's established base of national and international manufacturers of designer and brand-name merchandise, significantly enhances the competitive position of the Company's factory outlet centers.
The Company's factory outlet centers feature a diversified mix of nationally recognized manufacturers of designer and brand-name merchandise with which the Company and its employees have established long-standing relationships, including AnnTaylor/AnnTaylor Loft, Bose, Brooks Brothers, Corning-Revere, Danskin, Donna Karan, Eddie Bauer, Ellen Tracy, Esprit, First Choice/Escada, Guess?, J. Crew, Jones New York, Levi's/Dockers Outlet, Mikasa, Nautica, Nike, Phillips-Van Heusen (including Bass, Gant, Geoffrey Beene, Izod and Van Heusen), Polo/Ralph Lauren, Reading China & Glass, Reebok, Off-5th Saks Fifth Avenue, Sara Lee (including Champion, Coach, L'eggs, Hanes, Bali, Playtex, and Socks Galore), Sony, Springmaid-Wamsutta, Tommy Hilfiger and VF Corporation (including Lee, Wrangler, Barbizon and Vanity Fair). As a group, the foregoing merchants accounted for approximately 50.2% of the gross revenues of the Company during the year ended December 31, 1997, and occupied approximately 48.9% of the total leased GLA contained in the Company's outlet centers at December 31, 1997. During the year ended December 31, 1997, no group of merchants under common control accounted for more than 5.74% of the gross revenues of the Company or occupied more than 5.36% of the total leased GLA of the Company at December 31, 1997.
Management has developed close working relationships with its merchants to understand and better anticipate the merchants' immediate and long-term merchandising strategies and retail space requirements. The Company established The Manufacturers Forum(R), an organization of over 100 manufacturers that conducts between three and six industry meetings per year--two of which meetings are held at semi-annual conventions. The meetings are organized and hosted by executives of the Company and are attended by senior executives from member manufacturers. Industry experts are invited to attend as guest speakers to discuss ideas, trends, data and other issues pertinent to the ongoing growth of the factory outlet center business. The Manufacturers Forum(R) was developed as an educational tool for both the Company and the member merchants, including new manufacturers that are investigating opening factory outlet stores, and allows both the Company and member merchants to stay up-to-date with changes in the industry. Topics discussed at The Manufacturers Forum(R) lead to stronger relationships with key merchants and a shared vision with the manufacturers as to future growth of the industry.
Strategies For Growth
The Company intends, on a long-term basis, to increase its per share funds from operations ("FFO") and the value of its portfolio of factory outlet centers through the active management and expansion of existing factory outlet centers and the selective acquisition and development of factory outlet centers. FFO does not represent cash flow from operating activities in accordance with generally accepted accounting principles ("GAAP"), is not indicative of cash available to fund all of the Company's cash needs and should not be considered as an alternative to net income or any other GAAP measure as an indicator of the Company's performance or as an alternative to cash flow as a measure of liquidity or the ability to service debt or pay dividends. See "Funds from Operations" of Management's Discussion and Analysis of Financial Condition and Results of Operations.
The Company intends to continue to increase its FFO per share over time by (i) selectively acquiring, expanding, and developing factory outlet centers that offer strong prospects for cash flow growth and capital appreciation, subject to the availability of debt financing on favorable terms and additional equity capital and (ii) managing, leasing and marketing its portfolio of retail properties to increase consumer traffic, sales per square foot, tenant occupancy levels, and the effective base and percentage rents. While no assurances can be given that the Company will successfully implement the foregoing objectives, the Company intends to employ the following strategies:
Acquisition of Existing Outlet Centers. The Company explores opportunities to acquire factory outlet centers or interests therein that are compatible with the Company's existing portfolio and offer attractive yields, potential cash flow growth and capital appreciation. The Company draws upon its development, leasing, operating and marketing expertise to improve such centers through expansion and/or remerchandising or reletting. Properties may be acquired separately or as part of a portfolio, and may be acquired for cash and/or in exchange for equity securities of the Company. During 1997, the Company acquired seven centers totaling 1,221,000 square feet of GLA for an aggregate purchase price of $164,300.
Planned Development of New Factory Outlet Centers. The Company develops new factory outlet centers on sites with favorable demographics, access to interstate highways, good visibility and favorable market conditions that generally can accommodate a minimum of 300,000 square feet of GLA over multiple phases. In March 1997, the Company commenced construction on the Outlet Village of Lebanon located east of Nashville, Tennessee. The Outlet Village of Lebanon, which will contain approximately 208,000 square feet of GLA, has a total expected development cost of approximately $28,900 and is expected to open in the second quarter of 1998. In October 1997, the Company commenced construction on the Outlet Village of Hagerstown located west of Baltimore, Maryland and northwest of Washington, D.C. The Outlet Village of Hagerstown, which will contain approximately 216,000 square feet of GLA, has a total expected development cost of approximately $29,300 and is expected to open in the third quarter of 1998. Management believes that there is sufficient demand for continued development of new factory outlet centers and the expansion of existing outlet centers.
Strategic Expansions of Existing Centers. The Company selectively expands its existing factory outlet centers in phased developments that respond to merchant and consumer demand, thereby maximizing returns from these outlet centers through higher effective rents from new merchants based on the proven success and customer drawing power of existing phases. The Company expects to open approximately 327,000 square feet of GLA during 1998 in connection with planned expansions of existing centers. As of February 28, 1998, the Company owned, or held under long-term lease, land contiguous to its outlet centers to construct additional phases totaling approximately 1,500,000 square feet of GLA. The Company also holds options to purchase property adjoining its existing factory outlet centers upon which additional expansions could be constructed.
Active Property Management. The Company monitors and seeks to enhance the operating performance of its centers through intensive merchant and property management, and by providing experienced and professional on-site management. Property managers and marketing directors work with leasing representatives of the Company to systematically review merchant performance, merchandising mix and layout in order to improve sales per square foot. Through its intensive management efforts, the Company attempts to reduce the average occupancy cost on its outlet portfolio while at the same time continuing to provide a high level of merchant and customer service, maintenance and security.
Innovative Marketing and Promotion. The Company continuously seeks to increase the sales performance of each factory outlet center and markets its factory outlet centers with promotional materials and advertising strategies that target and attract customers. Substantially all factory outlet centers have an experienced marketing director who creates and administers retail marketing strategies that are designed to highlight each factory outlet center's unique merchandising strengths, customized to the local customer base and demographics. The Company advertises its centers using a wide variety of media that can include television, radio and print advertising, promotions, billboards, special events, and an extensive public relations program. These activities are supported by quantitative and qualitative market research based on such information gathering techniques as focus groups and detailed customer surveys. To better understand the needs and expectations of its customers, the Company routinely conducts exit surveys, the results of which are closely reviewed by senior management and, when appropriate, merchants in the center. All of these activities are monitored and reviewed at least quarterly by senior marketing management of the Company.
Competition
The Company's outlet centers compete for customers primarily with traditional shopping malls, "off-price" retailers and other outlet centers. The Company carefully considers the degree of existing and planned competition in a proposed trade area before developing a new outlet center. Merchants of outlet centers carefully avoid direct competition with major retailers and their own full-price stores. Generally, this is accomplished by locating outlet centers at least 20 miles from the nearest regional mall. For this reason, the Company's outlet centers compete only to a limited extent with traditional retail malls in or near metropolitan areas.
The Company's outlet centers compete to a limited extent with various full-price and off-price retailers in the highly fragmented retailing industry. However, management believes that the majority of the Company's customers visit outlet centers specifically for designer and brand-name goods at discounted prices. Traditional full-price and off-price retailers are often unable to provide such a variety of products at attractive prices.
Because several of the Company's outlet centers are located in relatively undeveloped areas, there are often other potential sites near the Company's outlet centers that may be developed into outlet centers by competitors. Seven projects in the Company's portfolio, Factory Outlets at Post Falls (Post Falls, Idaho), Gulf Coast Factory Shops (Ellenton, Florida), Magnolia Bluff Factory Shops (Darien, Georgia), Ohio Factory Shops (Jeffersonville, Ohio), Oxnard Factory Outlet (Oxnard, California), Prime Retail Outlets of Kittery (Kittery, Maine), and San Marcos Factory Shops (San Marcos, Texas), are located within twelve miles of competing factory outlet centers and, therefore, are subject to direct outlet competition. The existence or development of an outlet center with a more convenient location or lower rents may attract the Company's merchants or cause them to seek more favorable lease terms at or prior to renewal of their leases and, accordingly, may affect adversely the business, revenues and/or sales volume of the Company's outlet centers.
The Company's community shopping centers compete with similar community shopping centers located in the same geographic trade areas.
Relationship with Municipalities
Because of the favorable impact that the Company's properties may have on a local community's economy by generating sales and property taxes and increasing employment in the area, local communities often assist the Company with respect to zoning, economic incentives or favorable business development legislation. The Company explores opportunities to obtain incentives from local, county and state governments in connection with the development of its factory outlet centers. Such incentives often fund the cost of off-site sewer and water services to the site, required highway improvements and, on occasion, the cost of land and various on-site improvements.
Environmental Matters
Under various federal, state and local laws and regulations, an owner of real estate is liable for the costs of removal or remediation of certain hazardous substances on their property. Such laws often impose liability without regard to whether the owner knew of, or was responsible for, the presence of the hazardous substances. The costs of remediation or removal may be substantial, and the presence of the hazardous substances, or the failure to promptly remediate them, may adversely affect the owner's ability to sell the real estate or to borrow using the real estate as collateral. In connection with its ownership and operation of the Properties, the Company may be potentially liable for the costs of removal or remediation of hazardous substances.
The Company has no knowledge, nor has the Company been notified by any governmental authority, of any material noncompliance, liability or claim relating to hazardous substances in connection with any properties in which any of such entities now has or heretofore had an interest. However, no assurances can be given that (i) future laws, ordinances or regulations will not impose any material environmental liability or (ii) the current environmental condition of the Properties will not be affected by merchants and occupants of the Properties, by the condition of properties in the vicinity of the Properties (such as the presence of underground storage tanks) or by third parties unrelated to the Company.
Insurance
Management believes that each of the Properties is covered by adequate fire, flood, and property insurance provided by reputable companies and with commercially reasonable deductibles and limits.
Employees
As of December 31, 1997, the Company had 560 employees. The Company believes that its relations with its employees are satisfactory.
Executive Officers
The following table sets forth the names, positions and, as of December 31, 1997, ages of the executive officers of the Company:
Biographies of Executive Officers
Michael W. Reschke. Michael W. Reschke has been the Chairman of the Board of Directors of the Company since the Company's inception. Mr. Reschke founded PGI in 1981 and, since that time, has acted as PGI's Chairman, Chief Executive Officer, and President. For the last 16 years, Mr. Reschke has directed and managed the development, finance, construction, leasing, marketing, acquisition, renovation, and property management activities of PGI. Mr. Reschke also is Chairman of the Board of Directors of Prime Group Realty Trust (NYSE: PGE), a real estate investment trust engaged in the ownership, operation, acquisition and development of office and industrial properties, primarily in the greater Chicago market, and is the successor in interest to the former office and industrial divisions of PGI. Mr. Reschke also is Chairman of the Board of Directors of Brookdale Living Communities, Inc. (NASD: BLCI), a corporation engaged in the ownership, operation, acquisition, and development of senior housing and assisted living facilities and is the successor in interest to the former senior housing division of PGI. Mr. Reschke also is a member of the Board of Directors of Ambassador Apartments, Inc. (NYSE: AAH), a real estate investment trust engaged in the ownership, operation, acquisition and renovation of multi-family residential projects and the successor in interest to the former multi-family division of PGI. Mr. Reschke received a Juris Doctorate degree (summa cum laude) from the University of Illinois after having received a B.A. degree (summa cum laude) in Accounting from Northern Illinois University. Mr. Reschke is licensed to practice law in the State of Illinois and is a certified public accountant. Mr. Reschke is a member of the Chairman's Roundtable and the Executive Committee of the National Realty Committee, as well as a full member of the Urban Land Institute. Mr. Reschke is the brother of Glenn D. Reschke, an executive officer of the Company.
Abraham Rosenthal. Abraham Rosenthal has been the Chief Executive Officer and a Director of Prime Retail since the Company's inception. Prime Retail was formed to succeed the retail division of PGI, which has been a developer of retail and factory outlet centers since 1988. Mr. Rosenthal joined PGI in 1988, serving as Vice President, Senior Vice President and, immediately prior to joining the Company, as Executive Vice President. Mr. Rosenthal's responsibilities with the Company include strategic planning, investor relations, capital markets, financing, site selection, site planning and building design, and new business development for the
Company. Mr. Rosenthal has been involved in retail design and development for the past 20 years. Prior to joining PGI, Mr. Rosenthal was Vice President, Design and Construction of Cordish/Embry and Associates. Mr. Rosenthal received a Bachelor of Architecture degree from the University of Maryland School of Architecture, is a registered architect in the State of Maryland and is certified by the National Council of Architectural Registration Board. Mr. Rosenthal is a full member of the Urban Land Institute, the International Council of Shopping Centers ("ICSC"), the National Realty Committee and National Association of Real Estate Investment Trusts ("NAREIT"). Mr. Rosenthal is on the executive committee of the Baltimore Museum of Art and chairs the organization's Development, Marketing and Finance Committee. Mr. Rosenthal is also a member of the Maryland/Israel Development Center and is on the board and a member of the executive committee for Baltimore's Downtown Partnership. Mr. Rosenthal was therecipient of the 1995 Entrepreneur of the Year Award for Maryland Real Estate.
William H. Carpenter, Jr. William H. Carpenter, Jr. has been President, Chief Operating Officer and a Director of the Company since the Company's inception. Immediately prior to the Initial Public Offering, Mr. Carpenter was associated with PGI. Mr. Carpenter joined PGI in 1989, serving as Senior Vice President and, immediately prior to joining the Company, as Executive Vice President. Mr. Carpenter's responsibilities with the Company include leasing, marketing, operations and management, development, and construction for the Company's retail projects. Prior to joining PGI, Mr. Carpenter was President of D.I. Realty, Inc. (a division of Design International) from 1988 to 1989 and in such capacity managed all aspects of retail leasing and development for D.I. Realty, Inc., including property management, construction, and merchant coordination. Mr. Carpenter previously was senior regional leasing director with The Rouse Company and a partner with Cordish/Embry and Associates in Baltimore, Maryland. In these positions, Mr. Carpenter directed the development and leasing of a number of major urban projects in cooperation with city governments. Over the last 23 years, Mr. Carpenter has been involved in over 57 major urban, suburban and specialty projects throughout the United States. Mr. Carpenter attended the University of Baltimore, is a member of the ICSC, a member of Developers of Outlet Centers, a full member of the Urban Land Institute, sits on the Board and the Executive Committee of the BSO and also sits on the ICSC/VRN Executive Committee.
Glenn D. Reschke. Glenn D. Reschke is Executive Vice President of Development and Acquisitions and a Director of the Company, where he is responsible for site selection, design and construction for the Company's new retail projects as well as the acquisition of existing outlet centers nationwide. Mr. Reschke joined PGI in 1983 and, since that time, served as Vice President, Senior Vice President and Executive Vice President of PGI, and was responsible for PGI's multi-family, senior housing, single family and land development divisions. Prior to that, Mr. Reschke was the Director of the EPA's Automotive Emission Testing Laboratory in Ann Arbor, Michigan where he managed the nation's automotive emission certification and fuel economy testing programs for the Federal Government. Mr. Reschke received a Masters in Business Administration from Eastern Michigan University with a specialization in finance after receiving a Bachelor of Science degree with honors in Chemical Engineering from Rose Hulman Institute of Technology in Terre Haute, Indiana. Mr. Reschke is the brother of Michael W. Reschke, the Company's Chairman of the Board.
Robert P. Mulreaney. Robert P. Mulreaney is Executive Vice President, Chief Financial Officer and Treasurer of the Company. Mr. Mulreaney joined the Company in 1994. Mr. Mulreaney's responsibilities with the Company include capital market activities, corporate budgeting, financial reporting, investor relations, accounting, taxation, treasury, and management information systems. Prior to joining the Company, Mr. Mulreaney was associated for 14 years with Ernst & Young LLP, where he specialized in accounting and consulting issues related to real estate and financial institutions. Mr. Mulreaney received a Bachelor of Business Administration in Accounting in 1980 from Marshall University. Mr. Mulreaney is a member of the American Institute of Certified Public Accountants, the Maryland Association of Certified Public Accountants, and the West Virginia Society of Certified Public Accountants.
David G. Phillips. David G. Phillips is Executive Vice President, Operations and Marketing of the Company. Mr. Phillips joined PGI in 1989 and served as Vice President, Senior Vice President, and Executive Vice President, Leasing. Mr. Phillips' responsibilities with the Company include the management and supervision of the Company's operations, marketing and advertising efforts for all of the Company's outlet centers. Prior to joining PGI, Mr. Phillips was a leasing representative at D.I. Realty, Inc., leasing a variety of retail projects including outlet centers and traditional and specialty malls. Prior to joining D.I. Realty, Inc., Mr. Phillips owned and operated Bowdoin Street Contracting in Boston, Massachusetts. Mr. Phillips received a Masters of Science in Real Estate Development at Johns Hopkins University and received a Bachelor of Science degree in Business Administration from the University of Vermont. Mr. Phillips is a member of the ICSC with a CLS (Certified Leasing Specialist) designation and the Urban Land Institute.
C. Alan Schroeder. C. Alan Schroeder is Executive Vice President, General Counsel and Secretary of the Company. From 1990 to 1994, Mr. Schroeder was an Assistant General Counsel of PGI, responsible for legal matters relating to the retail division of PGI and involved in the division's development, financing, corporate, partnership, construction and management matters. Prior to joining PGI, Mr. Schroeder was associated for four years with Hopkins & Sutter,
a Chicago, Illinois based law firm, where he worked primarily on real estate and financing matters. Mr. Schroeder received a Juris Doctorate degree from The University of Chicago Law School. Mr. Schroeder received an A.B. degree in Economics and Sociology from Bowdoin College in Brunswick, Maine. Mr. Schroeder is licensed to practice law in Illinois.
R. Bruce Armiger. R. Bruce Armiger is Senior Vice President, Development and Construction Management Services for the Company. Mr. Armiger's responsibilities with the Company include supervision of project development and construction for all of the Company's outlet centers. Mr. Armiger joined PGI in 1992, and since that time, acted as Vice President of the Retail Division of PGI. Prior to joining PGI, Mr. Armiger was Vice President and Director of Construction and Engineering of The Rouse Company for a period of 15 years. At The Rouse Company, Mr. Armiger was responsible for all of the construction activities of the company consisting of over 5,000,000 square feet of GLA during his tenure. Mr. Armiger has a Bachelor of Arts degree and Masters of Business Administration from Loyola College, Baltimore, Maryland.
Steven Gothelf. Steven Gothelf is Senior Vice President, Finance of the Company. Mr. Gothelf joined PGI in 1990 and, since that time, served as Vice President of Asset and Development Management. Mr. Gothelf's responsibilities with the Company include financing, capital market activities, and the review and analysis of potential outlet center acquisitions. For two years prior to joining PGI, Mr. Gothelf was Vice President of Finance and Administration of Clarion Development Inc. Before joining Clarion Development Inc., Mr. Gothelf was a Market Maker for financial futures at the Chicago Board of Trade and prior to that was a Manager of Real Estate Tax and Consulting for KPMG Peat Marwick LLP. Mr. Gothelf received his B.S. degree in Accounting from the University of Illinois and is a certified public accountant.
Anya T. Harris. Anya T. Harris is Senior Vice President, Marketing and Communications of the Company. Ms. Harris began her tenure at the Company in September 1994 as Director of Public Relations, responsible for media relations and community outreach programs for the Company's various outlet centers nationwide. In her present position, Ms. Harris oversees all aspects of the Company's center marketing, public relations and corporate communications programs in order to increase the Company's marketing power and reach in terms of advertising, company identity and media relations. Prior to joining the Company, Ms. Harris served as Senior Account Executive for Trahan, Burden & Charles, Inc., an advertising and public relations firm in Baltimore. In this capacity, Ms. Harris managed advertising, public relations and marketing campaigns for numerous clients, including the Company. Formerly, she was Senior Account Executive for New York-based Edelman Public Relations, responsible for managing multi-million-dollar corporate communications and media relations for clients such as Motts U.S.A. and Weight Watchers International. Ms. Harris received her Bachelor of Arts in Political Science and Sociology from Goucher College.
John S. Mastin. John S. Mastin is Senior Vice President, Leasing of the Company. Mr. Mastin's responsibilities with the Company include supervision of leasing and merchandising for all of the Company's outlet centers. Mr. Mastin joined the Company in June of 1996. Prior to joining the Company, Mr. Mastin spent 24 years with The Rouse Company. At The Rouse Company, Mr. Mastin began his career as a Junior Leasing Representative and was promoted to Vice President and Assistant Director of Leasing. Mr. Mastin led the leasing effort for The Rouse Company with numerous regional malls as well as inner-city festival market places which include Bayside in Miami, Florida, and the redevelopment of Underground Atlanta in Atlanta, Georgia. Mr. Mastin was involved in the releasing and remerchandising effort for the operating properties division of The Rouse Company. Prior to The Rouse Company, Mr. Mastin was a Naval Aviator for four years. Mr. Mastin received his Bachelor of Arts in English from Niagara University. Mr. Mastin is a member of the ICSC.
Steven M. McGhee. Steven M. McGhee is Senior Vice President, Operations of the Company. Mr. McGhee has been affiliated with PGI since October, 1989, most recently as Vice President and Director of Operations. Prior to joining PGI, Mr. McGhee was General Manager for CBL and Associates for two years where he marketed and managed a portfolio of 1,500,000 square feet of retail properties. Prior to that Mr. McGhee spent 15 years with the Melville Corporation, a specialty retail chain were he was eventually responsible for the operations of approximately 140 stores nationwide. Mr. McGhee attended the University of Tennessee majoring in Business Administration. Mr. McGhee is a member of the ICSC, Value Retail News and Building Owners and Managers Association (BOMA), and Honorary Editorial Board Member for Specialty Retail Report. Mr. McGhee received designation as a CSM, (certified shopping center manager) from the ICSC in October 1995.
ITEM 2
ITEM 2 -- PROPERTIES
General
The Company's strategy is to build on its reputation and experience in the factory outlet center business and to capitalize on the current trend in value-oriented retailing through the selective acquisition and development of factory outlet centers and the strategic expansion of its existing factory outlet centers. As a fully-integrated real estate company, the Company provides development, construction, finance, leasing, accounting, marketing and management services for all of its properties. At December 31, 1997, the Company's portfolio consisted of (i) 28 factory outlet centers aggregating 7,217,000 square feet of GLA (including 595,000 square feet of GLA at factory outlet centers owned through joint venture partnerships), (ii) three community shopping centers aggregating 424,000 square feet of GLA and (iii) 159,000 square feet of GLA of office space.
The table set forth below summarizes certain information with respect to the Company's existing centers as of December 31, 1997 (see "Note 7 -- Bonds and Notes Payable" of the Notes to the Consolidated Financial Statements contained herein for information with respect to mortgage indebtedness on the Company's properties).
Notes: (1) Percentage reflects fully executed leases as of December 31, 1997 as a percent of square feet of GLA. (2) The Company acquired this factory outlet center on December 2, 1997 from an unrelated third party. (3) The Company acquired this factory outlet center on October 29, 1997 from an unrelated third party. (4) The Company owns a 2% partnership interest as the sole general partner in Phase I of this property but is entitled to 99% of the property's operating cash flow and net proceeds from a sale or refinancing. An unrelated third party holds a 35% limited partnership interest and the Company holds a 65% general partnership interest in the partnership that owns Phase II of this property. Phase I of this mixed-use development includes 154,000 square feet of office space and Phase II includes 5,000 square feet of office space. The total office space of 159,000 square feet is not included in this table and such space was 78% leased as of December 31, 1997. (5) The Company acquired this factory outlet center on February 13, 1997 from an unrelated third party. (6) Upon consummation of the Merger Agreement, the Company intends to sell this factory outlet center (see Note 15 - "Merger Agreement" of the Notes to Consolidated Financial Statements). (7) On February 7, 1997, the Company purchased an additional 20% interest from a joint venture partner, increasing the Company's ownership interest in this property to 50%. (8) The Company operates this property pursuant to a long-term ground lease under which the Company receives the economic benefit of a 100% ownership interest. (9) The Company owns 50% of this factory outlet center in a joint venture partnership with an unrelated third party. (10) The real property on which this outlet center is located is subject to a long-term ground lease. The Company receives the economic benefit of a 100% ownership interest. (11) On September 2, 1997, the Company purchased its joint venture partner's 25% partnership interest in Buckeye Factory Shops Limited Partnership and now owns 100% of this factory outlet center. (12) The Company also owns three community centers not included in this table containing 424,000 square feet of GLA in the aggregate that were 96% leased as of December 31, 1997.
As of February 28, 1998, the Company owned, or held under long-term leases, land contiguous to its outlet centers to construct additional phases totaling approximately 1,500,000 square feet of GLA. The Company also holds options to purchase property adjoining its existing factory outlet centers upon which additional expansion could be constructed. Property held for sale by a REIT is subject to significant restrictions imposed by the Code. Consequently, it is the Company's intention to hold its undeveloped parcels for future development, expansion or lease, rather than for sale.
Lease Terms
In general, the leases relating to the Company's outlet centers have a term of five to seven years. Most leases provide for the payment of percentage rents for annual sales in excess of certain thresholds. In addition, the typical lease agreement provides for the recovery of all of a merchant's proportionate share of actual common area maintenance ("CAM"), refuse removal, insurance, and real estate taxes as well as a collection for advertising and promotion and an administrative fee. CAM includes such items as common area utilities, security, parking lot cleaning, maintenance and repair of common areas, capital replacement reserves, landscaping, seasonal decorations, public restroom maintenance and certain administrative expenses.
The following table sets forth, as of December 31, 1997, tenant lease expirations for the next 10 years at the Company's factory outlet centers (assuming that none of the tenants exercise any renewal option and including leases at factory outlet centers owned through joint venture partnerships):
Tenants
In management's view, the tenant mix is one of the most important factors in promoting an outlet center's success. Virtually all aspects of the Company's outlet centers, ranging from site selection to architectural design, are planned to attract and retain a diverse mix of nationally and internationally recognized manufacturers of upscale designer and brand-name products. Crucial to the development of a new outlet center is having lead tenants committed to the outlet center early in the process. In management's view, lead tenants are manufacturers that during the development of an outlet center attract other high-quality manufacturers to the outlet center and provide for a well-balanced and diversified mix of tenants that will attract consumers to the outlet center. During the year ended December 31, 1997, no group of tenants under common control accounted for more than 5.74% of the gross revenues of the Company or occupied more than 5.36% of the total GLA of the Company.
Lead tenants are placed in strategic locations designed to draw customers into the outlet center and to encourage them to shop at more than one store. The Company continually examines the placement of tenants within each center and, in collaboration with its tenants, adjusts the size and location of their space within the center to improve sales per square foot.
The Company strives to identify tenants with potential credit problems at an early stage by closely monitoring tenant's performance. The Company has worked successfully to limit its delinquencies and bad debt losses. During the year ended December 31, 1997, total bad debt expense was approximately $970 or .01% of total revenues. The Company has not lost any material revenue related to tenant bankruptcies or other lease defaults.
ITEM 3
ITEM 3 -- LEGAL PROCEEDINGS
The Company is involved in various legal matters incidental to its business. The outcome of litigation is not susceptible to easy or certain prediction. While an unfavorable outcome in a particular proceeding could have a significant effect on the Company's consolidated results of operations in a future reporting period, the Company believes ultimate resolution of these matters would not, either singly or in the aggregate, significantly affect the Company's results of operations, liquidity or financial position.
On December 10, 1997, a shareholder of Horizon filed a purported class action lawsuit in the Circuit Court for Muskegon County, Michigan against Horizon, the Company, and certain directors and former directors of Horizon claiming, among other things, that Horizon's directors breached their fiduciary duties to Horizon's shareholders in approving the merger of Horizon and the Company and that the consideration to be paid to Horizon's shareholders in connection with the merger is unfair and inadequate. The lawsuit requests that such merger be enjoined or, in the event that the purported transaction is consummated, that it be rescinded or unspecified damages be awarded to the class members. On January 16, 1998, the defendants answered the complaint, denying that the Horizon board of directors breached their fiduciary duties and denying that such consideration is unfair or inadequate. Although the Company is named as a defendant in the complaint, the substantive allegations focus on the actions of Horizon and its board of directors and not on any actions of the Company or its board of directors. Since this litigation is in the initial phases of discovery, its outcome is not susceptible to easy or certain prediction; however, the Company intends to defend itself vigorously.
ITEM 4
ITEM 4 -- SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the quarter ended December 31, 1997.
PART II
ITEM 5
ITEM 5 -- MARKET FOR REGISTRANTS' COMMON EQUITY AND RELATED STOCKHOLDERS MATTERS
The Company's Common Stock commenced trading on the New York Stock Exchange ("NYSE") on August 27, 1997 under the trading symbol "PRT". Prior thereto, the Common Stock was quoted in the Nasdaq National Market under the trading symbol "PRME".
The following table sets forth the quarterly high, low and end of period closing sales prices per share of the Company's Common Stock as reported on the NYSE and in the Nasdaq National Market, as the case may be, as well as the cash distributions paid during the periods indicated:
Note: (1) Includes a special cash distribution of $0.145 per common share relating to the Company's exchange offer completed in June 1996 (see Note 8 -- "Equity Offerings and Other Transactions" of the Notes to Consolidated Financial Statements).
Instruments governing the Company's indebtedness contain certain covenants regarding the payment of dividends (see Note 7 -- "Bonds and Notes Payable" of the Notes to Consolidated Financial Statements) if the Company's debt service coverage ratio, as defined, falls below a minimum threshold. Based on continuing favorable operations and available funds from operations, management intends to continue to pay regular quarterly distributions.
The approximate number of holders of record of the Common Stock was 381 including participants in security position listings as of March 13, 1998. The Company believes, however, they have in excess of 5,000 beneficial shareholders as of March 13, 1998.
Notes: (1) On December 31, 1997, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings per Share" (see Note 2 - "Summary of Significant Accounting Policies - - Earnings per Share" of the Notes to Consolidated Financial Statements). The adoption of SFAS No. 128 had no impact on the Company's earnings per share computations for all periods presented and, therefore, no restatement of prior period computations was required. (2) Management believes that in order to facilitate a clear understanding of the consolidated historical operating results of the Company, Funds from Operations ("FFO") should be considered in conjunction with net income (loss) as presented in the financial statements included in this Annual Report on Form 10-K. Management generally considers FFO to be an appropriate measure of the performance of an equity REIT because industry analysts have accepted it as a performance measure of equity REITs. FFO represents net income (loss) (computed in accordance with generally accepted accounting principles ("GAAP")), excluding gains or losses from debt restructuring and sales of property, plus depreciation and amortization and after adjustments for unconsolidated investment partnerships and joint ventures. In March 1995, the National Association of Real Estate Investment Trusts ("NAREIT") issued a clarification of its definition of FFO. Prime cautions that the calculation of FFO may vary from entity to entity and as such the presentation of FFO by the Company may not be comparable to other similarly titled measures of other reporting companies. FFO does not represent cash flow from operating activities in accordance with GAAP and is not indicative of cash available to fund all of the Company's cash needs. FFO should not be considered as an alternative to net income or any other GAAP measure as an indicator of performance and should not be considered as an alternative to cash flow as a measure of liquidity or the ability to service debt or to pay dividends. A reconciliation of income (loss) before allocation to minority interests and preferred shareholders to FFO is as follows:
Notes: (i) Includes a nonrecurring charge of $6,131 related to the prepayment of long-term debt recorded during 1996. (ii) Amounts include net preferential partner distributions from a joint venture partnership of $162 and $2,538 for the year ended December 31, 1995 and the period from March 22, 1994 to December 31, 1994, respectively.
(3) Includes a special cash distribution of $0.145 per common share relating to the Company's exchange offer completed in June 1996 (see Note 8 -- "Equity Offerings and Other Transactions" of the Notes to Consolidated Financial Statements). (4) Includes factory outlet centers operated under joint venture partnerships with unrelated third parties as follows:
ITEM 7 -- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Amounts in thousands, except share, unit, and per square foot information)
Introduction
The following discussion and analysis of the consolidated financial condition and results of operations of Prime Retail, Inc. (the "Company") should be read in conjunction with the Consolidated Financial Statements and Notes thereto appearing elsewhere in this Annual Report on Form 10-K. The Company's operations are conducted through Prime Retail, L.P. (the "Operating Partnership"). The Company controls the Operating Partnership as its sole general partner and is dependent upon the distributions or other payments from the Operating Partnership to meet its financial obligationS. Historical results and percentage relationships set forth herein are not necessarily indicative of future operations.
Cautionary Statements
The following discussion in "Management's Discussion and Analysis of Financial Condition and Results of Operations" contain certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 which reflect management's current views with respect to future events and financial performance. Such forward-looking statements are subject to certain risks and uncertainties; including, but not limited to, the effects of future events on the Company's financial performance; the risk that the Company may be unable to finance its planned acquisition and development activities; risks related to the retail industry in which the Company's outlet centers compete, including the potential adverse impact of external factors such as inflation, consumer confidence, unemployment rates and consumer tastes and preferences; risks associated with the Company's property acquisition activities, such as the lack of predictability with respect to financial returns; risks associated with the Company's property development activities, such as the potential for cost overruns, delays and lack of predictability with respect to the financial returns associated with these development activities; the risk of potential increase in market interest rates from current rates; and risks associated with real estate ownership, such as the potential adverse impact of changes in the local economic climate on the revenues and the value of the Company's properties.
Portfolio Growth
The Company has grown by developing and acquiring factory outlet centers and expanding its existing factory outlet centers. The Company's factory outlet portfolio consisted of 28 operating factory outlet centers totaling 7,217,000 square feet of gross leasable area ("GLA") at December 31, 1997, compared to 21 factory outlet centers totaling 5,780,000 square feet of GLA at December 31, 1996 and 17 factory outlet centers totaling 4,331,000 square feet of GLA at December 31, 1995.
During 1997, the Company purchased seven factory outlet centers totaling 1,221,000 square feet of GLA and opened expansions to existing factory outlet centers totaling 224,000 square feet of GLA. Additionally, the Company acquired its joint venture partner's 25% ownership interest in Buckeye Factory Shops Limited Partnership ("Buckeye") on September 2, 1997 and now owns 100% of this factory outlet center with 205,000 square feet of GLA. During 1996, the Company opened two new factory outlet centers and nine expansions, and acquired two factory outlet centers from an unrelated third party, adding 1,449,000 square feet of GLA in the aggregate. Additionally, the Company purchased its joint venture partner's first mortgage and 50% partnership interest in Grove City Factory Shops Partnership on November 1, 1996 and owns 100% of this factory outlet center with 533,000 square feet of GLA. The significant increases in the number of the Company's operating properties and total GLA during 1996 and 1997 are collectively referred to as the "Portfolio Expansion."
Note: (1) On December 31, 1997, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings per Share" (see Note 2 - "Summary of Significant Accounting Policies - - Earnings per Share" of the Notes to Consolidated Financial Statements). The adoption of SFAS No. 128 had no impact on the Company's earnings per share computations for all periods presented and, therefore, no restatement of prior period computations was required.
Notes: (1) Includes total GLA in which the Company receives substantially all of the economic benefit. (2) Includes factory outlet centers operated under unconsolidated joint venture partnerships with unrelated third parties. (3) Based on occupied GLA weighted by months of operation. (4) Includes certain nonrecurring charges of $6,131, or $1.51 per square foot, relating to the prepayment of long-term debt recorded during 1996. (5) Includes certain nonrecurring charges of $1,806, or $0.51 per square foot, relating to the prepayment of long-term debt recorded during 1996.
Comparison of the year ended December 31, 1997 to the year ended December 31,
For the year ended December 31, 1997, the Company reported net income of $5,905. During the third quarter of 1997, the Company recorded an extraordinary loss of $2,061 related to the pre-payment of certain long-term debt. For the year ended December 31, 1997, the net loss applicable to common shareholders was $6,821, or $0.36 per common share on a basic and diluted basis. For the year ended December 31, 1996, the Company reported net income of $8,061. These results included a nonrecurring charge and an extraordinary loss of $6,131 and $1,017 (net of minority interests of $3,263), respectively, related to the pre-payment of certain long-term debt. For the year ended December 31, 1996, the net loss applicable to common shareholders was $6,175, or $0.75 per common share on a basic and diluted basis.
Total revenues were $129,130 for the year ended December 31, 1997, compared to $89,040 for the year ended December 31, 1996, an increase of $40,090, or 45%. Base rents increased $23,336, or 42.7%, in 1997 compared to 1996. These increases are primarily due to the Portfolio Expansion, including the effect of the acquisition of seven factory outlet centers from unrelated third parties and the Company's purchase of its joint venture partner's 25% partnership interest in a factory outlet center on September 2, 1997. Straight-line rents (included in base rents) were $643 and $600 for the years ended December 31, 1997 and 1996, respectively. The average base rent per square foot for new factory outlet leases negotiated and executed by the Company was $15.52 and $15.36 for the years ended December 31, 1997 and 1996, respectively.
Percentage rents, which represent rents based on a percentage of sales volume above a specified threshold, increased $1,290, or 64.9%, during the year ended December 31, 1997 compared to the same period in 1996. This increase was attributable to higher reported merchant sales in 1997 and the Portfolio Expansion.
As summarized in TABLE 3, merchant sales reported to the Company increased by $389.9 million, or 37.3%, to $1,434.2 million from $1,044.3 million for the years ended December 31, 1997 and 1996, respectively. The increase in total reported merchant sales is primarily due to the Portfolio Expansion, including the effect of the acquisition of certain properties in 1997. The weighted average reported merchant sales per square foot increased by 3.1% to $236.20 per square foot in 1997 from $229.08 per square foot in 1996. Total merchant occupancy cost per square foot increased slightly from $21.12 in 1996 to $21.36 in 1997 but decreased as a percentage of reported sales from 8.64% to 8.39%, respectively. The decrease in the cost of merchant occupancy to reported sales is primarily due to an increase in the weighted average reported merchant sales per square foot for the Company's entire factory outlet portfolio.
Notes: (1) Total reported merchant sales summarizes gross sales generated by merchants and includes changes in merchant mix and the effect of new space created from the acquisition and opening of new and expanded factory outlet centers. Several of the Company's factory outlet centers were constructed, expanded or acquired during the time periods contained in TABLE 3 and therefore, reported sales for such new openings, expansions and acquisitions were reported only for the partial period and were not annualized. TABLE 3 should be read in conjunction with the information summarized under the caption "Properties--Portfolio of Properties". (2) Weighted average reported sales per square foot is based on reported sales divided by the weighted average square footage occupied by the merchants reporting those sales. Same-space sales is defined as the weighted average reported merchant sales per square foot for space open since January 1, 1996. (3) Total merchant occupancy cost per square foot includes base rents, percentage rents and tenant reimbursements which includes tenant marketing contributions. (4) Computed as follows: total merchant occupancy cost per square foot divided by total weighted average reported merchant sales per square foot. (5) Computed as follows: total merchant occupancy cost per square foot (excluding marketing contributions paid by merchants) divided by total weighted average reported merchant sales per square foot.
Tenant reimbursements, which represent the contractual recovery from tenants of certain operating expenses, increased by $12,265, or 48.6%, in 1997 over 1996. These increases are primarily due to the Portfolio Expansion, including the effect of the acquisition of seven factory outlet centers from unrelated third parties and the Company's purchase of its joint venture partner's 25% partnership interest in a factory outlet center on September 2, 1997.
As shown in TABLE 4, tenant reimbursements as a percentage of recoverable property operating expenses and real estate taxes was 96.4% in 1997 compared to 98.2% in 1996. These levels reflect the Company's continued efforts to contain operating expenses at its properties while requiring merchants to pay their pro rata share of these expenses. TABLE 4 sets forth recoveries from merchants as a percentage of total recoverable expenses for 1997, 1996 and 1995:
Note: (1) Total recoverable expenses include property operating expenses and real estate taxes.
Income from investment partnerships decreased by $1,136, or 91.7%, to $103 for the year ended December 31, 1997 compared to $1,239 for the year ended December 31, 1996. This decrease reflects the Company's purchases of (i) its joint venture partner's first mortgage and 50% partnership interest in Grove City Factory Shops Partnership on November 1, 1996 and (ii) its joint venture partner's first mortgage and 25% partnership interest in Buckeye Factory Shops Partnership on September 2, 1997. As a result of these acquisitions, the Company owns 100% of both Grove City Factory Shops and Buckeye Factory Shops. Prior to the acquisition dates, the operating results of these factory outlet centers were accounted for by the Company under the equity method of accounting. Commencing with their respective acquisition dates, the operating results of these factory outlet centers were included in the consolidated results of the Company.
Interest and other income increased by $4,335, or 74.1%, to $10,185 during the year ended December 31, 1997 as compared to $5,850 for the year ended December 31, 1996. The increase reflects higher (i) interest income of $2,954, (ii) gains on sales of land of $988, (iii) municipal assistance income of $903, (iv) push cart income of $304, (v) temporary tenant income of $218, (vi) lease termination income of $213, and (vii) all other ancillary income of $63. Partially offsetting these increases were reduced property development and construction management fees and leasing commissions of $1,308. The increase in interest income was primarily due to interest earnings on the Company's expansion loan escrow account included in restricted cash.
Property operating expense increased by $9,071, or 44.4%, to $29,492 in 1997 compared to $20,421 in 1996. Real estate taxes expense increased by $4,129, or 78.1%, to $9,417 in 1997 from $5,288 in 1996. Depreciation and amortization expense increased by $7,459, or 38.7%, to $26,715 in 1997, compared to $19,256 in 1996. The increases in property operating, real estate taxes, and depreciation and amortization expense are primarily due to the Portfolio Expansion, including the acquisition of seven factory outlet centers from an unrelated third parties and the Company's purchase of its joint venture partner's partnership interest in two factory outlet centers.
Note: (1) In accordance with generally accepted accounting principles ("GAAP"), leasing commissions are classified as intangible assets. Therefore, the amortization of leasing commissions is reported as a component of depreciation and amortization expense.
As shown in TABLE 6, interest expense increased by $11,637, or 47.5%, to $36,122 in 1997 compared to $24,485 in 1996. This increase reflects higher interest incurred of $12,241, a reduction in interest earned on interest rate protection contracts of $86, an increase in amortization of deferred financing costs of $11, and an increase in amortization of interest rate protection contracts of $7. Partially offsetting these items was an increase in the amount of interest capitalized in connection with development projects of $708.
The increase in interest incurred is primarily attributable to an increase of $166,015 in the Company's average debt outstanding during 1997 compared to 1996. The increase in interest incurred also reflects a slightly higher weighted average interest rate for the year ended December 31, 1997 compared to the same period in 1996. The weighted average interest rates were 7.36% and 7.22% for 1997 and 1996, respectively.
Other charges decreased by $5,352 to $3,234 in 1997 compared to $8,586 for 1996. The 1996 amount reflects a nonrecurring loss of $6,131 related to the prepayment of certain long-term debt. Excluding this nonrecurring loss, other charges increased by $779, or 31.2%, in 1997. This increase reflects higher marketing costs of $272, an increase in the provision for uncollectible accounts receivable of $260, a higher provision for potentially unsuccessful pre-development efforts of $150, and an increase in other miscellaneous charges of $97.
Notes: (1) Includes the net assets acquired by the Company during 1997 consisting of (i) the purchase of seven factory outlet centers ($166,987) and (ii) the purchase of the Company's joint venture partner's partnership interest in Buckeye Factory Shops ($24,358). (2) Includes the net assets acquired by the Company during 1996 consisting of (i) the purchase of two factory outlet centers ($71,770) and (ii) the purchase of the Company's joint venture partner's partnership interest in Grove City Factory Shops ($57,094).
Notes: (1) On December 31, 1997, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings per Share" (see Note 2 - "Summary of Significant Accounting Policies - - Earnings per Share" of the Notes to Consolidated Financial Statements). The adoption of SFAS No. 128 had no impact on the Company's earnings per share computations for all periods presented and, therefore, no restatement of prior period computations was required. (2) Includes a special cash distribution of $0.145 per common share relating to the Company's exchange offer completed in June 1996 (see Note 8 -- "Equity Offerings and Other Transactions" of the Notes to Consolidated Financial Statements).
Comparison of the year ended December 31, 1996 to the year ended December 31,
For the year ended December 31, 1996, the Company reported net income of $8,061 on total revenues of $89,040. These results include a nonrecurring charge and an extraordinary loss of $6,131 and $1,017 (net of minority interests of $3,263), respectively, related to a binding loan commitment that the Company obtained on June 5, 1996 resulting in the pre-payment of certain long-term debt. For the year ended December 31, 1996, the net loss applicable to common shareholders was $6,175, or $0.75 per common share on a basic and diluted basis. For the year ended December 31, 1995, the Company reported net income of $18,170 on total revenues of $77,398. For the year ended December 31, 1995, the net loss applicable to common shareholders was $2,774, or $0.96 per common share on a basic and diluted basis.
Total revenues were $89,040 for the year ended December 31, 1996, as compared to $77,398 for the year ended December 31, 1995, an increase of $11,642, or 15.0%. Base rents increased $8,342, or 18.0%, in 1996 compared to 1995. These increases were primarily due to the Portfolio Expansion, including the effect of the acquisition of two factory outlet centers from an unrelated third party on November 1, 1996 and the Company's purchase of its joint venture partner's 50% partnership interest in a factory outlet center on November 1, 1996. Straight-line rents (included in base rents) were $600 and $931 for the years ended December 31, 1996 and 1995, respectively. The average base rent per square foot for new factory outlet leases negotiated and executed by the Company was $15.36 and $14.90 for the years ended December 31, 1996 and 1995, respectively.
As summarized in TABLE 3, merchant sales reported to the Company increased by $234.7 million, or 29.0%, to $1,044.3 million from $809.6 million for the years ended December 31, 1996 and 1995, respectively. The increase in total reported merchant sales was primarily due to the Portfolio Expansion, including the effect of the acquisition of certain properties in 1996. However, the weighted average reported merchant sales per square foot decreased by 2.9% to $229.08 per square foot from $235.99 per square foot for the years ended December 31, 1996 and 1995, respectively. The Company's factory outlet centers (including centers operated under partnerships with unrelated third parties) contained an average of 275,238 and 254,765 square feet of GLA at December 31, 1996 and 1995, respectively. The increase in the cost of merchant occupancy to reported sales was primarily due to a decrease in the weighted average reported merchant sales per square foot for the Company's entire factory outlet portfolio.
Tenant reimbursements, which represent the contractual recovery from tenants of certain operating expenses, increased by $2,971, or 13.3%, in 1996 over 1995. This increase was primarily due to the Portfolio Expansion, including the effect of the acquisition of two factory outlet centers from an unrelated third party and the Company's purchase of its joint venture partner's first mortgage and 50% partnership interest in a factory outlet center on November 1, 1996.
As shown in TABLE 4, tenant reimbursements as a percentage of recoverable operating expenses were 98.2% in 1996 compared to 99.6% in 1995. These levels reflect the Company's continued efforts to contain operating expenses at its properties while requiring merchants to pay their pro rata share of these expenses. TABLE 4 highlights the trend of recoveries from merchants as a percentage of total recoverable expenses.
Income from investment partnerships decreased by $490, or 28.3%, to $1,239 for the year ended December 31, 1996 compared to $1,729 for the year ended December 31, 1995. This decrease reflected the Company's purchase of its joint venture partner's first mortgage and 50% partnership interest in Grove City Factory Shops Partnership on November 1, 1996. As a result of its acquisition, the Company owns 100% of this factory outlet center and, therefore, commencing November 1, 1996, its operations were included in the consolidated results of the Company. Prior to November 1, 1996, the Company accounted for its interest under the equity method of accounting. The decrease in income from investment partnerships in 1996 compared to 1995 was offset, in part, by the openings of Arizona Factory Shops (Phase II-September 1996) and Buckeye Factory Shops (Phase I-November 1996).
Interest and other income increased by $352, or 6.4%, to $5,850 during the year ended December 31, 1996 as compared to the year ended December 31, 1995. The increase reflected higher temporary and customer service income, lease termination income, and property management fees of $736, $620, and $149, respectively, partially offset by lower leasing commissions, real estate brokerage commissions, ancillary income, interest income, municipal assistance income, and construction and development management fees of $364, $278, $139, $115, $104 and $47, respectively. Also offsetting this increase was a $106 gain on the sale of land during the year ended December 31, 1995.
Property operating expense increased by $3,032, or 17.4%, to $20,421 in 1996 compared to $17,389 in 1995. Real estate taxes expense increased by $311, or 6.2%, to $5,288 in 1996 from $4,977 in 1995. Depreciation and amortization expense increased by $3,818, or 24.7%, to $19,256 in 1996, compared to $15,438 in 1995. The increases in property operating expense and real estate taxes expense, and depreciation and amortization expense were primarily due to the Portfolio Expansion, including the acquisition of two factory outlet centers from an unrelated third party and the Company's purchase of its joint venture partner's 50% partnership interest in a factory outlet center on November 1, 1996.
As shown in TABLE 6, interest expense increased by $3,664, or 17.6%, to $24,485 in 1996 compared to $20,821 in 1995. This increase reflected higher interest incurred of $4,956, an increase in amortization of interest rate protection contracts of $107 and a reduction in interest earned on interest rate protection contracts of $520, partially offset by a decrease in amortization of deferred financing costs of $907 and an increase in the amount of interest capitalized in connection with development projects of $1,012.
The increase in interest incurred was primarily attributable to an increase of approximately $86,256 in the Company's average debt outstanding during 1996 compared to 1995. Additionally, the increase in interest incurred was offset by a decrease of 0.59% in the weighted average interest rate for the year ended December 31, 1996 compared to the same period in 1995. The weighted average interest rates were 7.22% and 7.81% for 1996 and 1995, respectively.
The decrease in amortization of deferred financing costs was primarily attributable to reduced amortization expense related to certain deferred financing costs which were written-off in 1996. These costs were part of the $10,411 nonrecurring loss recorded in the second quarter of 1996 related to a binding loan commitment that the Company obtained on June 5, 1996 in connection with the Company's refinancing approximately $253,000 of debt.
Other charges increased by $6,497 to $8,586 in 1996 compared to $2,089 for 1995. This increase was primarily due to the nonrecurring loss of $6,131 described above. Excluding this nonrecurring charge, other charges increased by $366, or 17.5%, to $2,455 in 1996 reflecting a higher provision for uncollectible accounts receivable of $364, an increase in ground lease expense of $228, offset by a lower provision for potentially unsuccessful pre-development efforts of $204 and a decline in miscellaneous other charges of $22.
Liquidity and Capital Resources
Sources and Uses of Cash
For the year ended December 31, 1997, net cash provided by operating activities was $49,856, net cash used in investing activities was $229,956, and net cash provided by financing activities was $182,549.
The primary uses of cash for investing activities during 1997 included (i) costs associated with the acquisition of seven factory outlet centers and the purchase of an unrelated joint venture partner's 25% equity interest in a factory outlet center, (ii) costs associated with development and construction of expansions to existing factory outlet centers aggregating 224,000 square feet of GLA which opened during 1997, (iii) costs associated with the completion of factory outlet centers and expansions to existing factory outlet centers aggregating 930,000 square feet of GLA which opened during 1996, and (iv) costs for pre-development activities associated with future developments.
The sources of cash from financing activities during 1997 included: (i) net proceeds from public and private equity offerings totaling $242,729 and (ii) proceeds from new borrowings of $160,057. Such proceeds were partially offset by (i) principal repayments on notes payable of $175,683, (ii) preferred and common stock distributions of $33,605, and (iii) distributions to minority interests (including distributions to limited partners of the Operating Partnership) of $10,366.
Sources and Uses of Cash -- Equity Offerings
On January 10, 1997, the Company filed a Form S-3 Registration Statement (the "January 1997 Shelf Registration") with the Securities and Exchange Commission (the "SEC") to register $100,000 of the Company's equity securities. On February 20, 1997, the Company completed a public offering by issuing 2,080,000 shares of its Common Stock at $12.50 per share and 175,800 shares of its Series B Cumulative Participating Convertible Preferred Stock (the "Series B Convertible Preferred Stock") at $22.75 per share. In addition, on March 10, 1997, the underwriter of the public offering exercised its overallotment option to purchase 310,300 shares of the Company's Common Stock at $12.50 per share. As a result of the public offering and the exercise of the overallotment option, the Company received net proceeds of $31,754 that were used to (i) repay certain outstanding indebtedness aggregating $26,500, (ii) fund development and construction activities, and (iii) fund general corporate expenditures.
On June 17, 1997, the Company filed a Form S-3 Registration Statement (the "June 1997 Shelf Registration") with the SEC to register $300,000 of the Company's equity securities, including $66,122 of the Company's equity securities that remained available under the January 1997 Shelf Registration.
On August 8, 1997, the Company entered into a purchase agreement with an institutional investor providing for the issuance of a new series of cumulative convertible non-voting preferred securities (the "Series C Preferred Securities") at $13.75 per unit, or an aggregate of $60,000 in cash (the "Private Placement"). The Series C Preferred Securities pay dividends equivalent to the amount being paid on the Company's Common Stock, with an annual minimum equal to $1.18 per security. In addition, the Company, subject to certain conditions, has agreed to waive the ownership limitations otherwise applicable to the Common Stock to permit the investor to own, at any one time, the shares of Common Stock issuable upon conversion of the Series C Preferred Securities. The Company has the right to call the Series C Preferred Securities, at par, after ten years. Subject to certain conditions, the Series C Preferred Securities may be issued in the form of shares of preferred stock in the Company or preferred units of partnership interest in Prime Retail, L.P. (the "Operating Partnership") that are exchangeable for shares of preferred stock or Common Stock on a one-to-one basis. The Series C Preferred Securities may be converted into shares of Common stock on a one-to-one basis commencing August 8, 1998 (or earlier subject to certain conditions). See Note 8 - "Equity Offerings and Other Transactions" of the Notes to the Consolidated Financial Statements for additional information.
In September 1997, the Company completed a public offering of 11,500,000 shares (including 1,500,000 shares related to exercise of underwriters' overallotment option) of its Common Stock at $14.00 per share (the "September 1997 Offering"). In addition, on September 8, 1997, the Company issued 727,273 Series C Preferred Securities at $13.75 per unit pursuant to the initial sale under the Private Placement. As a result of the September 1997 Offering and the initial sale under the Private Placement (collectively, the "September Capital Transactions"), the Company received net proceeds of $161,930 after commissions and underwriting discounts. A portion of the net proceeds from the September Capital Transactions were used (i) to repay certain outstanding corporate indebtedness aggregating $113,410 and (ii) to acquire the 25% ownership interest of the Company's joint venture partner in Buckeye for $23,148 (including $22,642 of mortgage indebtedness relating to such property). The remaining net proceeds from the September Capital Transactions of $26,192 were used (i) to fund development and construction activities, (ii) to fund property acquisitions, and (iii) for general corporate purposes.
As a result of the September Offering, as of December 31, 1997, the Company had $139,000 of availability under the June 1997 Shelf Registration. From time to time, the Company will consider issuing additional equity securities under the June 1997 Shelf Registration for the development or acquisition of additional properties, the expansion and improvement of existing properties, repayment of indebtedness, and for general corporate purposes.
On December 2, 1997 the Company issued 3,636,363 shares of its Series C Preferred Securities at $13.75 per share pursuant to the final sale under the Private Placement. As a result of this issuance, the Company received net proceeds of $49,045 that were used in the acquisition of Niagara International Factory Outlets and Shasta Factory Stores.
Sources and Uses of Cash -- Property Acquisitions
On February 13, 1997, the Company, acquired Oak Creek Factory Stores, Bend Factory Outlets and Factory Outlets at Post Falls from an unrelated third party for an aggregate purchase price of $37,250. The Company financed the purchase with loan proceeds from a financial institution and a $4,000 promissory note issued to the seller. The operating results of the Company for 1997 include the results of these acquisitions effective with the closing on February 13, 1997.
Oak Creek Factory Outlets is located in Sedona, Arizona, which is north of Phoenix and south of the Grand Canyon. Oak Creek Factory Outlets contains approximately 82,000 square feet of GLA and was 100% executed at December 31, 1997. Bend Factory Outlets is located in Bend, Oregon, which is east of Eugene, Oregon and southeast of Portland. Bend Factory Outlets contains approximately 97,000 square feet of GLA and was 86% executed at December 31, 1997. Factory Outlets at Post Falls is located in Post Falls, Idaho, which is 30 miles east of Spokane, Washington. Factory Outlets at Post Falls contains approximately 179,000 square feet of GLA and was 84% executed at December 31, 1997.
On September 2, 1997, the Company acquired the 25% ownership interest in Buckeye from its joint venture partner, SBRC, for $23,148 (including $22,642 of mortgage indebtedness relating to such property), thereby increasing its ownership percentage in such property to 100%. Prior to September 2, 1997, the Company accounted for its 75% investment in Buckeye using the equity method of accounting. Commencing September 2, 1997, the operating results of Buckeye are consolidated. The Company financed the acquisition with proceeds from the September Offering.
On October 29, 1997, the Company acquired Tidewater Outlet Mall, Manufacturer's Outlet Mall, Kittery Outlet Village (collectively "Prime Retail Outlets of Kittery"), and Latham Factory Outlet Center (the "Latham Property") from an unrelated third party for an aggregate purchase price of $26,000. The Company financed the purchase primarily with the proceeds from the September Offering.
Prime Retail Outlets of Kittery are located in Kittery, Maine and serve the Boston, Massachusetts and Portland, Maine markets. Prime Retail Outlets of Kittery contain approximately 121,000 square feet of GLA, and were 100% executed as of December 31, 1997. The Latham Property is located in Latham, New York, north of Albany, New York and south of Saratoga Springs, New York. The Latham Property contains approximately 43,000 square feet of GLA and was 100% executed as of December 31, 1997.
On December 2, 1997, the Company acquired Niagara International Factory Outlets ("Niagara") and Shasta Factory Stores ("Shasta") from an unrelated third party for an aggregate purchase price of $100,975, including the assumption of mortgage indebtedness of $31,368. The Company financed the purchase with proceeds from the September Offering and the Private Placement.
Niagara is located in Niagara Falls, New York and serves Buffalo, New York; Ontario, Canada; and tourist markets. Niagara contains approximately 534,000 square feet of GLA and was 88% executed as of December 31, 1997. Shasta is located six miles west of Redding, California and serves the Northern California tourist market. Shasta contains approximately 165,000 square feet of GLA and was 91% executed as of December 31, 1997.
During 1998, the Company will explore acquisitions of factory outlet centers in the United States and in Europe as well as consider possible strategic acquisitions of other assets in the retail sector. The Company has evaluated and is evaluating such opportunities and prospects and will continue to do so throughout 1998. The Company cannot predict if any transaction will be consummated, nor the terms or form of consideration required.
Merger Agreement
On November 12, 1997 and as amended on February 1, 1998, the Company entered into a definitive merger agreement (as amended, the "Merger Agreement") with Horizon Group, Inc. ("Horizon") for an aggregate consideration of approximately $945,200, including the assumption of $556,900 of Horizon debt and estimated transaction costs. Upon completion of the transaction, the Company will own and operate 48 outlet centers totaling approximately 13,406,261 square feet of GLA, including the purchase of Horizon's joint venture partner's 50% ownership interest in Finger Lakes Outlet Center for $46,100 (the "Finger Lakes Acquisition").
Under the terms of the Merger Agreement, the Company will pay a fixed exchange ratio of 0.20 of a share of Series B Convertible Preferred Stock and 0.597 of a share of Common Stock for each share of common stock of Horizon. In addition, each common unit in Horizon Partnership will entitle the holder to receive 0.9193 of a Common Unit of the Operating Partnership that will be exchangeable for a like number of shares of Common Stock of the Company.
Immediately prior to the merger, Horizon Group Properties, Inc. ("HGP"), a subsidiary of Horizon, will become the sole general partner of Horizon/Glen Outlet Center Limited Partnership ("Horizon Partnership") and the common stock of HGP will be distributed to the shareholders of both the Company and Horizon. All of the common equity of HGP will be distributed to the convertible preferred and common shareholders and unitholders of the Company and the shareholders and limited partners of Horizon based on their ownership in the Company immediately following the merger. It is presently expected that following the merger one share of common stock of HGP will be distributed for every 10 shares of Common Stock or Common Units of the Company, and that approximately 1.196 shares of common stock of HGP will be distributed for every 10 shares of Series B Convertible Preferred Stock held in the Company. Immediately prior to the closing of the merger, the Company will pay a special cash distribution of $0.60 per share of Series B Convertible Preferred Stock and $0.50 per share/unit of Common Stock, Series C Preferred Security and Common Unit, as applicable, totaling $21,865 (the "Special Cash Distribution"). Shareholders and limited partners in Horizon will not participate in this distribution. HGP will own and operate 15 outlet centers (including Indiana Factory Shops and Nebraska Crossing Factory Stores which will be acquired from the Company) totaling 3,084,823 square feet of GLA.
The merger will be accounted for as a purchase. It is conditioned upon, among other things, the approvals of each Company's shareholders and partners and the satisfaction of other customary conditions. The closing is expected during the second quarter of 1998. The exchange of shares of Horizon for shares of the Company will be made on a tax-free basis.
The Company expects to finance the Finger Lakes Acquisition, the Special Cash Distribution and estimated closing costs of $18,750 with proceeds from certain contemplated loan facilities expected to close concurrent with the closing of the merger. There can be no assurance that the Company will be successful in obtaining the required amount of debt financing or that the terms of such loan facilities will be as favorable as the Company has experienced in prior periods.
Planned Development
Management believes that there is sufficient demand for continued development of new factory outlet centers and expansions of certain existing factory outlet centers. The Company expects to open approximately 751,000 square feet of GLA during 1998 including two new factory outlet centers currently under construction. At December 31, 1997, the budgeted remaining capital expenditures for 1998 planned developments aggregated approximately $78,200, while anticipated capital expenditures related to the completion of expansions of existing factory outlet centers opened during 1997 (aggregating 224,000 square feet of GLA) approximated $5,200.
Management believes that the Company has sufficient capital and capital commitments to fund the remaining capital expenditures associated with its 1997 and 1998 development activities. These funding requirements are expected to be met, in large
part, with the proceeds from various loan facilities, including the financing of certain unencumbered properties. If adequate financing for such development and expansion is not available, the Company may not be able to develop new centers or expand existing centers at currently planned levels.
The Company currently plans to open one new factory outlet center and several expansions in 1999 that are expected to contain approximately 400,000 square feet of GLA, in the aggregate, and have a total expected development cost of approximately $56,000. The Company expects to fund the development cost of these projects from (i) certain line of credit facilities, (ii) joint venture partners, (iii) retained cash flow from operations, (iv) construction loans, and (v) the potential sale of common or preferred equity in the public or private capital markets. As of December 31, 1997, there were no material commitments with regard to the construction of the new factory outlet centers and expansions scheduled to open in 1999. There can be no assurance that the Company will be successful in obtaining the required amount of equity capital or debt financing for the 1999 planned openings or that the terms of such capital raising activities will be as favorable as the Company has experienced in prior periods.
Debt Transactions
On February 13, 1997, the Company closed on $30,000 of loan facilities with Nomura Asset Capital Corporation. The transaction provided (i) a $27,000 nonrecourse first mortgage loan (the "First Mortgage Loan") and (ii) a junior secured loan (the "Junior Secured Loan") of $3,000. The First Mortgage Loan (i) is cross collateralized by first mortgages on three of the Company's factory outlet centers, (ii) bears a fixed rate of interest of 8.35%, and (iii) requires monthly principal and interest payments pursuant to a 360-month amortization schedule. The Junior Secured Loan is a recourse loan to the Company that (i) is secured by a pledge of excess cash flow after debt service on the First Mortgage Loan, (ii) bears a variable interest rate at the London Interbank offered rate for 30-day deposits in U.S. dollars ("30-day LIBOR") plus 1.95%, (iii) matures in three years, (iv) requires monthly interest only payments through April 10, 1998 and (v) monthly principal and interest payments thereafter.
On July 11, 1997, the Company's $15,000 unsecured line of credit (the "Corporate Line") was renewed. The purpose of the Corporate Line is to provide working capital to facilitate the funding of short-term operating cash needs of the Company. The Corporate Line bears an interest rate of 30-day LIBOR plus 2.50% and matures on July 11, 1998. No amounts were outstanding under the Corporate Line at December 31, 1997.
In September 1997, the Company repaid certain outstanding corporate indebtedness aggregating $113,410, including the Junior Secured Loan, with proceeds from certain public and private equity offerings (see Note 8 - "Equity Offerings and Other Transactions" of the Notes to the Consolidated Financial Statements). As a result of the prepayment of such indebtedness, the Company incurred an extraordinary loss of $1,423 related to the write-off of certain unamortized financing costs. The Company also incurred an extraordinary loss of $638 related to the write-off of certain unamortized financing costs in connection with the Buckeye Acquisition (see Note 5 - "Investment in Partnerships" of the Notes to the Consolidated Financial Statements).
On November 13, 1997, the Company closed on a term loan with Nomura Securities (Bermuda) Ltd. ("Nomura Securities") of $53,290 (the "Term Loan"). The Term Loan is a recourse loan to the Company that (i) is secured by a pledge of excess cash flow after debt service on a first mortgage loan collateralized by 16 of the Company's factory outlet centers, (ii) bears a variable interest rate of 30-day LIBOR plus 1.95%, (iii) matures on November 11, 1999, (iv) requires monthly interest-only payments through February 10, 1998 and monthly interest payments and quarterly principal payments thereafter that approximate a six-year amortization schedule, and (v) may be subject to earlier principal payments via "mark-to-market" of the underlying debt instrument.
In addition, on November 13, 1997, the Company closed on a term loan with Nomura Securities of $3,000 (the "Second Term Loan"). The Second Term Loan is a recourse loan to the Company that (i) is secured by a pledge of excess cash flow after debt service on a first mortgage loan collaterlized by three of the Company's factory outlet centers, (ii) bears a variable interest rate of 30-day LIBOR plus 1.95%, (iii) matures on February 13, 2000, (iv) requires monthly interest-only payments through April 10, 1998 and monthly principal and interest payments thereafter that approximate a five-year amortization schedule, and (v) may be subject to earlier principal payments via "mark-to-market" of the underlying debt instrument.
On December 2, 1997, the Company assumed a $31,328 mortgage loan in connection with the purchase of Niagara International Factory Outlets (the "Niagara Loan"). The Niagara Loan (i) bears a fixed rate of interest of 6.83%, (ii) requires monthly principal and interest payments that approximates a 25-year amortization schedule, and (iii) is collateralized by Niagara International Factory Outlets.
On December 31, 1997, the Company obtained from a financial institution a commitment for a construction mortgage loan in an amount not to exceed $20,396 (the "Construction Mortgage Loan"). The Construction Mortgage Loan (i) bears a variable interest
rate at the financial institution's prime rate or, at the Company's option, a LIBOR index plus 1.75%, (ii) matures on December 31, 1999, and (iii) requires monthly interest-only payments. The Construction Mortgage Loan is collateralized by a first mortgage on Lebanon Factory Shops, a factory outlet center located in Lebanon, Tennessee. At December 31, 1997, no amounts were outstanding on the Construction Mortgage Loan.
Debt Repayments and Preferred Stock Dividends
The Company's aggregate indebtedness was $515,265 and $499,523 at December 31, 1997 and 1996, respectively. At December 31, 1997, such indebtedness had a weighted average maturity of 6. 5 years and bore interest at a weighted average interest rate of 7.36% per annum. At December 31, 1997, $74,729 , or 14.5%, of such indebtedness bore interest at fixed rates and $440,536, or 85.5%, of such indebtedness, including $28,250 of tax-exempt bonds, bore interest at variable rates. Of the variable rate indebtedness outstanding at December 31, 1997, $355,996 is scheduled to convert to a fixed rate of 7.782% in November 1998 for the remaining five year term of such indebtedness.
At December 31, 1997, the Company held interest rate protection contracts on all $28,250 of its floating rate tax-exempt indebtedness which expire in 1999 and approximately $355,996 of other floating rate indebtedness which expire in November 1998 (or approximately 80.8% of its total floating rate indebtedness). In addition, the Company held additional interest rate protection contracts on $43,900 (of which $22,000 expires in July 1998 and $21,900 expires in April 1999) of the $355,998 floating rate indebtedness to further reduce the Company's exposure to increases in interest rates. See Note 2 -- "Summary of Significant Accounting Policies" and Note 7 -- "Bonds and Notes Payable" of the Notes to Consolidated Financial Statements for additional information concerning the accounting policies and significant terms of the interest rate protection contracts.
The Company's ratio of debt to total market capitalization at December 31, 1997 (defined as total long-term debt divided by the sum of: (a) the aggregate market value of the outstanding shares of Common Stock, assuming the full exchange of Common Units, Series C Preferred Securities into Common Stock; (b) the aggregate market value of the outstanding shares of Series B Convertible Preferred Stock; (c) the aggregate liquidation preference of the Series A Senior Cumulative Preferred Stock ("Senior Preferred Stock") at $25.00 per share; and (d) the total long-term debt of the Company) was 42.4%.
The Company is obligated to repay $13,951 and $50,179 of mortgage indebtedness during 1998 and 1999, respectively. Annualized cumulative dividends on the Company's Senior Preferred Stock, Series B Convertible Preferred Stock, and Series C Preferred securities outstanding as of December 31, 1997 are $6,038, $6,336, and $5,149, respectively. These dividends are paid quarterly, in arrears.
The Company anticipates that cash flow from operations, together with cash available from borrowings and other sources, including proceeds from the September Offering and the Private Placement, will be sufficient to satisfy its debt service obligations, expected distribution and dividend requirements and operating cash needs for the next year.
Table 9--Taxability of Distributions
TABLE 9 summarizes the taxability of distributions paid during the years ended December 31, 1997 and 1996. Distributions paid by the Company out of its current or accumulated earnings and profits (and not designated as capital gains dividends) will constitute taxable distributions to each holder. To the extent the Company makes distributions (not designated as capital gains dividends) in excess of its current and accumulated earnings and profits, such distributions will be treated first as a tax-free return of capital to each holder, reducing the adjusted basis which such holder has in his shares of stock by the amount of such distributions (but not below zero), with distributions in excess of a holder's adjusted basis in his stock taxable as capital gains (provided that the shares have been held as a capital asset).
No assurances can be made that future distributions will be treated similarly. Each holder of stock may have a different basis in its stock and, accordingly, each holder is advised to consult its tax advisors.
Economic Conditions
Substantially all of the merchants' leases contain provisions that somewhat mitigate the impact of inflation. Such provisions include clauses providing for increases in base rent and clauses enabling the Company to receive percentage rentals based on merchants' gross sales. Substantially all leases require merchants to pay their proportionate share of operating expenses, including common area maintenance, real estate taxes and promotion, thereby reducing the Company's exposure to increased costs and operating expenses resulting from inflation. At December 31, 1997, the Company maintained interest rate protection contracts to protect against increases in interest rates on certain floating rate indebtedness (see "Debt Repayments and Preferred Stock Dividends").
The Company intends to reduce operating and leasing risks by managing its existing portfolio of properties with the goal of improving its tenant mix, rental rates and lease terms and attracting high fashion, upscale manufacturers and national brand-name manufacturers as merchants.
Year 2000
Recognizing the need to ensure that the Company's operations will not be adversely impacted by year 2000 software failures, management has assessed the potential impact of the year 2000 on the processing of date-sensitive information by the Company's computerized information systems. Based on this assessment, management believes that the Company's primary computerized information systems are year 2000 compliant and the Company's operations will not be adversely impacted by year 2000 software failures. Funds from Operations
Management believes that to facilitate a clear understanding of the Company's operating results, funds from operations ("FFO") should be considered in conjunction with net income (loss) presented in accordance with GAAP. In March 1995, the National Association of Real Estate Investment Trusts ("NAREIT") established guidelines clarifying the definition of FFO. FFO is defined as net income (loss) (determined in accordance with GAAP) excluding gains (or losses) from debt restructuring and sales of property, plus depreciation and amortization after adjustments for unconsolidated partnerships and joint ventures.
The Company generally considers FFO an appropriate measure of liquidity of an equity REIT because industry analysts have accepted it as a performance measure of equity REITs. The Company's FFO is not comparable to FFO reported by other REITs that do not define the term using the current NAREIT definition or that interpret the current NAREIT definition differently than does the Company. Therefore, the Company cautions that the calculation of FFO may vary from entity to entity and as such the presentation of FFO by the Company may not be comparable to other similarly titled measures of other reporting companies. The Company believes that in order to facilitate a clear understanding of its operating results, FFO should be examined in conjunction with net income determined in accordance with GAAP. FFO does not represent cash generated from operating activities in accordance with GAAP and should not be considered as an alternative to net income as an indication of the Company's performance or to cash flows as a measure of liquidity or ability to make distributions.
TABLE 10 provides a reconciliation of income before allocation to minority interests and preferred shareholders to FFO for the years ended December 31, 1997, 1996 and 1995. FFO increased $19,081, or 69.0% to $46,718 for the year ended December 31, 1997 from $27,637 for the year ended December 31, 1996. The increase in FFO primarily reflects the $6,131 nonrecurring charge related to the prepayment of certain long-term debt in 1996, offset by the Portfolio Expansion, including the effect of the acquisition of certain properties in November 1996.
The payout ratios based on distributions made by the Company divided by FFO for the applicable periods were 103.7%, 106.4%, and 108.7%, respectively.
ITEM 8 -- FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Information required by this Item is set forth at the pages indicated in Item 14(a) below.
ITEM 9 -- CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
The information required by Items 10, 11, 12 and 13 (except that information regarding executive officers called for by Item 10 that is contained in Part I) is incorporated herein by reference from the definitive proxy statement that the Company intends to file pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended, on or before April 30, 1998.
PART IV
ITEM 14 -- EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) 1. Financial Statements
Report of Independent Auditors
Consolidated Balance Sheets of the Company as of December 31, 1997 and 1996
Consolidated Statements of Operations of the Company for the years ended December 31, 1997, 1996 and 1995
Consolidated Statements of Cash Flows of the Company for the years ended December 31,1997, 1996 and 1995
Consolidated Statements of Shareholders' Equity of the Company for the years ended December 31, 1997, 1996 and 1995
Notes to Consolidated Financial Statements of the Company
2. Financial Statement Schedules
The following financial statement schedule of the Company is included in Item 14 (d):
Report of Independent Auditors on Schedule (included with consent filed as Exhibit 23)
Schedule III--Real Estate and Accumulated Depreciation
Notes to Schedule III
All other schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions or are inapplicable, and therefore have been omitted.
3. Exhibits
Exhibit Number Description
3.1 Restated Articles of Incorporation of Prime Retail, Inc. [Restated to incorporate amendment dated August 8, 1997 for purposes of Regulation S-T Section 232.102(c) only]
3.2 Amended and Restated By-Laws of Prime Retail, Inc. [Incorporated by reference to the same titled exhibit in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1995 (File No. 0-23616).]
4.1 Form of Senior Preferred Stock Certificate [Incorporated by reference to the same titled exhibit in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1996 (File No. 0-23616).]
4.2 Form of Convertible Preferred Stock Certificate [Incorporated by reference to the same titled exhibit in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1996 (File No. 0-23616).]
4.3 Form of Common Stock Certificate [Incorporated by reference to the same titled exhibit in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1996 (File No. 0-23616).]
10.1 Amended and Restated Agreement of Limited Partnership of Prime Retail, L.P. dated as of September 8, 1997
Exhibit Number Description
10.1A Common Unit Contribution Agreement [Incorporated by reference to the same titled exhibit in the Company's registration statement on Form S-11 (Registration No. 333-1666).]
# 10.2 1994 Stock Incentive Plan [Incorporated by reference to the same titled exhibit in the Company's registration statement on Form S-11 (Registration No. 33-68536).]
# 10.3 1995 Stock Incentive Plan [Incorporated by reference to the same titled exhibit in the Company's registration statement on Form S-11 (Registration No. 333-1666).]
# 10.4 Executive Employment Agreement (Michael W. Reschke) [Incorporated by reference to the same titled exhibit in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994, as amended (File No. 0-23616).]
10.5 Combined Service and Special Distribution and Allocation Agreement (Abraham Rosenthal) [Incorporated by reference to the same titled exhibit in the Company's registration statement on Form S-4 (Registration No. 333-1784).]
10.5A Special Distribution and Allocation Agreement by and between the Company, the Operating Partnership and the Rosenthal Family LLC [Incorporated by reference to the same titled exhibit in the Company's registration statement on Form S-4 (Registration No. 333-1784).]
10.5B Indemnification and Option Agreement by and between the Prime Group, Inc., the Rosenthal Family LLC and Abraham Rosenthal [Incorporated by reference to the same titled exhibit in the Company's registration statement on Form S-4 (Registration No. 333-1784).]
10.6 Combined Service and Special Distribution and Allocation Agreement (William H. Carpenter, Jr.) [Incorporated by reference to the same titled exhibit in the Company's registration statement on Form S-4 (Registration No. 333-1784).]
10.6A Special Distribution and Allocation Agreement by and between the Company, the Operating Partnership and the Carpenter Family Associates LLC [Incorporated by reference to the same titled exhibit in the Company's registration statement on Form S-4 (Registration No. 333-1784).]
10.6B Indemnification and Option Agreement by and between the Prime Group, Inc., William H. Carpenter, Jr. and the Carpenter Family Associates LLC [Incorporated by reference to the same titled exhibit in the Company's registration statement on Form S-4 (Registration No. 333-1784).]
# 10.7 Form of Executive Employment Agreement (David G. Phillips) [Incorporated by reference to the same titled exhibit in the Company's registration statement on Form S-11 (Registration No.33-68536).]
# 10.8 Letter Agreement with R. Bruce Armiger [Incorporated by reference to the same titled exhibit in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994, as amended (File No. 0-23616).]
10.9 Right of First Refusal Agreement (Northgate Plaza--Improved Parcel) [Incorporated by reference to the same titled exhibit in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994, as amended (File No. 0-23616).]
10.10 Right of First Refusal Agreement (Northgate Plaza--Vacant Parcel) [Incorporated by reference to the same titled exhibit in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994, as amended (File No. 0-23616).]
Exhibit Number Description
10.11 Right of First Refusal Agreement (Huntley Factory Shops) [Incorporated by reference to the same titled exhibit in the Company's registration statement on Form S-11 (Registration No. 33-68536).]
10.12 Right of First Refusal Agreement (San Marcos Factory Shops) [Incorporated by reference to the same titled exhibit in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994, as amended (File No. 0-23616).]
10.13 Purchase Option Agreement (Northgate Plaza--Excluded Parcel) [Incorporated by reference to the same titled exhibit in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994, as amended (File No. 0-23616).]
10.14A Purchase Option Agreement (Huntley Factory Shops) [Incorporated by reference to the same titled exhibit in the Company's registration statement on Form S-11 (Registration No. 33-68536).]
10.14B First Amendment to Purchase and Option Agreement (Huntley Factory Shops) [Incorporated by reference to the same titled exhibit in the Company's registration statement on Form S-11 (Registration No. 333-1666).]
10.15 Registration Rights Agreement [Incorporated by reference to the same titled exhibit in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994, as amended (File No. 0-23616).]
10.16 Form of Property Level General Partnership Agreement [Incorporated by reference to the same titled exhibit in the Company's registration statement on Form S-11 (Registration No. 33-68536).]
10.17 Form of Property Level Limited Partnership Agreement [Incorporated by reference to the same titled exhibit in the Company's registration statement on Form S-11 (Registration No. 33-68536).]
10.18 Noncompetition and Restriction Agreement with Michael W. Reschke of PGI [Incorporated by reference to the same titled exhibit in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994, as amended (File No. 0-23616).]
10.19 Second Amended and Restated Subscription Agreement of Abraham Rosenthal regarding Common Units of Prime Retail, L.P. [Incorporated by reference to the same titled exhibit in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994, as amended (File No. 0-23616).]
10.20 Second Amended and Restated Subscription Agreement of William H. Carpenter, Jr. regarding Common Units of Prime Retail, L.P. [Incorporated by reference to the same titled exhibit in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994, as amended (File No. 0-23616).]
10.21 Revolving Loan Agreement dated March 2, 1995 between Gainesville Factory shops Limited Partnership, Florida Keys Factory Shops Limited Partnership, Indianapolis Factory Shops Limited Partnership and Nomura Asset Capital Corporation [Incorporated by reference to the same titled exhibit in the Company's Current Report on Form 8-K dated December 18, 1995 (File No. 0-23616).]
# 10.22 Consulting Agreement between the Company and Marvin Traub Associates, Inc. [Incorporated by reference to the same titled exhibit in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1996 (File No. 0-23616).]
10.23 Secured Promissory Note of Rosenthal Family LLC with respect to the purchase of the Restricted Common Units [Incorporated by reference to the same titled exhibit in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994, as amended (File No. 0-23616).]
10.23A Allonge related to the Secured Promissory Note of Rosenthal Family LLC [Incorporated by reference to the same titled exhibit in the Company's registration statement on Form S-4 (Registration No. 333-1784).]
10.24 Secured Promissory Note of Carpenter Family Associates LLC with respect to the purchase of the Restricted Common Units [Incorporated by reference to the same titled exhibit in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994, as amended (File No 0-23616).]
10.24A Allonge related to the Secured Promissory Note of Carpenter Family Associates LLC [Incorporated by reference to the same titled exhibit in the Company's registration statement on Form S-4 (Registration No. 333- 1784).]
10.25 Pledge and Security Agreement of Rosenthal Family LLC with respect to the purchase of the Restricted Common Units [Incorporated by reference to the same titled exhibit in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994, as amended (File No. 0-23616).]
10.26 Pledge and Security Agreement of Carpenter Family Associates LLC with respect to the purchase of the Restricted Common Units [Incorporated by reference to the same titled exhibit in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994, as amended (File No. 0-23616).]
10.27 Guaranty of Abraham Rosenthal with respect to the purchase of the Restricted Common Units [Incorporated by reference to the same titled exhibit in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994, as amended (File No. 0-23616).]
10.27A Reaffirmation of Pledge and Guaranty with respect to the Restricted Common Units of Rosenthal Family LLC and Abraham Rosenthal [Incorporated by reference to the same titled exhibit in the Company's registration statement on Form S-4 (Registration No. 333-1784).]
10.28 Guaranty of William H. Carpenter, Jr. with respect to the purchase of the Restricted Common Units [Incorporated by reference to the same titled exhibit in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994, as amended (File No. 0-23616).]
10.28A Reaffirmation of Pledge and Guaranty with respect to the Restricted Common Units of Carpenter Family Associates LLC and William H. Carpenter, Jr. [Incorporated by reference to the same titled exhibit in the Company's registration statement on Form S-4 (Registration No. 333-1784).]
10.29 Waiver, Recontribution and Indemnity Agreement by the Limited Partners [Incorporated by reference to the same titled exhibit in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994, as amended (File No. 0-23616).]
10.30 Indemnity Agreement made by the Company in favor of Prime Group, Inc. and Prime Group Limited Partnership [Incorporated by reference to the same titled exhibit in the Company's registration statement on Form S-11 (Registration No. 333-1666).]
10.31 Promissory Note dated October 31, 1996 by and between Prime Retail, L.P. and Nomura Asset Capital Corporation [Incorporated by reference to the same titled exhibit in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1996 (File No. 0-23616).]
Exhibit Number Description
10.31A Form of Deed of Trust, Security Agreement, Assignment of Rents and Fixture Filings with Nomura Asset Capital Corporation [Incorporated by reference to the same titled exhibit in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1996 (File No. 0-23616).]
10.32 Form of Standby Bond Purchase and Indemnity Agreement [Incorporated by reference to the same titled exhibit in the Company's registration statement on Form S-11 (Registration No. 33-68536).]
10.33 Consulting Agreement between the Company and Financo, Inc. [Incorporated by reference to the same titled exhibit in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1996 (File No. 0-23616).]
10.34 Amended and Restated Agreement and Plan of Merger among Prime Retail, Inc., Prime Retail, L.P., Horizon Group, Inc., Sky Merger Corp., Horizon Group Properties, Inc., Horizon Group Properties, L.P., and Horizon/Glen Outlet Centers Limited Partnership dated as of February 1, 1998 [Incorporated by reference to the same titled exhibit in the Company's Current Report on Form 8-K dated February 1, 1998 (File No. 0-23616).]
10.35 Agreement among Prime Retail, Inc., Horizon Group, Inc., Mr. David H. Murdock, Castle & Cooke Properties, Inc., and Pacific Holding Company dated as of February 1, 1998 [Incorporated by reference to the same titled exhibit in the Company's Current Report on Form 8-K dated February 1, 1998 (File No. 0-23616).]
# 10.36 Letter Agreement with David G. Phillips regarding the purchase of units in Prime Retail, L.P. dated August 6,
12 Statement re Computation of Ratio Earnings to Combined Fixed Charges and Preferred Stock Dividends
21 Subsidiaries of Prime Retail, Inc.
23 Consent of Ernst & Young LLP
27.1 Financial Data Schedule
27.2 Financial Data Schedule -- Restated 1997 Interim Periods
27.3 Financial Data Schedule -- Restated 1996 Periods
Note: # Management contract or compensatory plan or arrangement required to be filed pursuant to Item 14(c).
(b) Reports on Form 8-K
On October 29, 1997, the Company filed a Current Report on Form 8-K, dated October 29, 1997, reporting that the Company purchased Tidewater Outlet Mall, Manufacturer's Outlet Mall, Kittery Outlet Village (collectively "Prime Retail Outlets of Kittery") and Latham Factory Outlet Center. No financial statements were included.
On November 12, 1997, the Company filed a Current Report on Form 8-K, dated November 12, 1997, reporting that the Company and Horizon Group, Inc. entered into a definitive merger agreement. No financial statements were included.
On December 2, 1997, the Company filed a Current Report on Form 8-K, dated December 2, 1997, reporting that the Company purchased Niagara International Factory Outlets and Shasta Factory Stores. No financial statements were included.
On December 31, 1997, the Company filed a Current Report on Form 8-K/A, dated October 29, 1997, reporting that the Company purchased Prime Retail Outlets of Kittery, Latham Factory Outlet Center, Niagara International Factory Outlets and Shasta Factory Stores. Proforma consolidated financial statements of the Company and audited statements of revenue and certain expenses of the acquired properties were filed with this Form 8-K/A.
On February 1, 1998, the Company filed a Current Report on Form 8-K, dated February 1, 1998, reporting the amended merger agreement between the Company and Horizon Group, Inc. No financial statements were included.
(c) Exhibits
The list of exhibits filed with this report is set forth in response to Item 14 (a)(3). The required exhibits have been filed as indicated in the Exhibit Index. The Company agrees to furnish a copy of any long-term debt instrument wherein the securities authorized do not exceed 10 percent of the registrant's total assets on a consolidated basis upon the request of the Securities and Exchange Commission.
(d) Financial Statements and Schedules
Schedule III -- Real Estate and Accumulated Depreciation attached hereto is hereby incorporated by reference to this Item.
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.
PRIME RETAIL, INC.
Dated: March 25, 1998 /s/ Abraham Rosenthal --------------------- Abraham Rosenthal Chief Executive Officer
Dated: March 25, 1998 /s/ Robert P. Mulreaney ----------------------- Robert P. Mulreaney Executive Vice President, Chief Financial Officer and Treasurer
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 date indicated.
/s/ Michael W. Reschke March 25, 1998 ------------------------------------------------- Michael W. Reschke Chairman of the Board
/s/ Abraham Rosenthal March 25, 1998 Abraham Rosenthal Chief Executive Officer and Director
/s/ William H. Carpenter, Jr. March 25, 1998 ------------------------------------------------- William H. Carpenter, Jr. President, Chief Operating Officer and Director
/s/ Glenn D. Reschke March 25, 1998 ------------------------------------------------- Glenn D. Reschke Executive Vice President, Development and Acquisitions and Director
/s/ Terence C. Golden March 25, 1998 ------------------------------------------------- Terence C. Golden Director
/s/ Kenneth A. Randall March 25, 1998 ------------------------------------------------- Kenneth A. Randall Director
/s/ Sharon Sharpe March 25, 1998 Sharon Sharpe Director
/s/ James R. Thompson March 25, 1998 ------------------------------------------------- James R. Thompson Director
/s/ Marvin S. Traub March 25, 1998 ------------------------------------------------- Marvin S. Traub Director
Report of Independent Auditors
To the Board of Directors and Shareholders Prime Retail, Inc.
We have audited the accompanying consolidated balance sheets of Prime Retail, Inc. (the "Company") as of December 31, 1997 and 1996 and the related consolidated statements of operations, shareholders' equity and cash flows for each of the three years in the period ended December 31, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with 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 the Company at December 31, 1997 and 1996, the consolidated results of the Company's operations and its cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles.
/s/ Ernst & Young LLP
Baltimore, Maryland January 23, 1998, except for Note 15, as to which the date is February 1, 1998
See accompanying notes to financial statements.
See accompanying notes to financial statements.
See accompanying notes to financial statements.
See accompanying notes to financial statements.
PRIME RETAIL, INC.
Notes to Consolidated Financial Statements of the Company
(Amounts in thousands, except share and unit information)
Note 1 -- Organization and Basis of Presentation
Organization
Prime Retail, Inc. (the "Company") was organized as a Maryland corporation on July 16, 1993. The Company is a self-administered and self-managed real estate investment trust ("REIT") that develops, acquires, owns and operates factory outlet centers in the United States. The Company's factory outlet center portfolio, including three factory outlet centers owned through joint venture partnerships, consists of 28 factory outlet centers in 20 states, which total approximately 7,217,000 square feet of gross leasable area ("GLA") at December 31, 1997. As a fully-integrated real estate firm, the Company provides development, construction, accounting, finance, leasing, marketing, and management services for all of its properties (the "Properties"). The Company's Properties are held and all of its business and operations are conducted through Prime Retail, L.P. (the "Operating Partnership"). The Company controls the Operating Partnership as its sole general partner and is dependent upon the distributions or other payments from the Operating Partnership to meet its financial obligations.
At December 31, 1997, the Company owned 2,300,000 Senior Preferred Units of the Operating Partnership (the "Senior Preferred Units"), 2,981,800 Series B Convertible Preferred Units of the Operating Partnership (the "Series B Convertible Preferred Units"), 3,636,363 Series C Preferred Units of the Operating Partnership (the "Series C Preferred Units"), and 27,294,951 Common Units of partnership interest in the Operating Partnership (the "Common Units"). Each Senior Preferred Unit, Series B Convertible Preferred Unit, and Series C Preferred Unit (collectively, the "Preferred Units") entitles the Company to receive distributions from the Operating Partnership in an amount equal to the dividend declared or paid with respect to a share of the Company's Series A Senior Cumulative Preferred Stock ("Senior Preferred Stock"), Series B Cumulative Participating Preferred Stock ("Series B Convertible Preferred Stock"), and Series C Cumulative Participating Convertible Redeemable Preferred Stock ("Series C Preferred Stock"), respectively, prior to the payment by the Operating Partnership of distributions with respect to the Common Units. Series B Convertible Preferred Units and Series C Preferred Units will be automatically converted into Common Units to the extent of any conversion of Series B Convertible Preferred Stock or Series C Preferred Stock into Common Stock. The Preferred Units will be redeemed by the Operating Partnership to the extent of any redemption of Senior Preferred Stock, Series B Convertible Preferred Stock, or Series C Preferred Stock. (See Note 8 "Equity Offerings and Other Transactions" of the Notes to the Consolidated Financial Statements for additional information concerning equity transactions that were completed by the Company in 1996 and 1997.)
A summary of the holders of units in the Operating Partnership as of December 31, 1997 is as follows:
Note: (1) Includes 742,180 units beneficially owned by management and 4,091,255 units owned by certain executive officers based on their ownership interests in PGI.
As of December 31, 1997, the Company has a 76.2% general partnership interest in the Operating Partnership with full and complete control over the management of the Operating Partnership as the sole general partner not subject to removal by the limited partners.
The Operating Partnership is the 1% sole general partner of Prime Retail Services Limited Partnership (the "Services Partnership"). The Operating Partnership owns 100% of the non-voting preferred stock of Prime Retail Services, Inc. (the "Services Corporation") which, in turn, is the 99% limited partner of the Services Partnership. Certain members of management own 100% of the voting common stock of the Services Corporation and no cash distributions were made during the years ended December 31, 1997, 1996 and 1995. The Services Partnership was formed primarily to operate business lines of the Company that are not directly associated with the collection of rents. The Services Corporation is subject to federal, state and local taxes.
Unless the context otherwise requires, all references to the Company herein mean Prime Retail, Inc. and those entities owned or controlled by Prime Retail, Inc., including the Operating Partnership and the Services Partnership.
Basis of Presentation
The consolidated financial statements include the accounts of the Company, the Operating Partnership and the partnerships in which the Company has operational control. Profits and losses are allocated in accordance with the terms of the agreement of limited partnership of the Operating Partnership. The preparation of financial statements in conformity with generally accepted accounting principles ("GAAP") 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.
Investments in partnerships in which the Company does not have operational control are accounted for on the equity method of accounting. Income (loss) applicable to minority interests and common shares as presented in the consolidated statements of operations is allocated based on income (loss) before minority interests after income allocated to preferred shareholders.
Significant intercompany accounts and transactions have been eliminated in consolidation and combination.
Note 2 -- Summary of Significant Accounting Policies
Rental Property
Depreciation is calculated on the straight-line basis over the estimated useful lives of the assets which are as follows:
Land improvements.................................... 20 years Buildings and improvements........................... Principally 40 years Tenant improvements.................................. Term of related lease Furniture and equipment.............................. 5 years
Rental property is carried at historical cost net of accumulated depreciation. Development costs, which include fees and costs incurred in developing new properties, are capitalized as incurred. Upon completion of construction, development costs are amortized over the useful lives of the respective properties on a straight-line basis. The Company evaluates its rental properties periodically to assess whether any impairment indications are present, including recurring operating losses and significant adverse changes in the business climate that affect the recovery of recorded asset value. If any rental property is considered impaired, a loss is provided to reduce the carrying value of the asset to its estimated fair value. No impairment losses have been recorded in any of the periods presented.
Expenditures for ordinary maintenance and repairs are expensed to operations as incurred. Significant renovations and improvements which improve and/or extend the useful life of assets are capitalized and depreciated over their estimated useful lives.
Cash Equivalents
The Company considers highly liquid investments with a maturity of three months or less when purchased to be cash equivalents.
Accounts Receivable
Management regularly reviews accounts receivable and determines an appropriate range for the allowance for doubtful accounts based upon the impact of economic conditions on the merchants' ability to pay, past collection experience and such other factors which, in management's judgment, deserve current recognition. In turn, a provision is charged against earnings in order to maintain the allowance level within this range. The allowance for doubtful accounts at December 31, 1997 and 1996 was $1,780 and $1,349, respectively.
Accounts receivable due after one year primarily representing straight-line rents were $5,969 and $5,310 at December 31, 1997 and 1996, respectively.
Deferred Charges
Deferred charges consist of leasing commissions and financing costs. Deferred leasing commissions incurred to originate and renew operating leases are amortized on a straight-line basis over the term of the related lease. Fees and costs incurred to obtain financing are deferred and are being amortized as a component of interest expense over the terms of the respective loans on a basis that approximates the interest method.
Revenue Recognition
Leases with tenants are accounted for as operating leases. Minimum rental income is recognized on a straight-line basis over the term of the lease and unpaid rents are included in accounts receivable in the accompanying balance sheet. Certain lease agreements contain provisions which provide for rents based on a percentage of sales or based on a percentage of sales volume above a specified threshold. In addition, the lease agreements generally provide for the reimbursement of real estate taxes, insurance, advertising and certain common area maintenance costs. These additional rents and tenant reimbursements are accounted for on the accrual basis.
Earnings per Share
On December 31, 1997, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings per Share" which specifies the method of computation, presentation, and disclosure for earnings per share ("EPS"). SFAS No. 128 requires the presentation of basic EPS and diluted EPS. Basic EPS is calculated by dividing net income available to common shareholders by the weighted average number of shares outstanding during the period. Diluted EPS includes the potentially dilutive effect, if any, which would occur if outstanding (i) options to purchase Common Stock were exercised, (ii) Common Units were converted into shares of Common Stock, (iii) shares of Series C Preferred Stock and Units were converted into shares of Common Stock, and (iv) Series B Convertible Preferred Stock were converted into shares of Common Stock. For all periods presented, the effect of these exercises and conversions was anti-dilutive and, therefore, dilutive EPS is equivalent to basic EPS.
Interest Rate Protection Contracts
The Company uses interest rate protection contracts, including interest rate caps and corridors, to manage interest rate risk associated with floating rate debt. These contracts generally involve limiting the Company's interest costs with an upper limit or specified range on the underlying interest rate index. The cost of such contracts are included in deferred charges and are being amortized on a straight-line basis as a component of interest expense over the life of the contracts. Amounts earned from interest rate protection contracts are recorded as a reduction of interest expense. The Company is exposed to credit losses in the event of counterparty nonperformance, but does not anticipate any such losses based on the creditworthiness of the counterparties.
Stock Based Compensation
The Company accounts for stock option grants in accordance with Accounting Principles Board Opinion ("APB") No. 25, "Accounting for Stock Issued to Employees" and, accordingly, recognizes no compensation expense for stock option grants. The Company has elected to adopt only the disclosure provisions of SFAS No. 123, "Accounting for Stock-Based Compensation."
Income Taxes
The Company has elected to be taxed as a REIT under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended. As a REIT, the Company generally will not be subject to federal income tax at the corporate level on income it distributes to its shareholders so long as it distributes at least 95% of its taxable income (excluding any net capital gain) each year. If the Company fails to qualify as a REIT in any taxable year, the Company will be subject to federal income tax (including any applicable alternative minimum tax) on its taxable income at regular corporate rates. Even if the Company qualifies as a REIT, the Company may be subject to certain state and local taxes on its income and property. The Company incurred $263, $116, and $90 for state and local taxes for the years ended December 31, 1997, 1996 and 1995, respectively. The Company paid $170, $102, and $81 of state and local income taxes during the years ended December 31, 1997 and 1996, and 1995, respectively.
The following table summarizes the taxability of dividends and distributions paid during the years ended December 31, 1997, 1996 and 1995:
Risks and Uncertainties
The Company's results of operations are significantly dependent on the overall health of the retail industry. The Company's tenant base is comprised almost exclusively of merchants in the retail industry. The retail industry is subject to external factors such as inflation, consumer confidence, unemployment rates and consumer tastes and preferences. A decline in the retail industry could reduce merchant sales, which could adversely affect the operating results of the Company. A number of the merchants have occupied space in more than one of the Company's factory outlet centers; however, no single merchant accounts for more than 5.7% of the Company's revenues.
Note 3 -- Restricted Cash
At December 31, 1997 and 1996, the Company had placed in escrow $41,736 and $45,127, respectively, to be used to complete certain development projects, to fund real estate taxes and debt service and to pay certain operating costs under a mortgage loan agreement. At December 31, 1997, restricted cash included $34,692 relating to a nonrecourse expansion loan which can only be used to fund certain development costs relating to the expansion of 13 of the Company's factory outlet centers, provided certain occupancy and other conditions have been attained.
Note 4 -- Deferred Charges
Deferred charges were as follows:
Note 5 -- Investment In Partnerships
At December 31, 1997, the Company owned a 50% partnership interest in two real estate ventures that are accounted for using the equity method of accounting. The Company manages these ventures and earns a property management fee based on the ventures' revenues. The condensed combined balance sheets of these ventures and their condensed statements of operations are summarized as follows:
As of December 31, 1997, the Company guaranteed long-term debt of joint venture partnerships of $24,019.
On September 2, 1997, the Company acquired a 25% ownership interest in Buckeye Factory Shops Limited Partnership ("Buckeye") from its joint venture partner for $23,148 (including $22,642 of mortgage indebtedness relating to such property), thereby increasing its ownership percentage in such property to 100% (the "Buckeye Acquisition"). Prior to September 2, 1997, the Company accounted for its 75% investment in Buckeye using the equity method of accounting. Commencing September 2, 1997, the operating results of Buckeye are consolidated. As a result of the prepayment of the mortgage indebtedness noted above, the joint venture partnership incurred an extraordinary loss of $851 related to the write-off of certain unamortized financing costs totaling $624 and a debt prepayment penalty of $227. The Company's 75% share of the extraordinary loss, or $638, is included in the extraordinary loss in the Consolidated Statements of Operations.
Note 6 -- Related Party Transactions
At December 31, 1997, the net amount due from affiliates consisted of $1,052 due from joint venture partnerships relating to reimbursement of costs paid by the Company on their behalf. At December 31, 1996, the net amount due from affiliates consisted of $595 due from joint venture partnerships relating to reimbursement of costs paid by the Company on their behalf and $954 of fees due from joint venture partnerships in connection with the development of two factory outlet centers.
Note 7 -- Bonds and Notes Payable
Under the terms of the loan agreements relating to the Bonds, the issuing partnerships are required to make interest-only payments calculated using a variable rate determined by the remarketing agents of the Bonds. The interest rates ranged from 3.00% to 4.70% in 1997, 2.45% to 5.30% in 1996 and 2.65% to 5.30% in 1995. Under certain conditions, the interest rate on the Bonds may be converted to a fixed rate at the request of the Company. A bondholder may tender bonds during the variable interest rate period and receive principal, plus accrued interest through the tender date. Upon tender, the remarketing agents are required to immediately remarket the Bonds. In the event the remarketing agents fail to remarket any bonds, the remarketing agents may draw on certain liquidity facilities as described below. The remarketing agents receive fees varying from 0.1% to 0.125% per annum on the outstanding bond balance, payable quarterly in arrears.
At December 31, 1997, the Bonds are collateralized by letters of credit (the "Letters of Credit") issued by a group of financial institutions pursuant to a master letter of credit agreement. A letter of credit fee of 1.0% per annum of the stated amount of the Letters of Credit is payable quarterly in advance to such financial institutions. The Letters of Credit are collateralized by a reimbursement agreement under the master letter of credit agreement (the "Reimbursement Agreement") which obligates an insurance company to reimburse the financial institutions for any funds drawn on the Letters of Credit. In addition, in March 1994, the issuing partnerships, the Operating Partnership and an insurance company entered into standby bond purchase and indemnity agreements (the "Standby Agreements") in order to address the scheduled expirations of various credit enhancements, including the Letters of Credit, through March 21, 1999.
Pursuant to the Standby Agreements, the insurance company agreed that in the event that any of the issuing partnerships are unable to arrange replacement credit enhancement facilities as necessary, the insurance company will purchase the applicable Bonds and hold the same until March 21, 1999, at which time the issuing partnership and the Operating Partnership will purchase the Bonds pursuant to the terms of the related Standby Agreement.
The Letters of Credit are scheduled to expire on December 31, 1998. The total commitments outstanding under the Letters of Credit, the Reimbursement Agreement and the Standby Agreements as of December 31, 1997 were $28,909. The due date of the Bonds accelerates upon the expiration of the Letters of Credit unless the Letters of Credit are extended or replaced.
The scheduled maturities of bonds and notes payable at December 31, 1997 were as follows:
The aggregate carrying amount of bonds and notes payable at December 31, 1997 approximated their fair value. At December 31, 1997, the aggregate carrying amount of rental property collateralizing bonds and notes payable was $712,247.
At December 31, 1997, the Company held interest rate protection contracts on all $28,250 of its floating rate tax-exempt indebtedness which expire in 1999 and approximately $355,996 of other floating rate indebtedness which expire in November 1998. In addition, the Company purchased additional interest rate protection contracts on $43,900 (of which $22,000 expires in July 1998 and $21,900 expires in April 1999) of the $355,996 floating rate indebtedness to further reduce the Company's exposure to increases in interest rates. These contracts have a weighted average maturity of approximately 0.9 years.
The following table summarizes the material terms of the interest rate protection contracts held for purposes other than trading and related borrowings at December 31, 1997:
The net carrying amount of interest rate protection contracts at December 31, 1997 was $1,266. The estimated fair value of interest rate protection contracts based on quoted market rates at December 31, 1997 was $99.
On February 13, 1997, the Company closed on $30,000 of loan facilities with Nomura Asset Capital Corporation. The transaction provided (i) a $27,000 nonrecourse first mortgage loan (the "First Mortgage Loan") and (ii) a junior secured loan (the "Junior Secured Loan") of $3,000. The First Mortgage Loan (i) is cross collateralized by first mortgages on three of the Company's factory outlet centers, (ii) bears a fixed rate of interest of 8.35%, and (iii) requires monthly principal and interest payments pursuant to a 360-month amortization schedule. The Junior Secured Loan is a recourse loan to the Company that (i) is secured by a pledge of excess cash flow after debt service on the First Mortgage Loan, (ii) bears a variable interest rate at the London Interbank offered rate for 30-day deposits in U.S. dollars ("30-day LIBOR") plus 1.95%, (iii) matures in three years and (iv) requires monthly interest only payments through April 10, 1998 and monthly principal and interest payments thereafter.
On July 11, 1997, the Company's $15,000 unsecured line of credit (the "Corporate Line") was renewed. The purpose of the Corporate Line is to provide working capital to facilitate the funding of short-term operating cash needs of the Company. The Corporate Line bears an interest rate of 30-day LIBOR plus 2.50% and matures on July 11, 1998. No amounts were outstanding under the Corporate Line at December 31, 1997.
In September 1997, the Company repaid certain outstanding corporate indebtedness aggregating $113,410, including the Junior Secured Loan, with proceeds from certain public and private equity offerings (see Note 8 - "Equity Offerings and Other Transactions" of the Notes to the Consolidated Financial Statements). As a result of the prepayment of such indebtedness, the Company incurred an extraordinary loss of $1,423 related to the write-off of certain unamortized financing costs. The Company also incurred an extraordinary loss of $638 related to the write-off of certain unamortized financing costs in connection with the Buckeye Acquisition (see Note 5 - "Investment in Partnerships" of the Notes to the Consolidated Financial Statements).
On November 13, 1997, the Company closed on a term loan with Nomura Securities (Bermuda) Ltd. ("Nomura Securities") of $53,290 (the "Term Loan"). The Term Loan is a recourse loan to the Company that (i) is secured by a pledge of excess cash flow after debt service on a first mortgage loan collateralized by 16 of the Company's factory outlet centers, (ii) bears a variable interest rate of 30-day LIBOR plus 1.95%, (iii) matures on November 11, 1999, (iv) requires monthly interest-only payments through February 10, 1998 and monthly interest payments and quarterly principal payments thereafter that approximate a six-year amortization schedule, and (v) may be subject to earlier principal payments via "mark-to-market" of the underlying debt instrument.
In addition, on November 13, 1997, the Company closed on a term loan with Nomura Securities of $3,000 (the "Second Term Loan"). The Second Term Loan is a recourse loan to the Company that (i) is secured by a pledge of excess cash flow after debt service on a first mortgage loan collaterlized by three of the Company's factory outlet centers, (ii) bears a variable interest rate of 30-day LIBOR plus 1.95%, (iii) matures on February 13, 2000, (iv) requires monthly interest-only payments through April 10, 1998 and monthly principal and interest payments thereafter that approximate a five-year amortization schedule, and (v) may be subject to earlier principal payments via "mark-to-market" of the underlying debt instrument.
On December 2, 1997, the Company assumed a $31,328 mortgage loan in connection with the purchase of Niagara International Factory Outlets (the "Niagara Loan"). The Niagara Loan (i) bears a fixed rate of interest of 6.83%, (ii) requires monthly principal and interest payments that approximates a 25-year amortization schedule, and (iii) is collateralized by Niagara International Factory Outlets.
On December 31, 1997, the Company obtained from a financial institution a commitment for a construction mortgage loan in an amount not to exceed $20,396 (the "Construction Mortgage Loan"). The Construction Mortgage Loan (i) bears a variable interest rate at the financial institution's prime rate or, at the Company's option, a LIBOR index plus 1.75%, (ii) matures on December 31, 1999, and (iii) requires monthly interest-only payments. The Construction Mortgage Loan is collateralized by a first mortgage on Lebanon Factory Shops, a factory outlet center located in Lebanon, Tennessee. At December 31, 1997, no amounts were outstanding on the Construction Mortgage Loan.
Note 8 - Equity Offerings and Other Transactions
On June 27, 1996, the Company completed a registered exchange offer (the "Exchange Offer") to exchange shares of its Common Stock for up to 4,209,000 shares, or 60%, of its Series B Convertible Preferred Stock. The Company received tender offers for 4,648,650 shares, or approximately 66.27%, of the Series B Convertible Preferred Stock. A proration factor was applied to each share of Series B Convertible Preferred Stock validly tendered by holders, and on June 27, 1996, the Company issued 6,734,323 shares of its Common Stock. In connection with the Exchange Offer, certain affiliates of the Company who are limited partners of the Operating Partnership (the "Limited Partners") contributed to the Operating Partnership 625,000 common units for cancellation. In addition, on June 26, 1996, the Company's Board of Directors approved a special cash distribution (the "Special Cash Distribution") on its Common Stock of $1,393, or $0.145 per common share, to holders of record on June 27, 1996. The Special Cash Distribution was paid on July 15, 1996. The Limited Partners were not entitled to receive and did not receive any portion of the Special Cash Distribution.
On February 20, 1997, the Company completed a public offering by issuing 2,080,000 shares of its Common Stock at $12.50 per share and 175,800 shares of its Series B Convertible Preferred Stock at $22.75 per share. In addition, on March 10, 1997, the underwriter of the public offering exercised its overallotment option to purchase 310,300 shares of the Company's Common Stock at $12.50 per share. As a result of the public offering and the exercise of the overallotment option, the Company received net proceeds of $31,754 that were used to (i) repay certain outstanding indebtedness aggregating $26,500, (ii) to fund development and construction activities, and (iii) for general corporate purposes.
On August 8, 1997, the Company entered into a purchase agreement with Security Capital Preferred Growth Incorporated ("Security Capital") providing for the issuance of a new series of cumulative convertible non-voting preferred securities (the "Series C Preferred Securities") at $13.75 per share, or an aggregate of $60,000 in cash (the "Private Placement"). The Series C Preferred Securities pay dividends equivalent to the amount being paid on the Company's Common Stock, with an annual minimum equal to $1.18 per security. In addition, the Company, subject to certain conditions, has agreed to waive the ownership limitations otherwise applicable to the Common Stock to permit Security Capital to own, at any one time, the shares of Common Stock issuable upon conversion of the Series C Preferred Securities. The Company has the right to call the Series C Preferred Securities, at par, after 10 years. Subject to certain conditions,the Series C Preferred Securities may be issued in the form of shares of preferred stock in the Company or preferred units of partnership interest in the Operating Partnership that are exchangeable for shares of preferred stock or Common Stock on a one-to-one basis. The Series C Preferred Securities may be converted into shares of Common Stock on a one-to-one basis commencing August 8, 1998 (or earlier subject to certain conditions).
In September 1997, the Company completed a public offering of 11,500,000 shares (including 1,500,000 shares related to the exercise of the underwriters' overallotment option) of its Common Stock at $14.00 per share (the "September 1997 Offering"). In addition, on September 8, 1997, the Company issued 727,273 Series C Preferred Units at $13.75 per unit pursuant to the initial sale under the Private Placement. As a result of the September 1997 Offering and the initial draw on the Private Placement (collectively, the "September Capital Transactions"), the Company received net proceeds of $161,930 after commissions and underwriting discounts. A portion of the net proceeds from the September Capital Transactions were used (i) to repay certain outstanding corporate indebtedness aggregating $113,410 and (ii) to acquire the 25% ownership interest of the Company's joint venture partner in Buckeye for $23,148 (including $22,642 of mortgage indebtedness relating to such property). The remaining net proceeds from the September Capital Transactions of $26,192 were used (i) to fund development and construction activities, (ii) to fund property acquisitions, and (iii) for general corporate purposes.
On December 2, 1997, the Company issued 3,636,363 shares of its Series C Preferred Stock at $13.75 per share pursuant to the final sale under the Private Placement. As a result of this issuance, the Company received net proceeds of $49,045 that were used in the acquisition of Niagara International Factory Outlets and Shasta Factory Stores.
Note 9 -- Minority Interests
In conjunction with the formation of the Company and the Operating Partnership, the predecessor owners contributed interests in certain properties to the Operating Partnership and, in exchange, received limited partnership interests in the Operating Partnership. Subject to certain conditions, each Common Unit held by a Limited Partner may be exchanged for one share of Common Stock or, at the option of the Company, cash equal to the fair market value of a share of Common Stock at the time of exchange. As of December 31, 1997, 8,505,472 Common Units were issued and outstanding. Minority interests also includes interests in three property partnerships that are not wholly owned by the Company. During the years ended December 31, 1997, 1996 and 1995, expenses totaling $1,468, $884, and $1,049, respectively, related solely to the operation of the Company were allocated only to the common shareholders. Such allocation is consistent with the federal and state tax treatment of these expenses. During the year ended December 31, 1996, cash distributions and losses allocated to minority interests reduced the minority interests balance to zero. After reducing the minority interests balance to zero, additional distributions and losses of $8,739 and $3,457 that were allocable to minority interests were allocated to common shareholders during the years ended December 31, 1997 and 1996, respectively.
On September 8, 1997 the Company issued 727,273 Series C Preferred Units at $13.75 per unit pursuant to the initial $10,000 sale under the Private Placement (see Note 8 - "Equity Offerings and Other Transactions" of the Notes to the Consolidated Financial Statements). The terms of the Series C Preferred Units are substantially the same as those of the Series C Preferred Stock (see Note 10 - "Preferred Stock" of the Notes to the Consolidated Financial Statements). The net proceeds of $9,710 from the issuance of the Series C Preferred Units are included in minority interests in the Consolidated Balance Sheets.
At December 31, 1997 and 1996, loans to certain limited partners, who also are executive officers of the Company, aggregating $4,750 were reported as a reduction in minority interests in the Consolidated Balance Sheets.
Note 10 -- Preferred Stock
The Company is authorized to issue up to 24,315,000 shares of preferred stock in one or more series. At December 31, 1997, 2,300,000 shares Senior Preferred Stock, 2,981,800 shares of Series B Convertible Preferred Stock, and 3,636,363 shares of Series C Preferred Stock were issued and outstanding. The Senior Preferred Stock and Series B Convertible Preferred Stock have a liquidation preference equivalent to $25.00 per share plus the amount equal to any accrued and unpaid dividends thereon. The Series C Preferred Stock has a liquidation preference equivalent to $13.75 per share plus the amount equal to any accrued and unpaid dividends thereon.
Dividends on the Senior Preferred Stock are payable quarterly in the amount of $2.625 per share per annum. Dividends on the Series B Convertible Preferred Stock are payable quarterly at the greater of (i) $2.125 per share per annum or (ii) the dividends on the number of shares of Common Stock into which a share of Series B Convertible Preferred Stock will be convertible at the conversion price of $20.90 per share of Common Stock. At December 31, 1997, there were 3,566,746 shares of Common Stock reserved for future issuance upon conversion of the Series B Convertible Preferred Stock. Dividends on the Series C Preferred Stock are equivalent to the amount being paid on the Company's Common Stock, with an annual minimum equal to $1.18 per share.
The Company has the right to redeem the Senior Preferred Stock and the Series B Convertible Preferred Stock beginning on and after March 31, 1999 at $26.75 and$27.125 per share, respectively, plus the amount equal to any accrued and unpaid dividends thereon. The redemption price decreases incrementally each year thereafter through March 31, 2004, at which date the redemption price is fixed at $25.00 per share plus the amount equal to any accrued and unpai dividends thereon. The Company, subject to certain conditions, has agreed to waive the ownership limitations otherwise applicable to the Common Stock to permit Security Capital to own, at any one time, the shares of Common Stock issuable upon conversion of the Series C Preferred Securities. The Company has the right to call the Series C Preferred Stock, at par, after 10 years. The Series C Preferred Stock is convertible into shares of Common Stoc on a one-to-one basis, subject to adjustment, commencing August 8, 1998 or earlier subject to certain conditions.
The holders of the Senior Preferred Stock and Convertible Preferred Stock, each series voting separately as a class, have the right to elect two additional members to the Company's Board of Directors if the equivalent of six quarterly dividends on these series of preferred stock are in arrears Each of such two directors will be elected to serve until the earlier of (i) the election and qualification of such directors' successor, or (ii) payment of the dividend arrearage. If distributions on any Series C Preferred Stock have been in arrears for two consecutive quarters or the Company fails to pay distributions on the Common Stock in an amount per share at least equal to $0.25 (subject to adjustment) for two consecutive quarters, the number of directors of the Company shall be increased by one (or two if the board of directors of the Company then consists of 10 or more members) as elected by the holders of Series C Preferred Stock together with the holders of shares on a parity as to distributions with the Series C Preferred Stock, voting as a single class regardless of series. Each of such two directors will be elected to serve until the earlier of (i) the election and qualification of such directors' successor, or (ii) payment of the dividend arrearage.
Note 11 -- Stock Option Plans
Under the Company's 1994 and 1995 Stock Option Plans, options to purchase shares of the Company's Common Stock have been or may be granted. The option price for shares granted under these plans is the fair market value on the grant date.
In 1994, the Company granted options to executive officers, outside directors and consultants to purchase 585,000 shares of Common Stock at $19.00 per share. The options granted to executive officers vest at a rate of 20% per year over five years and have a term of 10 years. The options granted to outside directors and consultants (aggregating 35,000 options) were fully vested at the grant date and have a term of 10 years.
In 1995, the Company granted options to purchase 20,000 common shares at $12.45 per share to outside directors and consultants. These options were fully vested at the grant date and have a term of 10 years.
In 1996, the Company granted options to executive officers, other key employees and consultants to purchase 302,500 shares of Common Stock at exercise prices ranging from $11.46 to $11.88 per share. These options were fully vested at the grant date and have a term of 10 years.
In 1997, the Company granted options to executive officers and other key employees to purchase 196,250 shares of Common Stock at an exercise price of $12.53 per share. These options were fully vested at the grant date and have a term of 10 years.
Unaudited pro forma information regarding net income and earnings per share is required by SFAS No. 123, which requires that the information be determined as if the Company has accounted for its stock options granted subsequent to December 31, 1994 under the fair value method of SFAS No. 123. 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:
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions 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 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 stock options.
For purposes of unaudited pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' applicable vesting period. The Company's unaudited pro forma information for the years ended December 31, 1997, 1996 and 1995 follows :
Options on 961,253, 640,253 and 224,750 shares were exercisable at December 31, 1997, 1996, and 1995, respectively, at a weighted average exercise price of $15.32 per share, $15.45 per share, and $18.42 per share, respectively. The weighted fair value of options granted during the years ended December 31, 1997, 1996, and 1995 was $1.90 per share, $1.69 per share, and $1.60 per share respectively. Exercise prices for options outstanding at December 31, 1997 ranged from $11.46 to $19.00 per share. The weighted average remaining contractual life of those options is 7.3 years. Under the Company's 1994 and 1995 Stock Option Plans, there were 106,250 and 311,500 shares reserved for future grants at December 31, 1997 and 1996, respectively.
Note 12 -- Lease Agreements
The Company is the lessor of retail and office space under operating leases with initial lease terms that expire from 1998 to 2016. Most leases are renewable for five years at the lessee's option. Future minimum base rent to be received under noncancelable operating leases were as follows:
The Company leases certain land, buildings, and equipment under various noncancelable operating lease agreements. Rental expense for operating leases was $1,059, $1,011, and $961for the years ended December 31, 1997, 1996, and 1995, respectively. Future minimum rental payments, by year and in the aggregate, payable under these noncancelable operating leases with initial or remaining terms of one year or more consisted of the following:
Note 13 -- Legal Proceedings
In the ordinary course of business, the Company is subject to certain legal actions. While any litigation contains an element of uncertainty, management believes that losses, if any, resulting from such matters, will not have a material adverse effect on the consolidated financial statements of the Company.
Note 14 -- Property Acquisitions
On November 1, 1996, the Company acquired Rocky Mountain Factory Stores and Kansas City Factory Outlets for an aggregate purchase price of $71,700.
On November 1, 1996, the Company purchased its joint venture partner's first mortgage on and 50% ownership interest in Grove City Factory Shops for $57,094 thereby increasing its ownership interest in such property to 100%.
On February 13, 1997, the Company, acquired Oak Creek Factory Stores, Bend Factory Outlets and Factory Outlets at Post Falls from an unrelated third party for an aggregate purchase price of $37,250. The Company financed the purchase with loan proceeds from a financial institution and a $4,000 promissory note issued to the seller. The operating results of the Company for 1997 include the results of these acquisitions effective with the closing on February 13, 1997.
On September 2, 1997, the Company acquired a 25% ownership interest in Buckeye from its joint venture partner for $23,148 (including $22,642 of mortgage indebtedness relating to such property), thereby increasing its ownership percentage in such property to 100%. Prior to September 2, 1997, the Company accounted for its 75% investment in Buckeye using the equity method of accounting. Commencing September 2, 1997, the operating results of Buckeye are consolidated. The Company financed the acquisition with proceeds from the September 1997 Offering.
On October 29, 1997, the Company acquired Tidewater Outlet Mall, Manufacturer's Outlet Mall, Kittery Outlet Village (collectively "Prime Retail Outlets of Kittery"), and Latham Factory Outlet Center (the "Latham Property") from an unrelated third party for an aggregate purchase price of $26,000. The Company financed the purchase primarily with the proceeds from the September 1997 Offering.
In addition, on December 2, 1997, the Company acquired Niagara International Factory Outlets ("Niagara") and Shasta Factory Stores ("Shasta") from an unrelated third party for an aggregate purchase price of $100,975, including the assumption of mortgage indebtedness of $31,368. The Company financed the purchase with proceeds from the September 1997 Offering and the Private Placement.
These unaudited pro forma results have been prepared for comparative purposes only and include certain adjustments, such as additional depreciation expense based on the purchase price of such assets acquired and interest expense on debt incurred on financing the acquisitions. These unaudited pro forma results do not purport to be indicative of the results of operations which actually would have resulted had the combination been in effect on January 1, 1996 or of future results of operations of the Company.
Note 15-- Merger Agreement
On November 12, 1997 and as amended on February 1, 1998, the Company entered into a definitive merger agreement (as amended, the "Merger Agreement") with Horizon Group, Inc. ("Horizon") for an aggregate consideration of approximately $945,200, including the assumption of $556,900 of Horizon debt and transaction costs. Upon completion of the transaction, the Company will own and operate 48 outlet centers totaling approximately 13,406,261 square feet of GLA.
Under the terms of the Merger Agreement, the Company will pay a fixed exchange ratio of 0.20 of a share of Series B Convertible Preferred Stock and 0.597 of a share of Common Stock for each share of common stock of Horizon. In addition, each common unit in Horizon Partnership will entitle the holder to receive 0.9193 of a Common Unit of the Operating Partnership that will be exchangeable for a like number of shares of Common Stock of the Company.
Immediately prior to the merger, Horizon Group Properties, Inc.("HGP"), a subsidiary of Horizon, will become the sole general partner of Horizon/Glen Outlet Center Limited Partnership ("Horizon Partnership") and the common stock of HGP will be distributed to the shareholders of both the Company and Horizon. All of the common equity of HGP will be distributed to the convertible preferred and common shareholders and unitholders of the Company and the shareholders and limited partners of Horizon based on their ownership in the Company immediately following the merger. It is presently expected that following the merger one share of common stock of HGP will be distributed for every 10 shares of Common Stock or Common Units of the Company, and that approximately 1.196 shares of common stock of HGP will be distributed for every 10 shares of Series B Convertible Preferred Stock held in the Company. Immediately prior to the closing of the merger, the Company will pay a special cash distribution of $0.60 per share of Series B Convertible Preferred Stock and $0.50 per share/unit of Common Stock, Series C Preferred Security and Common Unit, as applicable Shareholders and limited partners in Horizon will not participate in this distribution. HGP will own and operate 15 outlet centers (including Indiana Factory Shops and Nebraska Crossing Factory Stores which will be acquired from the Company) totaling 3,084,823 square feet of GLA.
The merger will be accounted for as a purchase. It is conditioned upon, among other things, the approvals of each Company's shareholders and partners and the satisfaction of other customary conditions. The closing is expected during the second quarter of 1998. The exchange of shares of Horizon for shares of the Company will be made on a tax-free basis.
On December 10, 1997, a shareholder of Horizon filed a purported class action lawsuit in the Circuit Court for Muskegon County, Michigan against Horizon, the Company, and certain directors and former directors of Horizon claiming, among other things, that Horizon's directors breached their fiduciary duties to Horizon's shareholders in approving the merger of Horizon and the Company and that the consideration to be paid to Horizon's shareholders in connection with the merger is unfair and inadequate. The lawsuit requests that such merger be enjoined or, in the event that the purported transaction is consummated, that it be rescinded or unspecified damages be awarded to the class members. On January 16, 1998, the defendants answered the complaint, denying that the Horizon board of directors breached their fiduciary duties and denying that such consideration is unfair or inadequate. Although the Company is named as a defendant in the complaint, the substantive allegations focus on the actions of Horizon and its board of directors and not on any actions of the Company or its board of directors. Since this litigation is in the initial phases of discovery, its outcome is not susceptible to easy or certain prediction; however, the Company intends to defend itself vigorously.
PRIME RETAIL, INC.
Notes to Schedule III - Real Estate and Accumulated Depreciation
December 31, 1997
(in thousands)
Depreciation on building and improvements is calculated on a straight-line basis over the estimated useful lives of the asset as follows:
Land improvements....................................20 years Buildings and improvements...............Principally 40 years Tenant improvements.....................Term of related lease Furniture and equipment...............................5 years
The aggregate cost for federal income tax purposes was $986,004 at December 31, 1997.
ITEM 7 -- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Amounts in thousands, except share, unit, and per square foot information)
Introduction
The following discussion and analysis of the consolidated financial condition and results of operations of Prime Retail, Inc. (the "Company") should be read in conjunction with the Consolidated Financial Statements and Notes thereto appearing elsewhere in this Annual Report on Form 10-K. The Company's operations are conducted through Prime Retail, L.P. (the "Operating Partnership"). The Company controls the Operating Partnership as its sole general partner and is dependent upon the distributions or other payments from the Operating Partnership to meet its financial obligationS. Historical results and percentage relationships set forth herein are not necessarily indicative of future operations.
Cautionary Statements
The following discussion in "Management's Discussion and Analysis of Financial Condition and Results of Operations" contain certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 which reflect management's current views with respect to future events and financial performance. Such forward-looking statements are subject to certain risks and uncertainties; including, but not limited to, the effects of future events on the Company's financial performance; the risk that the Company may be unable to finance its planned acquisition and development activities; risks related to the retail industry in which the Company's outlet centers compete, including the potential adverse impact of external factors such as inflation, consumer confidence, unemployment rates and consumer tastes and preferences; risks associated with the Company's property acquisition activities, such as the lack of predictability with respect to financial returns; risks associated with the Company's property development activities, such as the potential for cost overruns, delays and lack of predictability with respect to the financial returns associated with these development activities; the risk of potential increase in market interest rates from current rates; and risks associated with real estate ownership, such as the potential adverse impact of changes in the local economic climate on the revenues and the value of the Company's properties.
Portfolio Growth
The Company has grown by developing and acquiring factory outlet centers and expanding its existing factory outlet centers. The Company's factory outlet portfolio consisted of 28 operating factory outlet centers totaling 7,217,000 square feet of gross leasable area ("GLA") at December 31, 1997, compared to 21 factory outlet centers totaling 5,780,000 square feet of GLA at December 31, 1996 and 17 factory outlet centers totaling 4,331,000 square feet of GLA at December 31, 1995.
During 1997, the Company purchased seven factory outlet centers totaling 1,221,000 square feet of GLA and opened expansions to existing factory outlet centers totaling 224,000 square feet of GLA. Additionally, the Company acquired its joint venture partner's 25% ownership interest in Buckeye Factory Shops Limited Partnership ("Buckeye") on September 2, 1997 and now owns 100% of this factory outlet center with 205,000 square feet of GLA. During 1996, the Company opened two new factory outlet centers and nine expansions, and acquired two factory outlet centers from an unrelated third party, adding 1,449,000 square feet of GLA in the aggregate. Additionally, the Company purchased its joint venture partner's first mortgage and 50% partnership interest in Grove City Factory Shops Partnership on November 1, 1996 and owns 100% of this factory outlet center with 533,000 square feet of GLA. The significant increases in the number of the Company's operating properties and total GLA during 1996 and 1997 are collectively referred to as the "Portfolio Expansion."
Note: (1) On December 31, 1997, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings per Share" (see Note 2 - "Summary of Significant Accounting Policies - - Earnings per Share" of the Notes to Consolidated Financial Statements). The adoption of SFAS No. 128 had no impact on the Company's earnings per share computations for all periods presented and, therefore, no restatement of prior period computations was required.
Notes: (1) Includes total GLA in which the Company receives substantially all of the economic benefit. (2) Includes factory outlet centers operated under unconsolidated joint venture partnerships with unrelated third parties. (3) Based on occupied GLA weighted by months of operation. (4) Includes certain nonrecurring charges of $6,131, or $1.51 per square foot, relating to the prepayment of long-term debt recorded during 1996. (5) Includes certain nonrecurring charges of $1,806, or $0.51 per square foot, relating to the prepayment of long-term debt recorded during 1996.
Comparison of the year ended December 31, 1997 to the year ended December 31,
For the year ended December 31, 1997, the Company reported net income of $5,905. During the third quarter of 1997, the Company recorded an extraordinary loss of $2,061 related to the pre-payment of certain long-term debt. For the year ended December 31, 1997, the net loss applicable to common shareholders was $6,821, or $0.36 per common share on a basic and diluted basis. For the year ended December 31, 1996, the Company reported net income of $8,061. These results included a nonrecurring charge and an extraordinary loss of $6,131 and $1,017 (net of minority interests of $3,263), respectively, related to the pre-payment of certain long-term debt. For the year ended December 31, 1996, the net loss applicable to common shareholders was $6,175, or $0.75 per common share on a basic and diluted basis.
Total revenues were $129,130 for the year ended December 31, 1997, compared to $89,040 for the year ended December 31, 1996, an increase of $40,090, or 45%. Base rents increased $23,336, or 42.7%, in 1997 compared to 1996. These increases are primarily due to the Portfolio Expansion, including the effect of the acquisition of seven factory outlet centers from unrelated third parties and the Company's purchase of its joint venture partner's 25% partnership interest in a factory outlet center on September 2, 1997. Straight-line rents (included in base rents) were $643 and $600 for the years ended December 31, 1997 and 1996, respectively. The average base rent per square foot for new factory outlet leases negotiated and executed by the Company was $15.52 and $15.36 for the years ended December 31, 1997 and 1996, respectively.
Percentage rents, which represent rents based on a percentage of sales volume above a specified threshold, increased $1,290, or 64.9%, during the year ended December 31, 1997 compared to the same period in 1996. This increase was attributable to higher reported merchant sales in 1997 and the Portfolio Expansion.
As summarized in TABLE 3, merchant sales reported to the Company increased by $389.9 million, or 37.3%, to $1,434.2 million from $1,044.3 million for the years ended December 31, 1997 and 1996, respectively. The increase in total reported merchant sales is primarily due to the Portfolio Expansion, including the effect of the acquisition of certain properties in 1997. The weighted average reported merchant sales per square foot increased by 3.1% to $236.20 per square foot in 1997 from $229.08 per square foot in 1996. Total merchant occupancy cost per square foot increased slightly from $21.12 in 1996 to $21.36 in 1997 but decreased as a percentage of reported sales from 8.64% to 8.39%, respectively. The decrease in the cost of merchant occupancy to reported sales is primarily due to an increase in the weighted average reported merchant sales per square foot for the Company's entire factory outlet portfolio.
Notes: (1) Total reported merchant sales summarizes gross sales generated by merchants and includes changes in merchant mix and the effect of new space created from the acquisition and opening of new and expanded factory outlet centers. Several of the Company's factory outlet centers were constructed, expanded or acquired during the time periods contained in TABLE 3 and therefore, reported sales for such new openings, expansions and acquisitions were reported only for the partial period and were not annualized. TABLE 3 should be read in conjunction with the information summarized under the caption "Properties--Portfolio of Properties". (2) Weighted average reported sales per square foot is based on reported sales divided by the weighted average square footage occupied by the merchants reporting those sales. Same-space sales is defined as the weighted average reported merchant sales per square foot for space open since January 1, 1996. (3) Total merchant occupancy cost per square foot includes base rents, percentage rents and tenant reimbursements which includes tenant marketing contributions. (4) Computed as follows: total merchant occupancy cost per square foot divided by total weighted average reported merchant sales per square foot. (5) Computed as follows: total merchant occupancy cost per square foot (excluding marketing contributions paid by merchants) divided by total weighted average reported merchant sales per square foot.
Tenant reimbursements, which represent the contractual recovery from tenants of certain operating expenses, increased by $12,265, or 48.6%, in 1997 over 1996. These increases are primarily due to the Portfolio Expansion, including the effect of the acquisition of seven factory outlet centers from unrelated third parties and the Company's purchase of its joint venture partner's 25% partnership interest in a factory outlet center on September 2, 1997.
As shown in TABLE 4, tenant reimbursements as a percentage of recoverable property operating expenses and real estate taxes was 96.4% in 1997 compared to 98.2% in 1996. These levels reflect the Company's continued efforts to contain operating expenses at its properties while requiring merchants to pay their pro rata share of these expenses. TABLE 4 sets forth recoveries from merchants as a percentage of total recoverable expenses for 1997, 1996 and 1995:
Note: (1) Total recoverable expenses include property operating expenses and real estate taxes.
Income from investment partnerships decreased by $1,136, or 91.7%, to $103 for the year ended December 31, 1997 compared to $1,239 for the year ended December 31, 1996. This decrease reflects the Company's purchases of (i) its joint venture partner's first mortgage and 50% partnership interest in Grove City Factory Shops Partnership on November 1, 1996 and (ii) its joint venture partner's first mortgage and 25% partnership interest in Buckeye Factory Shops Partnership on September 2, 1997. As a result of these acquisitions, the Company owns 100% of both Grove City Factory Shops and Buckeye Factory Shops. Prior to the acquisition dates, the operating results of these factory outlet centers were accounted for by the Company under the equity method of accounting. Commencing with their respective acquisition dates, the operating results of these factory outlet centers were included in the consolidated results of the Company.
Interest and other income increased by $4,335, or 74.1%, to $10,185 during the year ended December 31, 1997 as compared to $5,850 for the year ended December 31, 1996. The increase reflects higher (i) interest income of $2,954, (ii) gains on sales of land of $988, (iii) municipal assistance income of $903, (iv) push cart income of $304, (v) temporary tenant income of $218, (vi) lease termination income of $213, and (vii) all other ancillary income of $63. Partially offsetting these increases were reduced property development and construction management fees and leasing commissions of $1,308. The increase in interest income was primarily due to interest earnings on the Company's expansion loan escrow account included in restricted cash.
Property operating expense increased by $9,071, or 44.4%, to $29,492 in 1997 compared to $20,421 in 1996. Real estate taxes expense increased by $4,129, or 78.1%, to $9,417 in 1997 from $5,288 in 1996. Depreciation and amortization expense increased by $7,459, or 38.7%, to $26,715 in 1997, compared to $19,256 in 1996. The increases in property operating, real estate taxes, and depreciation and amortization expense are primarily due to the Portfolio Expansion, including the acquisition of seven factory outlet centers from an unrelated third parties and the Company's purchase of its joint venture partner's partnership interest in two factory outlet centers.
Note: (1) In accordance with generally accepted accounting principles ("GAAP"), leasing commissions are classified as intangible assets. Therefore, the amortization of leasing commissions is reported as a component of depreciation and amortization expense.
As shown in TABLE 6, interest expense increased by $11,637, or 47.5%, to $36,122 in 1997 compared to $24,485 in 1996. This increase reflects higher interest incurred of $12,241, a reduction in interest earned on interest rate protection contracts of $86, an increase in amortization of deferred financing costs of $11, and an increase in amortization of interest rate protection contracts of $7. Partially offsetting these items was an increase in the amount of interest capitalized in connection with development projects of $708.
The increase in interest incurred is primarily attributable to an increase of $166,015 in the Company's average debt outstanding during 1997 compared to 1996. The increase in interest incurred also reflects a slightly higher weighted average interest rate for the year ended December 31, 1997 compared to the same period in 1996. The weighted average interest rates were 7.36% and 7.22% for 1997 and 1996, respectively.
Other charges decreased by $5,352 to $3,234 in 1997 compared to $8,586 for 1996. The 1996 amount reflects a nonrecurring loss of $6,131 related to the prepayment of certain long-term debt. Excluding this nonrecurring loss, other charges increased by $779, or 31.2%, in 1997. This increase reflects higher marketing costs of $272, an increase in the provision for uncollectible accounts receivable of $260, a higher provision for potentially unsuccessful pre-development efforts of $150, and an increase in other miscellaneous charges of $97.
Notes: (1) Includes the net assets acquired by the Company during 1997 consisting of (i) the purchase of seven factory outlet centers ($166,987) and (ii) the purchase of the Company's joint venture partner's partnership interest in Buckeye Factory Shops ($24,358). (2) Includes the net assets acquired by the Company during 1996 consisting of (i) the purchase of two factory outlet centers ($71,770) and (ii) the purchase of the Company's joint venture partner's partnership interest in Grove City Factory Shops ($57,094).
Notes: (1) On December 31, 1997, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings per Share" (see Note 2 - "Summary of Significant Accounting Policies - - Earnings per Share" of the Notes to Consolidated Financial Statements). The adoption of SFAS No. 128 had no impact on the Company's earnings per share computations for all periods presented and, therefore, no restatement of prior period computations was required. (2) Includes a special cash distribution of $0.145 per common share relating to the Company's exchange offer completed in June 1996 (see Note 8 -- "Equity Offerings and Other Transactions" of the Notes to Consolidated Financial Statements).
Comparison of the year ended December 31, 1996 to the year ended December 31,
For the year ended December 31, 1996, the Company reported net income of $8,061 on total revenues of $89,040. These results include a nonrecurring charge and an extraordinary loss of $6,131 and $1,017 (net of minority interests of $3,263), respectively, related to a binding loan commitment that the Company obtained on June 5, 1996 resulting in the pre-payment of certain long-term debt. For the year ended December 31, 1996, the net loss applicable to common shareholders was $6,175, or $0.75 per common share on a basic and diluted basis. For the year ended December 31, 1995, the Company reported net income of $18,170 on total revenues of $77,398. For the year ended December 31, 1995, the net loss applicable to common shareholders was $2,774, or $0.96 per common share on a basic and diluted basis.
Total revenues were $89,040 for the year ended December 31, 1996, as compared to $77,398 for the year ended December 31, 1995, an increase of $11,642, or 15.0%. Base rents increased $8,342, or 18.0%, in 1996 compared to 1995. These increases were primarily due to the Portfolio Expansion, including the effect of the acquisition of two factory outlet centers from an unrelated third party on November 1, 1996 and the Company's purchase of its joint venture partner's 50% partnership interest in a factory outlet center on November 1, 1996. Straight-line rents (included in base rents) were $600 and $931 for the years ended December 31, 1996 and 1995, respectively. The average base rent per square foot for new factory outlet leases negotiated and executed by the Company was $15.36 and $14.90 for the years ended December 31, 1996 and 1995, respectively.
As summarized in TABLE 3, merchant sales reported to the Company increased by $234.7 million, or 29.0%, to $1,044.3 million from $809.6 million for the years ended December 31, 1996 and 1995, respectively. The increase in total reported merchant sales was primarily due to the Portfolio Expansion, including the effect of the acquisition of certain properties in 1996. However, the weighted average reported merchant sales per square foot decreased by 2.9% to $229.08 per square foot from $235.99 per square foot for the years ended December 31, 1996 and 1995, respectively. The Company's factory outlet centers (including centers operated under partnerships with unrelated third parties) contained an average of 275,238 and 254,765 square feet of GLA at December 31, 1996 and 1995, respectively. The increase in the cost of merchant occupancy to reported sales was primarily due to a decrease in the weighted average reported merchant sales per square foot for the Company's entire factory outlet portfolio.
Tenant reimbursements, which represent the contractual recovery from tenants of certain operating expenses, increased by $2,971, or 13.3%, in 1996 over 1995. This increase was primarily due to the Portfolio Expansion, including the effect of the acquisition of two factory outlet centers from an unrelated third party and the Company's purchase of its joint venture partner's first mortgage and 50% partnership interest in a factory outlet center on November 1, 1996.
As shown in TABLE 4, tenant reimbursements as a percentage of recoverable operating expenses were 98.2% in 1996 compared to 99.6% in 1995. These levels reflect the Company's continued efforts to contain operating expenses at its properties while requiring merchants to pay their pro rata share of these expenses. TABLE 4 highlights the trend of recoveries from merchants as a percentage of total recoverable expenses.
Income from investment partnerships decreased by $490, or 28.3%, to $1,239 for the year ended December 31, 1996 compared to $1,729 for the year ended December 31, 1995. This decrease reflected the Company's purchase of its joint venture partner's first mortgage and 50% partnership interest in Grove City Factory Shops Partnership on November 1, 1996. As a result of its acquisition, the Company owns 100% of this factory outlet center and, therefore, commencing November 1, 1996, its operations were included in the consolidated results of the Company. Prior to November 1, 1996, the Company accounted for its interest under the equity method of accounting. The decrease in income from investment partnerships in 1996 compared to 1995 was offset, in part, by the openings of Arizona Factory Shops (Phase II-September 1996) and Buckeye Factory Shops (Phase I-November 1996).
Interest and other income increased by $352, or 6.4%, to $5,850 during the year ended December 31, 1996 as compared to the year ended December 31, 1995. The increase reflected higher temporary and customer service income, lease termination income, and property management fees of $736, $620, and $149, respectively, partially offset by lower leasing commissions, real estate brokerage commissions, ancillary income, interest income, municipal assistance income, and construction and development management fees of $364, $278, $139, $115, $104 and $47, respectively. Also offsetting this increase was a $106 gain on the sale of land during the year ended December 31, 1995.
Property operating expense increased by $3,032, or 17.4%, to $20,421 in 1996 compared to $17,389 in 1995. Real estate taxes expense increased by $311, or 6.2%, to $5,288 in 1996 from $4,977 in 1995. Depreciation and amortization expense increased by $3,818, or 24.7%, to $19,256 in 1996, compared to $15,438 in 1995. The increases in property operating expense and real estate taxes expense, and depreciation and amortization expense were primarily due to the Portfolio Expansion, including the acquisition of two factory outlet centers from an unrelated third party and the Company's purchase of its joint venture partner's 50% partnership interest in a factory outlet center on November 1, 1996.
As shown in TABLE 6, interest expense increased by $3,664, or 17.6%, to $24,485 in 1996 compared to $20,821 in 1995. This increase reflected higher interest incurred of $4,956, an increase in amortization of interest rate protection contracts of $107 and a reduction in interest earned on interest rate protection contracts of $520, partially offset by a decrease in amortization of deferred financing costs of $907 and an increase in the amount of interest capitalized in connection with development projects of $1,012.
The increase in interest incurred was primarily attributable to an increase of approximately $86,256 in the Company's average debt outstanding during 1996 compared to 1995. Additionally, the increase in interest incurred was offset by a decrease of 0.59% in the weighted average interest rate for the year ended December 31, 1996 compared to the same period in 1995. The weighted average interest rates were 7.22% and 7.81% for 1996 and 1995, respectively.
The decrease in amortization of deferred financing costs was primarily attributable to reduced amortization expense related to certain deferred financing costs which were written-off in 1996. These costs were part of the $10,411 nonrecurring loss recorded in the second quarter of 1996 related to a binding loan commitment that the Company obtained on June 5, 1996 in connection with the Company's refinancing approximately $253,000 of debt.
Other charges increased by $6,497 to $8,586 in 1996 compared to $2,089 for 1995. This increase was primarily due to the nonrecurring loss of $6,131 described above. Excluding this nonrecurring charge, other charges increased by $366, or 17.5%, to $2,455 in 1996 reflecting a higher provision for uncollectible accounts receivable of $364, an increase in ground lease expense of $228, offset by a lower provision for potentially unsuccessful pre-development efforts of $204 and a decline in miscellaneous other charges of $22.
Liquidity and Capital Resources
Sources and Uses of Cash
For the year ended December 31, 1997, net cash provided by operating activities was $49,856, net cash used in investing activities was $229,956, and net cash provided by financing activities was $182,549.
The primary uses of cash for investing activities during 1997 included (i) costs associated with the acquisition of seven factory outlet centers and the purchase of an unrelated joint venture partner's 25% equity interest in a factory outlet center, (ii) costs associated with development and construction of expansions to existing factory outlet centers aggregating 224,000 square feet of GLA which opened during 1997, (iii) costs associated with the completion of factory outlet centers and expansions to existing factory outlet centers aggregating 930,000 square feet of GLA which opened during 1996, and (iv) costs for pre-development activities associated with future developments.
The sources of cash from financing activities during 1997 included: (i) net proceeds from public and private equity offerings totaling $242,729 and (ii) proceeds from new borrowings of $160,057. Such proceeds were partially offset by (i) principal repayments on notes payable of $175,683, (ii) preferred and common stock distributions of $33,605, and (iii) distributions to minority interests (including distributions to limited partners of the Operating Partnership) of $10,366.
Sources and Uses of Cash -- Equity Offerings
On January 10, 1997, the Company filed a Form S-3 Registration Statement (the "January 1997 Shelf Registration") with the Securities and Exchange Commission (the "SEC") to register $100,000 of the Company's equity securities. On February 20, 1997, the Company completed a public offering by issuing 2,080,000 shares of its Common Stock at $12.50 per share and 175,800 shares of its Series B Cumulative Participating Convertible Preferred Stock (the "Series B Convertible Preferred Stock") at $22.75 per share. In addition, on March 10, 1997, the underwriter of the public offering exercised its overallotment option to purchase 310,300 shares of the Company's Common Stock at $12.50 per share. As a result of the public offering and the exercise of the overallotment option, the Company received net proceeds of $31,754 that were used to (i) repay certain outstanding indebtedness aggregating $26,500, (ii) fund development and construction activities, and (iii) fund general corporate expenditures.
On June 17, 1997, the Company filed a Form S-3 Registration Statement (the "June 1997 Shelf Registration") with the SEC to register $300,000 of the Company's equity securities, including $66,122 of the Company's equity securities that remained available under the January 1997 Shelf Registration.
On August 8, 1997, the Company entered into a purchase agreement with an institutional investor providing for the issuance of a new series of cumulative convertible non-voting preferred securities (the "Series C Preferred Securities") at $13.75 per unit, or an aggregate of $60,000 in cash (the "Private Placement"). The Series C Preferred Securities pay dividends equivalent to the amount being paid on the Company's Common Stock, with an annual minimum equal to $1.18 per security. In addition, the Company, subject to certain conditions, has agreed to waive the ownership limitations otherwise applicable to the Common Stock to permit the investor to own, at any one time, the shares of Common Stock issuable upon conversion of the Series C Preferred Securities. The Company has the right to call the Series C Preferred Securities, at par, after ten years. Subject to certain conditions, the Series C Preferred Securities may be issued in the form of shares of preferred stock in the Company or preferred units of partnership interest in Prime Retail, L.P. (the "Operating Partnership") that are exchangeable for shares of preferred stock or Common Stock on a one-to-one basis. The Series C Preferred Securities may be converted into shares of Common stock on a one-to-one basis commencing August 8, 1998 (or earlier subject to certain conditions). See Note 8 - "Equity Offerings and Other Transactions" of the Notes to the Consolidated Financial Statements for additional information.
In September 1997, the Company completed a public offering of 11,500,000 shares (including 1,500,000 shares related to exercise of underwriters' overallotment option) of its Common Stock at $14.00 per share (the "September 1997 Offering"). In addition, on September 8, 1997, the Company issued 727,273 Series C Preferred Securities at $13.75 per unit pursuant to the initial sale under the Private Placement. As a result of the September 1997 Offering and the initial sale under the Private Placement (collectively, the "September Capital Transactions"), the Company received net proceeds of $161,930 after commissions and underwriting discounts. A portion of the net proceeds from the September Capital Transactions were used (i) to repay certain outstanding corporate indebtedness aggregating $113,410 and (ii) to acquire the 25% ownership interest of the Company's joint venture partner in Buckeye for $23,148 (including $22,642 of mortgage indebtedness relating to such property). The remaining net proceeds from the September Capital Transactions of $26,192 were used (i) to fund development and construction activities, (ii) to fund property acquisitions, and (iii) for general corporate purposes.
As a result of the September Offering, as of December 31, 1997, the Company had $139,000 of availability under the June 1997 Shelf Registration. From time to time, the Company will consider issuing additional equity securities under the June 1997 Shelf Registration for the development or acquisition of additional properties, the expansion and improvement of existing properties, repayment of indebtedness, and for general corporate purposes.
On December 2, 1997 the Company issued 3,636,363 shares of its Series C Preferred Securities at $13.75 per share pursuant to the final sale under the Private Placement. As a result of this issuance, the Company received net proceeds of $49,045 that were used in the acquisition of Niagara International Factory Outlets and Shasta Factory Stores.
Sources and Uses of Cash -- Property Acquisitions
On February 13, 1997, the Company, acquired Oak Creek Factory Stores, Bend Factory Outlets and Factory Outlets at Post Falls from an unrelated third party for an aggregate purchase price of $37,250. The Company financed the purchase with loan proceeds from a financial institution and a $4,000 promissory note issued to the seller. The operating results of the Company for 1997 include the results of these acquisitions effective with the closing on February 13, 1997.
Oak Creek Factory Outlets is located in Sedona, Arizona, which is north of Phoenix and south of the Grand Canyon. Oak Creek Factory Outlets contains approximately 82,000 square feet of GLA and was 100% executed at December 31, 1997. Bend Factory Outlets is located in Bend, Oregon, which is east of Eugene, Oregon and southeast of Portland. Bend Factory Outlets contains approximately 97,000 square feet of GLA and was 86% executed at December 31, 1997. Factory Outlets at Post Falls is located in Post Falls, Idaho, which is 30 miles east of Spokane, Washington. Factory Outlets at Post Falls contains approximately 179,000 square feet of GLA and was 84% executed at December 31, 1997.
On September 2, 1997, the Company acquired the 25% ownership interest in Buckeye from its joint venture partner, SBRC, for $23,148 (including $22,642 of mortgage indebtedness relating to such property), thereby increasing its ownership percentage in such property to 100%. Prior to September 2, 1997, the Company accounted for its 75% investment in Buckeye using the equity method of accounting. Commencing September 2, 1997, the operating results of Buckeye are consolidated. The Company financed the acquisition with proceeds from the September Offering.
On October 29, 1997, the Company acquired Tidewater Outlet Mall, Manufacturer's Outlet Mall, Kittery Outlet Village (collectively "Prime Retail Outlets of Kittery"), and Latham Factory Outlet Center (the "Latham Property") from an unrelated third party for an aggregate purchase price of $26,000. The Company financed the purchase primarily with the proceeds from the September Offering.
Prime Retail Outlets of Kittery are located in Kittery, Maine and serve the Boston, Massachusetts and Portland, Maine markets. Prime Retail Outlets of Kittery contain approximately 121,000 square feet of GLA, and were 100% executed as of December 31, 1997. The Latham Property is located in Latham, New York, north of Albany, New York and south of Saratoga Springs, New York. The Latham Property contains approximately 43,000 square feet of GLA and was 100% executed as of December 31, 1997.
On December 2, 1997, the Company acquired Niagara International Factory Outlets ("Niagara") and Shasta Factory Stores ("Shasta") from an unrelated third party for an aggregate purchase price of $100,975, including the assumption of mortgage indebtedness of $31,368. The Company financed the purchase with proceeds from the September Offering and the Private Placement.
Niagara is located in Niagara Falls, New York and serves Buffalo, New York; Ontario, Canada; and tourist markets. Niagara contains approximately 534,000 square feet of GLA and was 88% executed as of December 31, 1997. Shasta is located six miles west of Redding, California and serves the Northern California tourist market. Shasta contains approximately 165,000 square feet of GLA and was 91% executed as of December 31, 1997.
During 1998, the Company will explore acquisitions of factory outlet centers in the United States and in Europe as well as consider possible strategic acquisitions of other assets in the retail sector. The Company has evaluated and is evaluating such opportunities and prospects and will continue to do so throughout 1998. The Company cannot predict if any transaction will be consummated, nor the terms or form of consideration required.
Merger Agreement
On November 12, 1997 and as amended on February 1, 1998, the Company entered into a definitive merger agreement (as amended, the "Merger Agreement") with Horizon Group, Inc. ("Horizon") for an aggregate consideration of approximately $945,200, including the assumption of $556,900 of Horizon debt and estimated transaction costs. Upon completion of the transaction, the Company will own and operate 48 outlet centers totaling approximately 13,406,261 square feet of GLA, including the purchase of Horizon's joint venture partner's 50% ownership interest in Finger Lakes Outlet Center for $46,100 (the "Finger Lakes Acquisition").
Under the terms of the Merger Agreement, the Company will pay a fixed exchange ratio of 0.20 of a share of Series B Convertible Preferred Stock and 0.597 of a share of Common Stock for each share of common stock of Horizon. In addition, each common unit in Horizon Partnership will entitle the holder to receive 0.9193 of a Common Unit of the Operating Partnership that will be exchangeable for a like number of shares of Common Stock of the Company.
Immediately prior to the merger, Horizon Group Properties, Inc. ("HGP"), a subsidiary of Horizon, will become the sole general partner of Horizon/Glen Outlet Center Limited Partnership ("Horizon Partnership") and the common stock of HGP will be distributed to the shareholders of both the Company and Horizon. All of the common equity of HGP will be distributed to the convertible preferred and common shareholders and unitholders of the Company and the shareholders and limited partners of Horizon based on their ownership in the Company immediately following the merger. It is presently expected that following the merger one share of common stock of HGP will be distributed for every 10 shares of Common Stock or Common Units of the Company, and that approximately 1.196 shares of common stock of HGP will be distributed for every 10 shares of Series B Convertible Preferred Stock held in the Company. Immediately prior to the closing of the merger, the Company will pay a special cash distribution of $0.60 per share of Series B Convertible Preferred Stock and $0.50 per share/unit of Common Stock, Series C Preferred Security and Common Unit, as applicable, totaling $21,865 (the "Special Cash Distribution"). Shareholders and limited partners in Horizon will not participate in this distribution. HGP will own and operate 15 outlet centers (including Indiana Factory Shops and Nebraska Crossing Factory Stores which will be acquired from the Company) totaling 3,084,823 square feet of GLA.
The merger will be accounted for as a purchase. It is conditioned upon, among other things, the approvals of each Company's shareholders and partners and the satisfaction of other customary conditions. The closing is expected during the second quarter of 1998. The exchange of shares of Horizon for shares of the Company will be made on a tax-free basis.
The Company expects to finance the Finger Lakes Acquisition, the Special Cash Distribution and estimated closing costs of $18,750 with proceeds from certain contemplated loan facilities expected to close concurrent with the closing of the merger. There can be no assurance that the Company will be successful in obtaining the required amount of debt financing or that the terms of such loan facilities will be as favorable as the Company has experienced in prior periods.
Planned Development
Management believes that there is sufficient demand for continued development of new factory outlet centers and expansions of certain existing factory outlet centers. The Company expects to open approximately 751,000 square feet of GLA during 1998 including two new factory outlet centers currently under construction. At December 31, 1997, the budgeted remaining capital expenditures for 1998 planned developments aggregated approximately $78,200, while anticipated capital expenditures related to the completion of expansions of existing factory outlet centers opened during 1997 (aggregating 224,000 square feet of GLA) approximated $5,200.
Management believes that the Company has sufficient capital and capital commitments to fund the remaining capital expenditures associated with its 1997 and 1998 development activities. These funding requirements are expected to be met, in large
part, with the proceeds from various loan facilities, including the financing of certain unencumbered properties. If adequate financing for such development and expansion is not available, the Company may not be able to develop new centers or expand existing centers at currently planned levels.
The Company currently plans to open one new factory outlet center and several expansions in 1999 that are expected to contain approximately 400,000 square feet of GLA, in the aggregate, and have a total expected development cost of approximately $56,000. The Company expects to fund the development cost of these projects from (i) certain line of credit facilities, (ii) joint venture partners, (iii) retained cash flow from operations, (iv) construction loans, and (v) the potential sale of common or preferred equity in the public or private capital markets. As of December 31, 1997, there were no material commitments with regard to the construction of the new factory outlet centers and expansions scheduled to open in 1999. There can be no assurance that the Company will be successful in obtaining the required amount of equity capital or debt financing for the 1999 planned openings or that the terms of such capital raising activities will be as favorable as the Company has experienced in prior periods.
Debt Transactions
On February 13, 1997, the Company closed on $30,000 of loan facilities with Nomura Asset Capital Corporation. The transaction provided (i) a $27,000 nonrecourse first mortgage loan (the "First Mortgage Loan") and (ii) a junior secured loan (the "Junior Secured Loan") of $3,000. The First Mortgage Loan (i) is cross collateralized by first mortgages on three of the Company's factory outlet centers, (ii) bears a fixed rate of interest of 8.35%, and (iii) requires monthly principal and interest payments pursuant to a 360-month amortization schedule. The Junior Secured Loan is a recourse loan to the Company that (i) is secured by a pledge of excess cash flow after debt service on the First Mortgage Loan, (ii) bears a variable interest rate at the London Interbank offered rate for 30-day deposits in U.S. dollars ("30-day LIBOR") plus 1.95%, (iii) matures in three years, (iv) requires monthly interest only payments through April 10, 1998 and (v) monthly principal and interest payments thereafter.
On July 11, 1997, the Company's $15,000 unsecured line of credit (the "Corporate Line") was renewed. The purpose of the Corporate Line is to provide working capital to facilitate the funding of short-term operating cash needs of the Company. The Corporate Line bears an interest rate of 30-day LIBOR plus 2.50% and matures on July 11, 1998. No amounts were outstanding under the Corporate Line at December 31, 1997.
In September 1997, the Company repaid certain outstanding corporate indebtedness aggregating $113,410, including the Junior Secured Loan, with proceeds from certain public and private equity offerings (see Note 8 - "Equity Offerings and Other Transactions" of the Notes to the Consolidated Financial Statements). As a result of the prepayment of such indebtedness, the Company incurred an extraordinary loss of $1,423 related to the write-off of certain unamortized financing costs. The Company also incurred an extraordinary loss of $638 related to the write-off of certain unamortized financing costs in connection with the Buckeye Acquisition (see Note 5 - "Investment in Partnerships" of the Notes to the Consolidated Financial Statements).
On November 13, 1997, the Company closed on a term loan with Nomura Securities (Bermuda) Ltd. ("Nomura Securities") of $53,290 (the "Term Loan"). The Term Loan is a recourse loan to the Company that (i) is secured by a pledge of excess cash flow after debt service on a first mortgage loan collateralized by 16 of the Company's factory outlet centers, (ii) bears a variable interest rate of 30-day LIBOR plus 1.95%, (iii) matures on November 11, 1999, (iv) requires monthly interest-only payments through February 10, 1998 and monthly interest payments and quarterly principal payments thereafter that approximate a six-year amortization schedule, and (v) may be subject to earlier principal payments via "mark-to-market" of the underlying debt instrument.
In addition, on November 13, 1997, the Company closed on a term loan with Nomura Securities of $3,000 (the "Second Term Loan"). The Second Term Loan is a recourse loan to the Company that (i) is secured by a pledge of excess cash flow after debt service on a first mortgage loan collaterlized by three of the Company's factory outlet centers, (ii) bears a variable interest rate of 30-day LIBOR plus 1.95%, (iii) matures on February 13, 2000, (iv) requires monthly interest-only payments through April 10, 1998 and monthly principal and interest payments thereafter that approximate a five-year amortization schedule, and (v) may be subject to earlier principal payments via "mark-to-market" of the underlying debt instrument.
On December 2, 1997, the Company assumed a $31,328 mortgage loan in connection with the purchase of Niagara International Factory Outlets (the "Niagara Loan"). The Niagara Loan (i) bears a fixed rate of interest of 6.83%, (ii) requires monthly principal and interest payments that approximates a 25-year amortization schedule, and (iii) is collateralized by Niagara International Factory Outlets.
On December 31, 1997, the Company obtained from a financial institution a commitment for a construction mortgage loan in an amount not to exceed $20,396 (the "Construction Mortgage Loan"). The Construction Mortgage Loan (i) bears a variable interest
rate at the financial institution's prime rate or, at the Company's option, a LIBOR index plus 1.75%, (ii) matures on December 31, 1999, and (iii) requires monthly interest-only payments. The Construction Mortgage Loan is collateralized by a first mortgage on Lebanon Factory Shops, a factory outlet center located in Lebanon, Tennessee. At December 31, 1997, no amounts were outstanding on the Construction Mortgage Loan.
Debt Repayments and Preferred Stock Dividends
The Company's aggregate indebtedness was $515,265 and $499,523 at December 31, 1997 and 1996, respectively. At December 31, 1997, such indebtedness had a weighted average maturity of 6. 5 years and bore interest at a weighted average interest rate of 7.36% per annum. At December 31, 1997, $74,729 , or 14.5%, of such indebtedness bore interest at fixed rates and $440,536, or 85.5%, of such indebtedness, including $28,250 of tax-exempt bonds, bore interest at variable rates. Of the variable rate indebtedness outstanding at December 31, 1997, $355,996 is scheduled to convert to a fixed rate of 7.782% in November 1998 for the remaining five year term of such indebtedness.
At December 31, 1997, the Company held interest rate protection contracts on all $28,250 of its floating rate tax-exempt indebtedness which expire in 1999 and approximately $355,996 of other floating rate indebtedness which expire in November 1998 (or approximately 80.8% of its total floating rate indebtedness). In addition, the Company held additional interest rate protection contracts on $43,900 (of which $22,000 expires in July 1998 and $21,900 expires in April 1999) of the $355,998 floating rate indebtedness to further reduce the Company's exposure to increases in interest rates. See Note 2 -- "Summary of Significant Accounting Policies" and Note 7 -- "Bonds and Notes Payable" of the Notes to Consolidated Financial Statements for additional information concerning the accounting policies and significant terms of the interest rate protection contracts.
The Company's ratio of debt to total market capitalization at December 31, 1997 (defined as total long-term debt divided by the sum of: (a) the aggregate market value of the outstanding shares of Common Stock, assuming the full exchange of Common Units, Series C Preferred Securities into Common Stock; (b) the aggregate market value of the outstanding shares of Series B Convertible Preferred Stock; (c) the aggregate liquidation preference of the Series A Senior Cumulative Preferred Stock ("Senior Preferred Stock") at $25.00 per share; and (d) the total long-term debt of the Company) was 42.4%.
The Company is obligated to repay $13,951 and $50,179 of mortgage indebtedness during 1998 and 1999, respectively. Annualized cumulative dividends on the Company's Senior Preferred Stock, Series B Convertible Preferred Stock, and Series C Preferred securities outstanding as of December 31, 1997 are $6,038, $6,336, and $5,149, respectively. These dividends are paid quarterly, in arrears.
The Company anticipates that cash flow from operations, together with cash available from borrowings and other sources, including proceeds from the September Offering and the Private Placement, will be sufficient to satisfy its debt service obligations, expected distribution and dividend requirements and operating cash needs for the next year.
Table 9--Taxability of Distributions
TABLE 9 summarizes the taxability of distributions paid during the years ended December 31, 1997 and 1996. Distributions paid by the Company out of its current or accumulated earnings and profits (and not designated as capital gains dividends) will constitute taxable distributions to each holder. To the extent the Company makes distributions (not designated as capital gains dividends) in excess of its current and accumulated earnings and profits, such distributions will be treated first as a tax-free return of capital to each holder, reducing the adjusted basis which such holder has in his shares of stock by the amount of such distributions (but not below zero), with distributions in excess of a holder's adjusted basis in his stock taxable as capital gains (provided that the shares have been held as a capital asset).
No assurances can be made that future distributions will be treated similarly. Each holder of stock may have a different basis in its stock and, accordingly, each holder is advised to consult its tax advisors.
Economic Conditions
Substantially all of the merchants' leases contain provisions that somewhat mitigate the impact of inflation. Such provisions include clauses providing for increases in base rent and clauses enabling the Company to receive percentage rentals based on merchants' gross sales. Substantially all leases require merchants to pay their proportionate share of operating expenses, including common area maintenance, real estate taxes and promotion, thereby reducing the Company's exposure to increased costs and operating expenses resulting from inflation. At December 31, 1997, the Company maintained interest rate protection contracts to protect against increases in interest rates on certain floating rate indebtedness (see "Debt Repayments and Preferred Stock Dividends").
The Company intends to reduce operating and leasing risks by managing its existing portfolio of properties with the goal of improving its tenant mix, rental rates and lease terms and attracting high fashion, upscale manufacturers and national brand-name manufacturers as merchants.
Year 2000
Recognizing the need to ensure that the Company's operations will not be adversely impacted by year 2000 software failures, management has assessed the potential impact of the year 2000 on the processing of date-sensitive information by the Company's computerized information systems. Based on this assessment, management believes that the Company's primary computerized information systems are year 2000 compliant and the Company's operations will not be adversely impacted by year 2000 software failures. Funds from Operations
Management believes that to facilitate a clear understanding of the Company's operating results, funds from operations ("FFO") should be considered in conjunction with net income (loss) presented in accordance with GAAP. In March 1995, the National Association of Real Estate Investment Trusts ("NAREIT") established guidelines clarifying the definition of FFO. FFO is defined as net income (loss) (determined in accordance with GAAP) excluding gains (or losses) from debt restructuring and sales of property, plus depreciation and amortization after adjustments for unconsolidated partnerships and joint ventures.
The Company generally considers FFO an appropriate measure of liquidity of an equity REIT because industry analysts have accepted it as a performance measure of equity REITs. The Company's FFO is not comparable to FFO reported by other REITs that do not define the term using the current NAREIT definition or that interpret the current NAREIT definition differently than does the Company. Therefore, the Company cautions that the calculation of FFO may vary from entity to entity and as such the presentation of FFO by the Company may not be comparable to other similarly titled measures of other reporting companies. The Company believes that in order to facilitate a clear understanding of its operating results, FFO should be examined in conjunction with net income determined in accordance with GAAP. FFO does not represent cash generated from operating activities in accordance with GAAP and should not be considered as an alternative to net income as an indication of the Company's performance or to cash flows as a measure of liquidity or ability to make distributions.
TABLE 10 provides a reconciliation of income before allocation to minority interests and preferred shareholders to FFO for the years ended December 31, 1997, 1996 and 1995. FFO increased $19,081, or 69.0% to $46,718 for the year ended December 31, 1997 from $27,637 for the year ended December 31, 1996. The increase in FFO primarily reflects the $6,131 nonrecurring charge related to the prepayment of certain long-term debt in 1996, offset by the Portfolio Expansion, including the effect of the acquisition of certain properties in November 1996.
The payout ratios based on distributions made by the Company divided by FFO for the applicable periods were 103.7%, 106.4%, and 108.7%, respectively.
ITEM 8
ITEM 8 -- FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Information required by this Item is set forth at the pages indicated in Item 14(a) below.
ITEM 9
ITEM 9 -- CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
The information required by Items 10, 11, 12 and 13 (except that information regarding executive officers called for by Item 10
ITEM 14 -- EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) 1. Financial Statements
Report of Independent Auditors
Consolidated Balance Sheets of the Company as of December 31, 1997 and 1996
Consolidated Statements of Operations of the Company for the years ended December 31, 1997, 1996 and 1995
Consolidated Statements of Cash Flows of the Company for the years ended December 31,1997, 1996 and 1995
Consolidated Statements of Shareholders' Equity of the Company for the years ended December 31, 1997, 1996 and 1995
Notes to Consolidated Financial Statements of the Company
2. Financial Statement Schedules
The following financial statement schedule of the Company is included in Item 14 (d):
Report of Independent Auditors on Schedule (included with consent filed as Exhibit 23)
Schedule III--Real Estate and Accumulated Depreciation
Notes to Schedule III
All other schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions or are inapplicable, and therefore have been omitted.
3. Exhibits
Exhibit Number Description
3.1 Restated Articles of Incorporation of Prime Retail, Inc. [Restated to incorporate amendment dated August 8, 1997 for purposes of Regulation S-T Section 232.102(c) only]
3.2 Amended and Restated By-Laws of Prime Retail, Inc. [Incorporated by reference to the same titled exhibit in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1995 (File No. 0-23616).]
4.1 Form of Senior Preferred Stock Certificate [Incorporated by reference to the same titled exhibit in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1996 (File No. 0-23616).]
4.2 Form of Convertible Preferred Stock Certificate [Incorporated by reference to the same titled exhibit in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1996 (File No. 0-23616).]
4.3 Form of Common Stock Certificate [Incorporated by reference to the same titled exhibit in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1996 (File No. 0-23616).]
10.1 Amended and Restated Agreement of Limited Partnership of Prime Retail, L.P. dated as of September 8, 1997
Exhibit Number Description
10.1A Common Unit Contribution Agreement [Incorporated by reference to the same titled exhibit in the Company's registration statement on Form S-11 (Registration No. 333-1666).]
# 10.2 1994 Stock Incentive Plan [Incorporated by reference to the same titled exhibit in the Company's registration statement on Form S-11 (Registration No. 33-68536).]
# 10.3 1995 Stock Incentive Plan [Incorporated by reference to the same titled exhibit in the Company's registration statement on Form S-11 (Registration No. 333-1666).]
# 10.4 Executive Employment Agreement (Michael W. Reschke) [Incorporated by reference to the same titled exhibit in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994, as amended (File No. 0-23616).]
10.5 Combined Service and Special Distribution and Allocation Agreement (Abraham Rosenthal) [Incorporated by reference to the same titled exhibit in the Company's registration statement on Form S-4 (Registration No. 333-1784).]
10.5A Special Distribution and Allocation Agreement by and between the Company, the Operating Partnership and the Rosenthal Family LLC [Incorporated by reference to the same titled exhibit in the Company's registration statement on Form S-4 (Registration No. 333-1784).]
10.5B Indemnification and Option Agreement by and between the Prime Group, Inc., the Rosenthal Family LLC and Abraham Rosenthal [Incorporated by reference to the same titled exhibit in the Company's registration statement on Form S-4 (Registration No. 333-1784).]
10.6 Combined Service and Special Distribution and Allocation Agreement (William H. Carpenter, Jr.) [Incorporated by reference to the same titled exhibit in the Company's registration statement on Form S-4 (Registration No. 333-1784).]
10.6A Special Distribution and Allocation Agreement by and between the Company, the Operating Partnership and the Carpenter Family Associates LLC [Incorporated by reference to the same titled exhibit in the Company's registration statement on Form S-4 (Registration No. 333-1784).]
10.6B Indemnification and Option Agreement by and between the Prime Group, Inc., William H. Carpenter, Jr. and the Carpenter Family Associates LLC [Incorporated by reference to the same titled exhibit in the Company's registration statement on Form S-4 (Registration No. 333-1784).]
# 10.7 Form of Executive Employment Agreement (David G. Phillips) [Incorporated by reference to the same titled exhibit in the Company's registration statement on Form S-11 (Registration No.33-68536).]
# 10.8 Letter Agreement with R. Bruce Armiger [Incorporated by reference to the same titled exhibit in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994, as amended (File No. 0-23616).]
10.9 Right of First Refusal Agreement (Northgate Plaza--Improved Parcel) [Incorporated by reference to the same titled exhibit in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994, as amended (File No. 0-23616).]
10.10 Right of First Refusal Agreement (Northgate Plaza--Vacant Parcel) [Incorporated by reference to the same titled exhibit in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994, as amended (File No. 0-23616).]
Exhibit Number Description
10.11 Right of First Refusal Agreement (Huntley Factory Shops) [Incorporated by reference to the same titled exhibit in the Company's registration statement on Form S-11 (Registration No. 33-68536).]
10.12 Right of First Refusal Agreement (San Marcos Factory Shops) [Incorporated by reference to the same titled exhibit in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994, as amended (File No. 0-23616).]
10.13 Purchase Option Agreement (Northgate Plaza--Excluded Parcel) [Incorporated by reference to the same titled exhibit in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994, as amended (File No. 0-23616).]
10.14A Purchase Option Agreement (Huntley Factory Shops) [Incorporated by reference to the same titled exhibit in the Company's registration statement on Form S-11 (Registration No. 33-68536).]
10.14B First Amendment to Purchase and Option Agreement (Huntley Factory Shops) [Incorporated by reference to the same titled exhibit in the Company's registration statement on Form S-11 (Registration No. 333-1666).]
10.15 Registration Rights Agreement [Incorporated by reference to the same titled exhibit in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994, as amended (File No. 0-23616).]
10.16 Form of Property Level General Partnership Agreement [Incorporated by reference to the same titled exhibit in the Company's registration statement on Form S-11 (Registration No. 33-68536).]
10.17 Form of Property Level Limited Partnership Agreement [Incorporated by reference to the same titled exhibit in the Company's registration statement on Form S-11 (Registration No. 33-68536).]
10.18 Noncompetition and Restriction Agreement with Michael W. Reschke of PGI [Incorporated by reference to the same titled exhibit in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994, as amended (File No. 0-23616).]
10.19 Second Amended and Restated Subscription Agreement of Abraham Rosenthal regarding Common Units of Prime Retail, L.P. [Incorporated by reference to the same titled exhibit in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994, as amended (File No. 0-23616).]
10.20 Second Amended and Restated Subscription Agreement of William H. Carpenter, Jr. regarding Common Units of Prime Retail, L.P. [Incorporated by reference to the same titled exhibit in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994, as amended (File No. 0-23616).]
10.21 Revolving Loan Agreement dated March 2, 1995 between Gainesville Factory shops Limited Partnership, Florida Keys Factory Shops Limited Partnership, Indianapolis Factory Shops Limited Partnership and Nomura Asset Capital Corporation [Incorporated by reference to the same titled exhibit in the Company's Current Report on Form 8-K dated December 18, 1995 (File No. 0-23616).]
# 10.22 Consulting Agreement between the Company and Marvin Traub Associates, Inc. [Incorporated by reference to the same titled exhibit in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1996 (File No. 0-23616).]
10.23 Secured Promissory Note of Rosenthal Family LLC with respect to the purchase of the Restricted Common Units [Incorporated by reference to the same titled exhibit in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994, as amended (File No. 0-23616).]
10.23A Allonge related to the Secured Promissory Note of Rosenthal Family LLC [Incorporated by reference to the same titled exhibit in the Company's registration statement on Form S-4 (Registration No. 333-1784).]
10.24 Secured Promissory Note of Carpenter Family Associates LLC with respect to the purchase of the Restricted Common Units [Incorporated by reference to the same titled exhibit in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994, as amended (File No 0-23616).]
10.24A Allonge related to the Secured Promissory Note of Carpenter Family Associates LLC [Incorporated by reference to the same titled exhibit in the Company's registration statement on Form S-4 (Registration No. 333- 1784).]
10.25 Pledge and Security Agreement of Rosenthal Family LLC with respect to the purchase of the Restricted Common Units [Incorporated by reference to the same titled exhibit in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994, as amended (File No. 0-23616).]
10.26 Pledge and Security Agreement of Carpenter Family Associates LLC with respect to the purchase of the Restricted Common Units [Incorporated by reference to the same titled exhibit in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994, as amended (File No. 0-23616).]
10.27 Guaranty of Abraham Rosenthal with respect to the purchase of the Restricted Common Units [Incorporated by reference to the same titled exhibit in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994, as amended (File No. 0-23616).]
10.27A Reaffirmation of Pledge and Guaranty with respect to the Restricted Common Units of Rosenthal Family LLC and Abraham Rosenthal [Incorporated by reference to the same titled exhibit in the Company's registration statement on Form S-4 (Registration No. 333-1784).]
10.28 Guaranty of William H. Carpenter, Jr. with respect to the purchase of the Restricted Common Units [Incorporated by reference to the same titled exhibit in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994, as amended (File No. 0-23616).]
10.28A Reaffirmation of Pledge and Guaranty with respect to the Restricted Common Units of Carpenter Family Associates LLC and William H. Carpenter, Jr. [Incorporated by reference to the same titled exhibit in the Company's registration statement on Form S-4 (Registration No. 333-1784).]
10.29 Waiver, Recontribution and Indemnity Agreement by the Limited Partners [Incorporated by reference to the same titled exhibit in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994, as amended (File No. 0-23616).]
10.30 Indemnity Agreement made by the Company in favor of Prime Group, Inc. and Prime Group Limited Partnership [Incorporated by reference to the same titled exhibit in the Company's registration statement on Form S-11 (Registration No. 333-1666).]
10.31 Promissory Note dated October 31, 1996 by and between Prime Retail, L.P. and Nomura Asset Capital Corporation [Incorporated by reference to the same titled exhibit in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1996 (File No. 0-23616).]
Exhibit Number Description
10.31A Form of Deed of Trust, Security Agreement, Assignment of Rents and Fixture Filings with Nomura Asset Capital Corporation [Incorporated by reference to the same titled exhibit in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1996 (File No. 0-23616).]
10.32 Form of Standby Bond Purchase and Indemnity Agreement [Incorporated by reference to the same titled exhibit in the Company's registration statement on Form S-11 (Registration No. 33-68536).]
10.33 Consulting Agreement between the Company and Financo, Inc. [Incorporated by reference to the same titled exhibit in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1996 (File No. 0-23616).]
10.34 Amended and Restated Agreement and Plan of Merger among Prime Retail, Inc., Prime Retail, L.P., Horizon Group, Inc., Sky Merger Corp., Horizon Group Properties, Inc., Horizon Group Properties, L.P., and Horizon/Glen Outlet Centers Limited Partnership dated as of February 1, 1998 [Incorporated by reference to the same titled exhibit in the Company's Current Report on Form 8-K dated February 1, 1998 (File No. 0-23616).]
10.35 Agreement among Prime Retail, Inc., Horizon Group, Inc., Mr. David H. Murdock, Castle & Cooke Properties, Inc., and Pacific Holding Company dated as of February 1, 1998 [Incorporated by reference to the same titled exhibit in the Company's Current Report on Form 8-K dated February 1, 1998 (File No. 0-23616).]
# 10.36 Letter Agreement with David G. Phillips regarding the purchase of units in Prime Retail, L.P. dated August 6,
12 Statement re Computation of Ratio Earnings to Combined Fixed Charges and Preferred Stock Dividends
21 Subsidiaries of Prime Retail, Inc.
23 Consent of Ernst & Young LLP
27.1 Financial Data Schedule
27.2 Financial Data Schedule -- Restated 1997 Interim Periods
27.3 Financial Data Schedule -- Restated 1996 Periods
Note: # Management contract or compensatory plan or arrangement required to be filed pursuant to Item 14(c).
(b) Reports on Form 8-K
On October 29, 1997, the Company filed a Current Report on Form 8-K, dated October 29, 1997, reporting that the Company purchased Tidewater Outlet Mall, Manufacturer's Outlet Mall, Kittery Outlet Village (collectively "Prime Retail Outlets of Kittery") and Latham Factory Outlet Center. No financial statements were included.
On November 12, 1997, the Company filed a Current Report on Form 8-K, dated November 12, 1997, reporting that the Company and Horizon Group, Inc. entered into a definitive merger agreement. No financial statements were included.
On December 2, 1997, the Company filed a Current Report on Form 8-K, dated December 2, 1997, reporting that the Company purchased Niagara International Factory Outlets and Shasta Factory Stores. No financial statements were included.
On December 31, 1997, the Company filed a Current Report on Form 8-K/A, dated October 29, 1997, reporting that the Company purchased Prime Retail Outlets of Kittery, Latham Factory Outlet Center, Niagara International Factory Outlets and Shasta Factory Stores. Proforma consolidated financial statements of the Company and audited statements of revenue and certain expenses of the acquired properties were filed with this Form 8-K/A.
On February 1, 1998, the Company filed a Current Report on Form 8-K, dated February 1, 1998, reporting the amended merger agreement between the Company and Horizon Group, Inc. No financial statements were included.
(c) Exhibits
The list of exhibits filed with this report is set forth in response to Item 14 (a)(3). The required exhibits have been filed as indicated in the Exhibit Index. The Company agrees to furnish a copy of any long-term debt instrument wherein the securities authorized do not exceed 10 percent of the registrant's total assets on a consolidated basis upon the request of the Securities and Exchange Commission.
(d) Financial Statements and Schedules
Schedule III -- Real Estate and Accumulated Depreciation attached hereto is hereby incorporated by reference to this Item.
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.
PRIME RETAIL, INC.
Dated: March 25, 1998 /s/ Abraham Rosenthal --------------------- Abraham Rosenthal Chief Executive Officer
Dated: March 25, 1998 /s/ Robert P. Mulreaney ----------------------- Robert P. Mulreaney Executive Vice President, Chief Financial Officer and Treasurer
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 date indicated.
/s/ Michael W. Reschke March 25, 1998 ------------------------------------------------- Michael W. Reschke Chairman of the Board
/s/ Abraham Rosenthal March 25, 1998 Abraham Rosenthal Chief Executive Officer and Director
/s/ William H. Carpenter, Jr. March 25, 1998 ------------------------------------------------- William H. Carpenter, Jr. President, Chief Operating Officer and Director
/s/ Glenn D. Reschke March 25, 1998 ------------------------------------------------- Glenn D. Reschke Executive Vice President, Development and Acquisitions and Director
/s/ Terence C. Golden March 25, 1998 ------------------------------------------------- Terence C. Golden Director
/s/ Kenneth A. Randall March 25, 1998 ------------------------------------------------- Kenneth A. Randall Director
/s/ Sharon Sharpe March 25, 1998 Sharon Sharpe Director
/s/ James R. Thompson March 25, 1998 ------------------------------------------------- James R. Thompson Director
/s/ Marvin S. Traub March 25, 1998 ------------------------------------------------- Marvin S. Traub Director
Report of Independent Auditors
To the Board of Directors and Shareholders Prime Retail, Inc.
We have audited the accompanying consolidated balance sheets of Prime Retail, Inc. (the "Company") as of December 31, 1997 and 1996 and the related consolidated statements of operations, shareholders' equity and cash flows for each of the three years in the period ended December 31, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with 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 the Company at December 31, 1997 and 1996, the consolidated results of the Company's operations and its cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles.
/s/ Ernst & Young LLP
Baltimore, Maryland January 23, 1998, except for Note 15, as to which the date is February 1, 1998
See accompanying notes to financial statements.
See accompanying notes to financial statements.
See accompanying notes to financial statements.
See accompanying notes to financial statements.
PRIME RETAIL, INC.
Notes to Consolidated Financial Statements of the Company
(Amounts in thousands, except share and unit information)
Note 1 -- Organization and Basis of Presentation
Organization
Prime Retail, Inc. (the "Company") was organized as a Maryland corporation on July 16, 1993. The Company is a self-administered and self-managed real estate investment trust ("REIT") that develops, acquires, owns and operates factory outlet centers in the United States. The Company's factory outlet center portfolio, including three factory outlet centers owned through joint venture partnerships, consists of 28 factory outlet centers in 20 states, which total approximately 7,217,000 square feet of gross leasable area ("GLA") at December 31, 1997. As a fully-integrated real estate firm, the Company provides development, construction, accounting, finance, leasing, marketing, and management services for all of its properties (the "Properties"). The Company's Properties are held and all of its business and operations are conducted through Prime Retail, L.P. (the "Operating Partnership"). The Company controls the Operating Partnership as its sole general partner and is dependent upon the distributions or other payments from the Operating Partnership to meet its financial obligations.
At December 31, 1997, the Company owned 2,300,000 Senior Preferred Units of the Operating Partnership (the "Senior Preferred Units"), 2,981,800 Series B Convertible Preferred Units of the Operating Partnership (the "Series B Convertible Preferred Units"), 3,636,363 Series C Preferred Units of the Operating Partnership (the "Series C Preferred Units"), and 27,294,951 Common Units of partnership interest in the Operating Partnership (the "Common Units"). Each Senior Preferred Unit, Series B Convertible Preferred Unit, and Series C Preferred Unit (collectively, the "Preferred Units") entitles the Company to receive distributions from the Operating Partnership in an amount equal to the dividend declared or paid with respect to a share of the Company's Series A Senior Cumulative Preferred Stock ("Senior Preferred Stock"), Series B Cumulative Participating Preferred Stock ("Series B Convertible Preferred Stock"), and Series C Cumulative Participating Convertible Redeemable Preferred Stock ("Series C Preferred Stock"), respectively, prior to the payment by the Operating Partnership of distributions with respect to the Common Units. Series B Convertible Preferred Units and Series C Preferred Units will be automatically converted into Common Units to the extent of any conversion of Series B Convertible Preferred Stock or Series C Preferred Stock into Common Stock. The Preferred Units will be redeemed by the Operating Partnership to the extent of any redemption of Senior Preferred Stock, Series B Convertible Preferred Stock, or Series C Preferred Stock. (See Note 8 "Equity Offerings and Other Transactions" of the Notes to the Consolidated Financial Statements for additional information concerning equity transactions that were completed by the Company in 1996 and 1997.)
A summary of the holders of units in the Operating Partnership as of December 31, 1997 is as follows:
Note: (1) Includes 742,180 units beneficially owned by management and 4,091,255 units owned by certain executive officers based on their ownership interests in PGI.
As of December 31, 1997, the Company has a 76.2% general partnership interest in the Operating Partnership with full and complete control over the management of the Operating Partnership as the sole general partner not subject to removal by the limited partners.
The Operating Partnership is the 1% sole general partner of Prime Retail Services Limited Partnership (the "Services Partnership"). The Operating Partnership owns 100% of the non-voting preferred stock of Prime Retail Services, Inc. (the "Services Corporation") which, in turn, is the 99% limited partner of the Services Partnership. Certain members of management own 100% of the voting common stock of the Services Corporation and no cash distributions were made during the years ended December 31, 1997, 1996 and 1995. The Services Partnership was formed primarily to operate business lines of the Company that are not directly associated with the collection of rents. The Services Corporation is subject to federal, state and local taxes.
Unless the context otherwise requires, all references to the Company herein mean Prime Retail, Inc. and those entities owned or controlled by Prime Retail, Inc., including the Operating Partnership and the Services Partnership.
Basis of Presentation
The consolidated financial statements include the accounts of the Company, the Operating Partnership and the partnerships in which the Company has operational control. Profits and losses are allocated in accordance with the terms of the agreement of limited partnership of the Operating Partnership. The preparation of financial statements in conformity with generally accepted accounting principles ("GAAP") 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.
Investments in partnerships in which the Company does not have operational control are accounted for on the equity method of accounting. Income (loss) applicable to minority interests and common shares as presented in the consolidated statements of operations is allocated based on income (loss) before minority interests after income allocated to preferred shareholders.
Significant intercompany accounts and transactions have been eliminated in consolidation and combination.
Note 2 -- Summary of Significant Accounting Policies
Rental Property
Depreciation is calculated on the straight-line basis over the estimated useful lives of the assets which are as follows:
Land improvements.................................... 20 years Buildings and improvements........................... Principally 40 years Tenant improvements.................................. Term of related lease Furniture and equipment.............................. 5 years
Rental property is carried at historical cost net of accumulated depreciation. Development costs, which include fees and costs incurred in developing new properties, are capitalized as incurred. Upon completion of construction, development costs are amortized over the useful lives of the respective properties on a straight-line basis. The Company evaluates its rental properties periodically to assess whether any impairment indications are present, including recurring operating losses and significant adverse changes in the business climate that affect the recovery of recorded asset value. If any rental property is considered impaired, a loss is provided to reduce the carrying value of the asset to its estimated fair value. No impairment losses have been recorded in any of the periods presented.
Expenditures for ordinary maintenance and repairs are expensed to operations as incurred. Significant renovations and improvements which improve and/or extend the useful life of assets are capitalized and depreciated over their estimated useful lives.
Cash Equivalents
The Company considers highly liquid investments with a maturity of three months or less when purchased to be cash equivalents.
Accounts Receivable
Management regularly reviews accounts receivable and determines an appropriate range for the allowance for doubtful accounts based upon the impact of economic conditions on the merchants' ability to pay, past collection experience and such other factors which, in management's judgment, deserve current recognition. In turn, a provision is charged against earnings in order to maintain the allowance level within this range. The allowance for doubtful accounts at December 31, 1997 and 1996 was $1,780 and $1,349, respectively.
Accounts receivable due after one year primarily representing straight-line rents were $5,969 and $5,310 at December 31, 1997 and 1996, respectively.
Deferred Charges
Deferred charges consist of leasing commissions and financing costs. Deferred leasing commissions incurred to originate and renew operating leases are amortized on a straight-line basis over the term of the related lease. Fees and costs incurred to obtain financing are deferred and are being amortized as a component of interest expense over the terms of the respective loans on a basis that approximates the interest method.
Revenue Recognition
Leases with tenants are accounted for as operating leases. Minimum rental income is recognized on a straight-line basis over the term of the lease and unpaid rents are included in accounts receivable in the accompanying balance sheet. Certain lease agreements contain provisions which provide for rents based on a percentage of sales or based on a percentage of sales volume above a specified threshold. In addition, the lease agreements generally provide for the reimbursement of real estate taxes, insurance, advertising and certain common area maintenance costs. These additional rents and tenant reimbursements are accounted for on the accrual basis.
Earnings per Share
On December 31, 1997, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings per Share" which specifies the method of computation, presentation, and disclosure for earnings per share ("EPS"). SFAS No. 128 requires the presentation of basic EPS and diluted EPS. Basic EPS is calculated by dividing net income available to common shareholders by the weighted average number of shares outstanding during the period. Diluted EPS includes the potentially dilutive effect, if any, which would occur if outstanding (i) options to purchase Common Stock were exercised, (ii) Common Units were converted into shares of Common Stock, (iii) shares of Series C Preferred Stock and Units were converted into shares of Common Stock, and (iv) Series B Convertible Preferred Stock were converted into shares of Common Stock. For all periods presented, the effect of these exercises and conversions was anti-dilutive and, therefore, dilutive EPS is equivalent to basic EPS.
Interest Rate Protection Contracts
The Company uses interest rate protection contracts, including interest rate caps and corridors, to manage interest rate risk associated with floating rate debt. These contracts generally involve limiting the Company's interest costs with an upper limit or specified range on the underlying interest rate index. The cost of such contracts are included in deferred charges and are being amortized on a straight-line basis as a component of interest expense over the life of the contracts. Amounts earned from interest rate protection contracts are recorded as a reduction of interest expense. The Company is exposed to credit losses in the event of counterparty nonperformance, but does not anticipate any such losses based on the creditworthiness of the counterparties.
Stock Based Compensation
The Company accounts for stock option grants in accordance with Accounting Principles Board Opinion ("APB") No. 25, "Accounting for Stock Issued to Employees" and, accordingly, recognizes no compensation expense for stock option grants. The Company has elected to adopt only the disclosure provisions of SFAS No. 123, "Accounting for Stock-Based Compensation."
Income Taxes
The Company has elected to be taxed as a REIT under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended. As a REIT, the Company generally will not be subject to federal income tax at the corporate level on income it distributes to its shareholders so long as it distributes at least 95% of its taxable income (excluding any net capital gain) each year. If the Company fails to qualify as a REIT in any taxable year, the Company will be subject to federal income tax (including any applicable alternative minimum tax) on its taxable income at regular corporate rates. Even if the Company qualifies as a REIT, the Company may be subject to certain state and local taxes on its income and property. The Company incurred $263, $116, and $90 for state and local taxes for the years ended December 31, 1997, 1996 and 1995, respectively. The Company paid $170, $102, and $81 of state and local income taxes during the years ended December 31, 1997 and 1996, and 1995, respectively.
The following table summarizes the taxability of dividends and distributions paid during the years ended December 31, 1997, 1996 and 1995:
Risks and Uncertainties
The Company's results of operations are significantly dependent on the overall health of the retail industry. The Company's tenant base is comprised almost exclusively of merchants in the retail industry. The retail industry is subject to external factors such as inflation, consumer confidence, unemployment rates and consumer tastes and preferences. A decline in the retail industry could reduce merchant sales, which could adversely affect the operating results of the Company. A number of the merchants have occupied space in more than one of the Company's factory outlet centers; however, no single merchant accounts for more than 5.7% of the Company's revenues.
Note 3 -- Restricted Cash
At December 31, 1997 and 1996, the Company had placed in escrow $41,736 and $45,127, respectively, to be used to complete certain development projects, to fund real estate taxes and debt service and to pay certain operating costs under a mortgage loan agreement. At December 31, 1997, restricted cash included $34,692 relating to a nonrecourse expansion loan which can only be used to fund certain development costs relating to the expansion of 13 of the Company's factory outlet centers, provided certain occupancy and other conditions have been attained.
Note 4 -- Deferred Charges
Deferred charges were as follows:
Note 5 -- Investment In Partnerships
At December 31, 1997, the Company owned a 50% partnership interest in two real estate ventures that are accounted for using the equity method of accounting. The Company manages these ventures and earns a property management fee based on the ventures' revenues. The condensed combined balance sheets of these ventures and their condensed statements of operations are summarized as follows:
As of December 31, 1997, the Company guaranteed long-term debt of joint venture partnerships of $24,019.
On September 2, 1997, the Company acquired a 25% ownership interest in Buckeye Factory Shops Limited Partnership ("Buckeye") from its joint venture partner for $23,148 (including $22,642 of mortgage indebtedness relating to such property), thereby increasing its ownership percentage in such property to 100% (the "Buckeye Acquisition"). Prior to September 2, 1997, the Company accounted for its 75% investment in Buckeye using the equity method of accounting. Commencing September 2, 1997, the operating results of Buckeye are consolidated. As a result of the prepayment of the mortgage indebtedness noted above, the joint venture partnership incurred an extraordinary loss of $851 related to the write-off of certain unamortized financing costs totaling $624 and a debt prepayment penalty of $227. The Company's 75% share of the extraordinary loss, or $638, is included in the extraordinary loss in the Consolidated Statements of Operations.
Note 6 -- Related Party Transactions
At December 31, 1997, the net amount due from affiliates consisted of $1,052 due from joint venture partnerships relating to reimbursement of costs paid by the Company on their behalf. At December 31, 1996, the net amount due from affiliates consisted of $595 due from joint venture partnerships relating to reimbursement of costs paid by the Company on their behalf and $954 of fees due from joint venture partnerships in connection with the development of two factory outlet centers.
Note 7 -- Bonds and Notes Payable
Under the terms of the loan agreements relating to the Bonds, the issuing partnerships are required to make interest-only payments calculated using a variable rate determined by the remarketing agents of the Bonds. The interest rates ranged from 3.00% to 4.70% in 1997, 2.45% to 5.30% in 1996 and 2.65% to 5.30% in 1995. Under certain conditions, the interest rate on the Bonds may be converted to a fixed rate at the request of the Company. A bondholder may tender bonds during the variable interest rate period and receive principal, plus accrued interest through the tender date. Upon tender, the remarketing agents are required to immediately remarket the Bonds. In the event the remarketing agents fail to remarket any bonds, the remarketing agents may draw on certain liquidity facilities as described below. The remarketing agents receive fees varying from 0.1% to 0.125% per annum on the outstanding bond balance, payable quarterly in arrears.
At December 31, 1997, the Bonds are collateralized by letters of credit (the "Letters of Credit") issued by a group of financial institutions pursuant to a master letter of credit agreement. A letter of credit fee of 1.0% per annum of the stated amount of the Letters of Credit is payable quarterly in advance to such financial institutions. The Letters of Credit are collateralized by a reimbursement agreement under the master letter of credit agreement (the "Reimbursement Agreement") which obligates an insurance company to reimburse the financial institutions for any funds drawn on the Letters of Credit. In addition, in March 1994, the issuing partnerships, the Operating Partnership and an insurance company entered into standby bond purchase and indemnity agreements (the "Standby Agreements") in order to address the scheduled expirations of various credit enhancements, including the Letters of Credit, through March 21, 1999.
Pursuant to the Standby Agreements, the insurance company agreed that in the event that any of the issuing partnerships are unable to arrange replacement credit enhancement facilities as necessary, the insurance company will purchase the applicable Bonds and hold the same until March 21, 1999, at which time the issuing partnership and the Operating Partnership will purchase the Bonds pursuant to the terms of the related Standby Agreement.
The Letters of Credit are scheduled to expire on December 31, 1998. The total commitments outstanding under the Letters of Credit, the Reimbursement Agreement and the Standby Agreements as of December 31, 1997 were $28,909. The due date of the Bonds accelerates upon the expiration of the Letters of Credit unless the Letters of Credit are extended or replaced.
The scheduled maturities of bonds and notes payable at December 31, 1997 were as follows:
The aggregate carrying amount of bonds and notes payable at December 31, 1997 approximated their fair value. At December 31, 1997, the aggregate carrying amount of rental property collateralizing bonds and notes payable was $712,247.
At December 31, 1997, the Company held interest rate protection contracts on all $28,250 of its floating rate tax-exempt indebtedness which expire in 1999 and approximately $355,996 of other floating rate indebtedness which expire in November 1998. In addition, the Company purchased additional interest rate protection contracts on $43,900 (of which $22,000 expires in July 1998 and $21,900 expires in April 1999) of the $355,996 floating rate indebtedness to further reduce the Company's exposure to increases in interest rates. These contracts have a weighted average maturity of approximately 0.9 years.
The following table summarizes the material terms of the interest rate protection contracts held for purposes other than trading and related borrowings at December 31, 1997:
The net carrying amount of interest rate protection contracts at December 31, 1997 was $1,266. The estimated fair value of interest rate protection contracts based on quoted market rates at December 31, 1997 was $99.
On February 13, 1997, the Company closed on $30,000 of loan facilities with Nomura Asset Capital Corporation. The transaction provided (i) a $27,000 nonrecourse first mortgage loan (the "First Mortgage Loan") and (ii) a junior secured loan (the "Junior Secured Loan") of $3,000. The First Mortgage Loan (i) is cross collateralized by first mortgages on three of the Company's factory outlet centers, (ii) bears a fixed rate of interest of 8.35%, and (iii) requires monthly principal and interest payments pursuant to a 360-month amortization schedule. The Junior Secured Loan is a recourse loan to the Company that (i) is secured by a pledge of excess cash flow after debt service on the First Mortgage Loan, (ii) bears a variable interest rate at the London Interbank offered rate for 30-day deposits in U.S. dollars ("30-day LIBOR") plus 1.95%, (iii) matures in three years and (iv) requires monthly interest only payments through April 10, 1998 and monthly principal and interest payments thereafter.
On July 11, 1997, the Company's $15,000 unsecured line of credit (the "Corporate Line") was renewed. The purpose of the Corporate Line is to provide working capital to facilitate the funding of short-term operating cash needs of the Company. The Corporate Line bears an interest rate of 30-day LIBOR plus 2.50% and matures on July 11, 1998. No amounts were outstanding under the Corporate Line at December 31, 1997.
In September 1997, the Company repaid certain outstanding corporate indebtedness aggregating $113,410, including the Junior Secured Loan, with proceeds from certain public and private equity offerings (see Note 8 - "Equity Offerings and Other Transactions" of the Notes to the Consolidated Financial Statements). As a result of the prepayment of such indebtedness, the Company incurred an extraordinary loss of $1,423 related to the write-off of certain unamortized financing costs. The Company also incurred an extraordinary loss of $638 related to the write-off of certain unamortized financing costs in connection with the Buckeye Acquisition (see Note 5 - "Investment in Partnerships" of the Notes to the Consolidated Financial Statements).
On November 13, 1997, the Company closed on a term loan with Nomura Securities (Bermuda) Ltd. ("Nomura Securities") of $53,290 (the "Term Loan"). The Term Loan is a recourse loan to the Company that (i) is secured by a pledge of excess cash flow after debt service on a first mortgage loan collateralized by 16 of the Company's factory outlet centers, (ii) bears a variable interest rate of 30-day LIBOR plus 1.95%, (iii) matures on November 11, 1999, (iv) requires monthly interest-only payments through February 10, 1998 and monthly interest payments and quarterly principal payments thereafter that approximate a six-year amortization schedule, and (v) may be subject to earlier principal payments via "mark-to-market" of the underlying debt instrument.
In addition, on November 13, 1997, the Company closed on a term loan with Nomura Securities of $3,000 (the "Second Term Loan"). The Second Term Loan is a recourse loan to the Company that (i) is secured by a pledge of excess cash flow after debt service on a first mortgage loan collaterlized by three of the Company's factory outlet centers, (ii) bears a variable interest rate of 30-day LIBOR plus 1.95%, (iii) matures on February 13, 2000, (iv) requires monthly interest-only payments through April 10, 1998 and monthly principal and interest payments thereafter that approximate a five-year amortization schedule, and (v) may be subject to earlier principal payments via "mark-to-market" of the underlying debt instrument.
On December 2, 1997, the Company assumed a $31,328 mortgage loan in connection with the purchase of Niagara International Factory Outlets (the "Niagara Loan"). The Niagara Loan (i) bears a fixed rate of interest of 6.83%, (ii) requires monthly principal and interest payments that approximates a 25-year amortization schedule, and (iii) is collateralized by Niagara International Factory Outlets.
On December 31, 1997, the Company obtained from a financial institution a commitment for a construction mortgage loan in an amount not to exceed $20,396 (the "Construction Mortgage Loan"). The Construction Mortgage Loan (i) bears a variable interest rate at the financial institution's prime rate or, at the Company's option, a LIBOR index plus 1.75%, (ii) matures on December 31, 1999, and (iii) requires monthly interest-only payments. The Construction Mortgage Loan is collateralized by a first mortgage on Lebanon Factory Shops, a factory outlet center located in Lebanon, Tennessee. At December 31, 1997, no amounts were outstanding on the Construction Mortgage Loan.
Note 8 - Equity Offerings and Other Transactions
On June 27, 1996, the Company completed a registered exchange offer (the "Exchange Offer") to exchange shares of its Common Stock for up to 4,209,000 shares, or 60%, of its Series B Convertible Preferred Stock. The Company received tender offers for 4,648,650 shares, or approximately 66.27%, of the Series B Convertible Preferred Stock. A proration factor was applied to each share of Series B Convertible Preferred Stock validly tendered by holders, and on June 27, 1996, the Company issued 6,734,323 shares of its Common Stock. In connection with the Exchange Offer, certain affiliates of the Company who are limited partners of the Operating Partnership (the "Limited Partners") contributed to the Operating Partnership 625,000 common units for cancellation. In addition, on June 26, 1996, the Company's Board of Directors approved a special cash distribution (the "Special Cash Distribution") on its Common Stock of $1,393, or $0.145 per common share, to holders of record on June 27, 1996. The Special Cash Distribution was paid on July 15, 1996. The Limited Partners were not entitled to receive and did not receive any portion of the Special Cash Distribution.
On February 20, 1997, the Company completed a public offering by issuing 2,080,000 shares of its Common Stock at $12.50 per share and 175,800 shares of its Series B Convertible Preferred Stock at $22.75 per share. In addition, on March 10, 1997, the underwriter of the public offering exercised its overallotment option to purchase 310,300 shares of the Company's Common Stock at $12.50 per share. As a result of the public offering and the exercise of the overallotment option, the Company received net proceeds of $31,754 that were used to (i) repay certain outstanding indebtedness aggregating $26,500, (ii) to fund development and construction activities, and (iii) for general corporate purposes.
On August 8, 1997, the Company entered into a purchase agreement with Security Capital Preferred Growth Incorporated ("Security Capital") providing for the issuance of a new series of cumulative convertible non-voting preferred securities (the "Series C Preferred Securities") at $13.75 per share, or an aggregate of $60,000 in cash (the "Private Placement"). The Series C Preferred Securities pay dividends equivalent to the amount being paid on the Company's Common Stock, with an annual minimum equal to $1.18 per security. In addition, the Company, subject to certain conditions, has agreed to waive the ownership limitations otherwise applicable to the Common Stock to permit Security Capital to own, at any one time, the shares of Common Stock issuable upon conversion of the Series C Preferred Securities. The Company has the right to call the Series C Preferred Securities, at par, after 10 years. Subject to certain conditions,the Series C Preferred Securities may be issued in the form of shares of preferred stock in the Company or preferred units of partnership interest in the Operating Partnership that are exchangeable for shares of preferred stock or Common Stock on a one-to-one basis. The Series C Preferred Securities may be converted into shares of Common Stock on a one-to-one basis commencing August 8, 1998 (or earlier subject to certain conditions).
In September 1997, the Company completed a public offering of 11,500,000 shares (including 1,500,000 shares related to the exercise of the underwriters' overallotment option) of its Common Stock at $14.00 per share (the "September 1997 Offering"). In addition, on September 8, 1997, the Company issued 727,273 Series C Preferred Units at $13.75 per unit pursuant to the initial sale under the Private Placement. As a result of the September 1997 Offering and the initial draw on the Private Placement (collectively, the "September Capital Transactions"), the Company received net proceeds of $161,930 after commissions and underwriting discounts. A portion of the net proceeds from the September Capital Transactions were used (i) to repay certain outstanding corporate indebtedness aggregating $113,410 and (ii) to acquire the 25% ownership interest of the Company's joint venture partner in Buckeye for $23,148 (including $22,642 of mortgage indebtedness relating to such property). The remaining net proceeds from the September Capital Transactions of $26,192 were used (i) to fund development and construction activities, (ii) to fund property acquisitions, and (iii) for general corporate purposes.
On December 2, 1997, the Company issued 3,636,363 shares of its Series C Preferred Stock at $13.75 per share pursuant to the final sale under the Private Placement. As a result of this issuance, the Company received net proceeds of $49,045 that were used in the acquisition of Niagara International Factory Outlets and Shasta Factory Stores.
Note 9 -- Minority Interests
In conjunction with the formation of the Company and the Operating Partnership, the predecessor owners contributed interests in certain properties to the Operating Partnership and, in exchange, received limited partnership interests in the Operating Partnership. Subject to certain conditions, each Common Unit held by a Limited Partner may be exchanged for one share of Common Stock or, at the option of the Company, cash equal to the fair market value of a share of Common Stock at the time of exchange. As of December 31, 1997, 8,505,472 Common Units were issued and outstanding. Minority interests also includes interests in three property partnerships that are not wholly owned by the Company. During the years ended December 31, 1997, 1996 and 1995, expenses totaling $1,468, $884, and $1,049, respectively, related solely to the operation of the Company were allocated only to the common shareholders. Such allocation is consistent with the federal and state tax treatment of these expenses. During the year ended December 31, 1996, cash distributions and losses allocated to minority interests reduced the minority interests balance to zero. After reducing the minority interests balance to zero, additional distributions and losses of $8,739 and $3,457 that were allocable to minority interests were allocated to common shareholders during the years ended December 31, 1997 and 1996, respectively.
On September 8, 1997 the Company issued 727,273 Series C Preferred Units at $13.75 per unit pursuant to the initial $10,000 sale under the Private Placement (see Note 8 - "Equity Offerings and Other Transactions" of the Notes to the Consolidated Financial Statements). The terms of the Series C Preferred Units are substantially the same as those of the Series C Preferred Stock (see Note 10 - "Preferred Stock" of the Notes to the Consolidated Financial Statements). The net proceeds of $9,710 from the issuance of the Series C Preferred Units are included in minority interests in the Consolidated Balance Sheets.
At December 31, 1997 and 1996, loans to certain limited partners, who also are executive officers of the Company, aggregating $4,750 were reported as a reduction in minority interests in the Consolidated Balance Sheets.
Note 10 -- Preferred Stock
The Company is authorized to issue up to 24,315,000 shares of preferred stock in one or more series. At December 31, 1997, 2,300,000 shares Senior Preferred Stock, 2,981,800 shares of Series B Convertible Preferred Stock, and 3,636,363 shares of Series C Preferred Stock were issued and outstanding. The Senior Preferred Stock and Series B Convertible Preferred Stock have a liquidation preference equivalent to $25.00 per share plus the amount equal to any accrued and unpaid dividends thereon. The Series C Preferred Stock has a liquidation preference equivalent to $13.75 per share plus the amount equal to any accrued and unpaid dividends thereon.
Dividends on the Senior Preferred Stock are payable quarterly in the amount of $2.625 per share per annum. Dividends on the Series B Convertible Preferred Stock are payable quarterly at the greater of (i) $2.125 per share per annum or (ii) the dividends on the number of shares of Common Stock into which a share of Series B Convertible Preferred Stock will be convertible at the conversion price of $20.90 per share of Common Stock. At December 31, 1997, there were 3,566,746 shares of Common Stock reserved for future issuance upon conversion of the Series B Convertible Preferred Stock. Dividends on the Series C Preferred Stock are equivalent to the amount being paid on the Company's Common Stock, with an annual minimum equal to $1.18 per share.
The Company has the right to redeem the Senior Preferred Stock and the Series B Convertible Preferred Stock beginning on and after March 31, 1999 at $26.75 and$27.125 per share, respectively, plus the amount equal to any accrued and unpaid dividends thereon. The redemption price decreases incrementally each year thereafter through March 31, 2004, at which date the redemption price is fixed at $25.00 per share plus the amount equal to any accrued and unpai dividends thereon. The Company, subject to certain conditions, has agreed to waive the ownership limitations otherwise applicable to the Common Stock to permit Security Capital to own, at any one time, the shares of Common Stock issuable upon conversion of the Series C Preferred Securities. The Company has the right to call the Series C Preferred Stock, at par, after 10 years. The Series C Preferred Stock is convertible into shares of Common Stoc on a one-to-one basis, subject to adjustment, commencing August 8, 1998 or earlier subject to certain conditions.
The holders of the Senior Preferred Stock and Convertible Preferred Stock, each series voting separately as a class, have the right to elect two additional members to the Company's Board of Directors if the equivalent of six quarterly dividends on these series of preferred stock are in arrears Each of such two directors will be elected to serve until the earlier of (i) the election and qualification of such directors' successor, or (ii) payment of the dividend arrearage. If distributions on any Series C Preferred Stock have been in arrears for two consecutive quarters or the Company fails to pay distributions on the Common Stock in an amount per share at least equal to $0.25 (subject to adjustment) for two consecutive quarters, the number of directors of the Company shall be increased by one (or two if the board of directors of the Company then consists of 10 or more members) as elected by the holders of Series C Preferred Stock together with the holders of shares on a parity as to distributions with the Series C Preferred Stock, voting as a single class regardless of series. Each of such two directors will be elected to serve until the earlier of (i) the election and qualification of such directors' successor, or (ii) payment of the dividend arrearage.
Note 11 -- Stock Option Plans
Under the Company's 1994 and 1995 Stock Option Plans, options to purchase shares of the Company's Common Stock have been or may be granted. The option price for shares granted under these plans is the fair market value on the grant date.
In 1994, the Company granted options to executive officers, outside directors and consultants to purchase 585,000 shares of Common Stock at $19.00 per share. The options granted to executive officers vest at a rate of 20% per year over five years and have a term of 10 years. The options granted to outside directors and consultants (aggregating 35,000 options) were fully vested at the grant date and have a term of 10 years.
In 1995, the Company granted options to purchase 20,000 common shares at $12.45 per share to outside directors and consultants. These options were fully vested at the grant date and have a term of 10 years.
In 1996, the Company granted options to executive officers, other key employees and consultants to purchase 302,500 shares of Common Stock at exercise prices ranging from $11.46 to $11.88 per share. These options were fully vested at the grant date and have a term of 10 years.
In 1997, the Company granted options to executive officers and other key employees to purchase 196,250 shares of Common Stock at an exercise price of $12.53 per share. These options were fully vested at the grant date and have a term of 10 years.
Unaudited pro forma information regarding net income and earnings per share is required by SFAS No. 123, which requires that the information be determined as if the Company has accounted for its stock options granted subsequent to December 31, 1994 under the fair value method of SFAS No. 123. 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:
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions 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 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 stock options.
For purposes of unaudited pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' applicable vesting period. The Company's unaudited pro forma information for the years ended December 31, 1997, 1996 and 1995 follows :
Options on 961,253, 640,253 and 224,750 shares were exercisable at December 31, 1997, 1996, and 1995, respectively, at a weighted average exercise price of $15.32 per share, $15.45 per share, and $18.42 per share, respectively. The weighted fair value of options granted during the years ended December 31, 1997, 1996, and 1995 was $1.90 per share, $1.69 per share, and $1.60 per share respectively. Exercise prices for options outstanding at December 31, 1997 ranged from $11.46 to $19.00 per share. The weighted average remaining contractual life of those options is 7.3 years. Under the Company's 1994 and 1995 Stock Option Plans, there were 106,250 and 311,500 shares reserved for future grants at December 31, 1997 and 1996, respectively.
Note 12 -- Lease Agreements
The Company is the lessor of retail and office space under operating leases with initial lease terms that expire from 1998 to 2016. Most leases are renewable for five years at the lessee's option. Future minimum base rent to be received under noncancelable operating leases were as follows:
The Company leases certain land, buildings, and equipment under various noncancelable operating lease agreements. Rental expense for operating leases was $1,059, $1,011, and $961for the years ended December 31, 1997, 1996, and 1995, respectively. Future minimum rental payments, by year and in the aggregate, payable under these noncancelable operating leases with initial or remaining terms of one year or more consisted of the following:
Note 13 -- Legal Proceedings
In the ordinary course of business, the Company is subject to certain legal actions. While any litigation contains an element of uncertainty, management believes that losses, if any, resulting from such matters, will not have a material adverse effect on the consolidated financial statements of the Company.
Note 14 -- Property Acquisitions
On November 1, 1996, the Company acquired Rocky Mountain Factory Stores and Kansas City Factory Outlets for an aggregate purchase price of $71,700.
On November 1, 1996, the Company purchased its joint venture partner's first mortgage on and 50% ownership interest in Grove City Factory Shops for $57,094 thereby increasing its ownership interest in such property to 100%.
On February 13, 1997, the Company, acquired Oak Creek Factory Stores, Bend Factory Outlets and Factory Outlets at Post Falls from an unrelated third party for an aggregate purchase price of $37,250. The Company financed the purchase with loan proceeds from a financial institution and a $4,000 promissory note issued to the seller. The operating results of the Company for 1997 include the results of these acquisitions effective with the closing on February 13, 1997.
On September 2, 1997, the Company acquired a 25% ownership interest in Buckeye from its joint venture partner for $23,148 (including $22,642 of mortgage indebtedness relating to such property), thereby increasing its ownership percentage in such property to 100%. Prior to September 2, 1997, the Company accounted for its 75% investment in Buckeye using the equity method of accounting. Commencing September 2, 1997, the operating results of Buckeye are consolidated. The Company financed the acquisition with proceeds from the September 1997 Offering.
On October 29, 1997, the Company acquired Tidewater Outlet Mall, Manufacturer's Outlet Mall, Kittery Outlet Village (collectively "Prime Retail Outlets of Kittery"), and Latham Factory Outlet Center (the "Latham Property") from an unrelated third party for an aggregate purchase price of $26,000. The Company financed the purchase primarily with the proceeds from the September 1997 Offering.
In addition, on December 2, 1997, the Company acquired Niagara International Factory Outlets ("Niagara") and Shasta Factory Stores ("Shasta") from an unrelated third party for an aggregate purchase price of $100,975, including the assumption of mortgage indebtedness of $31,368. The Company financed the purchase with proceeds from the September 1997 Offering and the Private Placement.
These unaudited pro forma results have been prepared for comparative purposes only and include certain adjustments, such as additional depreciation expense based on the purchase price of such assets acquired and interest expense on debt incurred on financing the acquisitions. These unaudited pro forma results do not purport to be indicative of the results of operations which actually would have resulted had the combination been in effect on January 1, 1996 or of future results of operations of the Company.
Note 15-- Merger Agreement
On November 12, 1997 and as amended on February 1, 1998, the Company entered into a definitive merger agreement (as amended, the "Merger Agreement") with Horizon Group, Inc. ("Horizon") for an aggregate consideration of approximately $945,200, including the assumption of $556,900 of Horizon debt and transaction costs. Upon completion of the transaction, the Company will own and operate 48 outlet centers totaling approximately 13,406,261 square feet of GLA.
Under the terms of the Merger Agreement, the Company will pay a fixed exchange ratio of 0.20 of a share of Series B Convertible Preferred Stock and 0.597 of a share of Common Stock for each share of common stock of Horizon. In addition, each common unit in Horizon Partnership will entitle the holder to receive 0.9193 of a Common Unit of the Operating Partnership that will be exchangeable for a like number of shares of Common Stock of the Company.
Immediately prior to the merger, Horizon Group Properties, Inc.("HGP"), a subsidiary of Horizon, will become the sole general partner of Horizon/Glen Outlet Center Limited Partnership ("Horizon Partnership") and the common stock of HGP will be distributed to the shareholders of both the Company and Horizon. All of the common equity of HGP will be distributed to the convertible preferred and common shareholders and unitholders of the Company and the shareholders and limited partners of Horizon based on their ownership in the Company immediately following the merger. It is presently expected that following the merger one share of common stock of HGP will be distributed for every 10 shares of Common Stock or Common Units of the Company, and that approximately 1.196 shares of common stock of HGP will be distributed for every 10 shares of Series B Convertible Preferred Stock held in the Company. Immediately prior to the closing of the merger, the Company will pay a special cash distribution of $0.60 per share of Series B Convertible Preferred Stock and $0.50 per share/unit of Common Stock, Series C Preferred Security and Common Unit, as applicable Shareholders and limited partners in Horizon will not participate in this distribution. HGP will own and operate 15 outlet centers (including Indiana Factory Shops and Nebraska Crossing Factory Stores which will be acquired from the Company) totaling 3,084,823 square feet of GLA.
The merger will be accounted for as a purchase. It is conditioned upon, among other things, the approvals of each Company's shareholders and partners and the satisfaction of other customary conditions. The closing is expected during the second quarter of 1998. The exchange of shares of Horizon for shares of the Company will be made on a tax-free basis.
On December 10, 1997, a shareholder of Horizon filed a purported class action lawsuit in the Circuit Court for Muskegon County, Michigan against Horizon, the Company, and certain directors and former directors of Horizon claiming, among other things, that Horizon's directors breached their fiduciary duties to Horizon's shareholders in approving the merger of Horizon and the Company and that the consideration to be paid to Horizon's shareholders in connection with the merger is unfair and inadequate. The lawsuit requests that such merger be enjoined or, in the event that the purported transaction is consummated, that it be rescinded or unspecified damages be awarded to the class members. On January 16, 1998, the defendants answered the complaint, denying that the Horizon board of directors breached their fiduciary duties and denying that such consideration is unfair or inadequate. Although the Company is named as a defendant in the complaint, the substantive allegations focus on the actions of Horizon and its board of directors and not on any actions of the Company or its board of directors. Since this litigation is in the initial phases of discovery, its outcome is not susceptible to easy or certain prediction; however, the Company intends to defend itself vigorously.
PRIME RETAIL, INC.
Notes to Schedule III - Real Estate and Accumulated Depreciation
December 31, 1997
(in thousands)
Depreciation on building and improvements is calculated on a straight-line basis over the estimated useful lives of the asset as follows:
Land improvements....................................20 years Buildings and improvements...............Principally 40 years Tenant improvements.....................Term of related lease Furniture and equipment...............................5 years
The aggregate cost for federal income tax purposes was $986,004 at December 31, 1997.