ITEM 1. BUSINESS THE COMPANY
Crescent Operating, Inc. ("Crescent Operating" or the "Company"), a Delaware corporation, was formed on April 1, 1997, by Crescent Real Estate Equities Company ("Crescent Equities" or "CEI") and its subsidiary Crescent Real Estate Equities Limited Partnership ("Crescent Partnership"). Effective June 12, 1997 Crescent Equities distributed shares of Crescent Operating common stock to shareholders of Crescent Equities and unit holders of Crescent Partnership, and, on that date, Crescent Operating became a public company. Crescent Operating was formed to be the lessee and operator of certain assets owned or to be acquired by Crescent Partnership. The relationship between the Company and Crescent Partnership is governed by the "Intercompany Agreement" which provides the Company and Crescent Partnership with rights to participate in certain transactions. The Company also engages in other business enterprises not related to Crescent Equities or the Intercompany Agreement, such as the Equipment Sales and Leasing segment. Unless the context otherwise requires, the terms "Crescent Operating", "the Company", "Crescent Equities", "CEI" and "Crescent Partnership" include the subsidiaries of each and, in the case of "CEI" and "Crescent Equities", includes "Crescent Partnership".
On December 17, 1999, President Clinton signed into law the REIT Modernization Act which will become effective after December 31, 2000, and contains a provision that would permit real estate investments trusts ("REITS"), such as Crescent Equities, to own and operate certain types of investments that are currently owned and operated by Crescent Operating. The REIT Modernization Act is expected to reduce the number of business opportunities that Crescent Equities would otherwise offer to the Company pursuant to the Intercompany Agreement. Crescent Equities has expressed an interest in certain of the investments currently owned or operated by the Company that the REIT Modernization Act would allow Crescent Equities to own or operate. Crescent Operating is exploring alternatives with Crescent Equities regarding a potential future transaction with respect to certain of the Company's assets. See Transactions with Crescent Partnership for further discussions of the Intercompany Agreement.
On October 25, 1999, the Company received notice from The Nasdaq-Amex Market Group (the "Nasdaq") that, for the 30 consecutive trading days preceding such date, the Company's common stock failed to maintain a closing bid price of greater than or equal to $5.00 per share, the minimum closing bid price required for continued listing under
the Nasdaq National Market System ("NMS") maintenance standard applicable to the Company. On March 3, 2000, the Company had a hearing before a Nasdaq panel to determine whether the Company will be permitted to maintain its NMS listing. Pending the outcome of the hearing, the Company's common stock will continue to be listed for trading on NMS. In the event of an unfavorable outcome of the hearing, the Company intends to apply for listing on the Nasdaq SmallCap Market. While the Company believes it satisfies the requirements for listing on the Nasdaq SmallCap Market, there can be no assurances that Nasdaq will approve listing of the Company's shares on such market.
Crescent Operating, through various subsidiaries and affiliates, has assets and operations comprising four business segments: (i) Equipment Sales and Leasing, (ii) Hospitality, (iii) Temperature Controlled Logistics (formerly Refrigerated Warehousing) and (iv) Land Development. Within these segments the Company owned the following for all or some portion of 1999:
o THE EQUIPMENT SALES AND LEASING SEGMENT consisted of a wholly owned interest in Crescent Machinery Company, a construction equipment sales, leasing and service company with 18 locations in seven states.
o THE HOSPITALITY SEGMENT consisted of (i) the Company's lessee interests in the Denver Marriott City Center, the Hyatt Regency Beaver Creek, the Hyatt Regency Albuquerque, Canyon Ranch-Tucson, Canyon Ranch-Lenox, the Ventana Inn and Spa, the Sonoma Mission Inn and Spa (including the Sonoma Mission Inn Golf and Country Club), the Four Seasons Hotel in Houston, Texas and the Renaissance Hotel in Houston, Texas (collectively, the "Hospitality Properties"), (ii) a two-thirds interest in the Houston Center Athletic Club Venture (see Hospitality Segment - Recent Developments) and (iii) a 5% economic interest in CRL Investments, Inc. ("CRL"), which has an investment in the Canyon Ranch Day Spa in the Venetian Hotel in Las Vegas, Nevada and participates in the future use of the "Canyon Ranch" name.
o THE TEMPERATURE CONTROLLED LOGISTICS SEGMENT consisted primarily of a 40% interest in the operations of Vornado Crescent Logistics Operating Partnership ("AmeriCold Logistics"), which currently operates 104 refrigerated storage properties with an aggregate storage capacity of approximately 519.2 million cubic feet, and a 1% interest in Crescent CS Holdings Corporation ("CS I") and Crescent CS Holdings II Corporation ("CS II", and together with CS I, the "Temperature Controlled Logistics Partnerships").
o THE LAND DEVELOPMENT SEGMENT consisted of (i) a 4.65% economic interest in Desert Mountain, a master planned, luxury residential and recreational community in northern Scottsdale, Arizona, (ii) a 42.5% general partner interest in The Woodlands Operating Company, L.P. ("Woodlands Operating"), (iii) a 2.125% economic interest in The Woodlands Land Development Company L.P. ("Landevco"), (iv) a 50% economic interest in COPI Colorado, LP ("COPI Colorado"), a company that has a 10% economic interest in Crescent Development Management Corp. ("CDMC") and (v) a 5% economic interest in an entity which owns a 6.19% interest in the construction and operation of a new multipurpose entertainment and sports center (the "Arena Project") in downtown Dallas, Texas as well as a 2.6% economic interest in Hillwood/1642, Ltd. See Land Development Segment - Recent Developments.
The Company has previously written-off its entire investment and has no obligation or commitment to fund CBHS ongoing operations. As a result of the write-off, and irrespective of the transactions described in Note 3 to the Company's financial statements, the Company does not anticipate that it will recognize any additional CBHS losses for accounting purposes. The Company does incur costs of ownership related to the CBHS investment, such as legal and accounting costs, and COPI Healthcare incurs costs related to due diligence on the assets it has offered to purchase out of bankruptcy. See Other Investments - Charter Behavioral Health Systems, LLC - Recent Developments. Because the Company has written-off its CBHS investment and did not recognize income or loss from CBHS in 1999, the Company no longer reports its operations related to CBHS as a separate segment.
SEGMENT FINANCIAL INFORMATION (AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA)
The following is a summary of Crescent Operating's financial information reported by segment for the year ended December 31, 1999:
(1) EBITDA represents earnings before interest, income taxes, depreciation and amortization. Amounts are calculated based on the Company's ownership percentage of the EBITDA components. Management believes that EBITDA can be a meaningful measure of the Company's operating performance, cash generation and ability to service debt. However, EBITDA should not be considered as an alternative to either: (i) net earnings (determined in accordance with GAAP); (ii) operating cash flow (determined in accordance with GAAP); or (iii) liquidity. There can be no assurance that the Company's calculation of EBITDA is comparable to similarly titled items reported by other companies.
EQUIPMENT SALES AND LEASING
OVERVIEW
Crescent Machinery is engaged in the sale, leasing and service of construction equipment and accessories to the construction and utility industries located primarily in seven states. The Company has dramatically expanded the equipment sales and leasing business it acquired in 1997. Historically, construction equipment businesses have been owned and operated primarily by individuals in a localized area. Crescent Operating has consolidated some of these businesses in order to gain improvement through purchasing and operating efficiencies. All of the Crescent Machinery locations are registered equipment dealers representing major lines of equipment. This differentiates Crescent Machinery from some of its pure rent-to-rent competition. Crescent Machinery's locations offer new and used equipment for sale and rent, have factory trained service personnel and provide parts and warranty service.
The management of Crescent Machinery is focused on increasing the rental and leasing components of Crescent Machinery's business, which management believes have the potential to generate higher profit margins while maintaining the sales and service aspects of the dealership. Management believes that Crescent Machinery's status as an equipment dealer affords it a competitive advantage because Crescent Machinery is able to stock rental and leasing equipment at reduced costs that are offered only to equipment dealers and national accounts. Additionally, dealerships have significant advantages over rental yards in down cycles that occur in the industry. In down cycles, contractors will retain their equipment longer, and as a consequence, additional service and parts, which are provided by dealerships, are required. The growth of rental fleet, while positioning Crescent Machinery to compete more effectively in its markets, has resulted in, and during the foreseeable future is likely to result in, increased depreciation and interest expense.
Crescent Machinery's operations are seasonal, and adverse weather conditions, such as extended periods of precipitation, could adversely affect its operations. The months of June through October typically have the greatest positive impact and the months of December, January and February typically have the greatest negative impact on the Company's consolidated results.
Crescent Machinery competes with various large and small companies. Crescent Machinery believes that the principal competitive factors in its markets for sale and rental of the construction equipment and accessories it offers are availability of requested equipment, competitive pricing, product features, parts and service. Crescent Machinery's products and services are marketed directly by its sales force.
Crescent Machinery's acquisition efforts are limited by access to capital to fund acquisitions and by the Company's depressed stock prices, which adversely affects the ability of Crescent Machinery to use the Company's stock as consideration in acquisitions. Crescent Operating opened a new start-up location in Fort Worth, Texas in August 1999 and the Company believes that it has other opportunities to open new start-up locations in proximity to its current operations and to expand its business with limited capital requirements.
RECENT DEVELOPMENTS
Effective March 4, 1999, the Company acquired certain assets of Westco Tractor & Equipment, Inc. ("Westco"), a company engaged in equipment sales, leasing and servicing, located in Santa Rosa, California. The purchase price of approximately $2.6 million was comprised of $0.5 million cash and the assumption of liabilities of $2.1 million.
Effective July 1, 1999, the Company acquired all of the stock of E. L. Lester and Company ("Lester"), a company engaged in equipment sales, leasing and servicing, located in Houston, Texas. Lester specializes in the sales and rental of 8 to 300-ton conventional and hydraulic cranes to highway, building and industrial contractors. The purchase price of approximately $17.2 million was comprised of $8.9 million cash, the issuance of notes payable by Crescent Operating in the amount of $6.0 million and the assumption of liabilities of $2.3 million.
Effective July 1, 1999, the Company acquired all of the stock of Solveson Crane Rental, Inc. ("Solveson"), a company engaged in equipment sales, leasing and servicing, located in Tracy, California. Solveson specializes in
the rental of 40 to 90-ton rough terrain cranes to highway, building and industrial contractors. The purchase price of approximately $7.3 million was comprised of $3.0 million cash and the assumption of liabilities of $4.3 million.
On August 1, 1999, Crescent Machinery opened a new location located in Fort Worth, Texas. This location offers new equipment sales, equipment rental, parts and services. A full assortment of rental equipment is available and products from JCB, Ingersoll Rand, Terex Cranes, Target and Pioneer are available for new equipment sales.
With the completion of the Lester, Solveson, and Westco acquisitions, and the opening of the new location in Fort Worth, Texas, Crescent Machinery has 18 locations in Texas, California, Nevada, Oklahoma, Ohio, Indiana and Hawaii.
OPERATIONAL STATISTICS
(1) Same store rental equipment revenue grew 26% from 1999 to 1998.
MARKET INFORMATION
According to survey's conducted by The CIT Group, it is expected that over 25% more contractors will turn to distributors for their rental needs during 2000 as compared to 1999. Top items in demand for rent are backhoes, loaders, excavating equipment and cranes. Crescent Machinery has all such equipment available for rent or purchase at each of its locations.
Additionally, Crescent Machinery is beginning to realize an increase in highway construction-related business partially as a result of the Transportation Equity Act for the 21st Century ("TEA-21"). TEA-21 provides for record federal highway program funding of $173 billion over the next five years, which represents a 40% increase over previous funding levels. In Texas and California, the states in which Crescent Machinery is most active, the percentage increase in federal funding for highway programs over previous levels is 60% and 45%, respectively.
HOSPITALITY
OVERVIEW
The Hospitality segment generally consists of the operations of the Hospitality Properties. Each of such properties is owned by Crescent Partnership or its affiliates and all are leased to subsidiaries of the Company under long term leases. In addition to these properties, the Company also has other investments in CRL and, until January 2000, the Houston Center Athletic Club Venture ("HCAC").
The Hospitality Properties are comprised of unique luxury resorts, luxury business and convention hotels and destination health and fitness resorts and make up a small portion of the hospitality industry. Because Crescent Operating, for the most part, relies on third-party operators such as Marriott, Hyatt and Four Seasons, the Company enjoys the advantage of the third-party operators' nationwide advertising, reservation services and strong management.
The Company has limited the potential impact of downturns in the hospitality industry on the Company by limiting Crescent Operating's guarantee of rent payments. The Company's guarantee related to rent payments is limited to
cash generated by the Hospitality segment, i.e. cash flows from segments other than Hospitality would not be used to fund rent payments in the event cash flows of the Hospitality Properties were less than scheduled rent payments.
The individual Hospitality Properties are affected by seasonality; however, the seasonal fluctuations are varied and are determined by both location and the nature of the business conducted on the property. The effects of seasonality of the Hospitality Properties are generally offsetting; however, March and October have the greatest positive impact and November through January have the greatest negative impact on the Company's consolidated results.
The Company's Hospitality Properties in Denver, Albuquerque and Houston are business and convention center hotels that compete against other similar hotels in their markets. The Company believes, however, that its destination health and fitness resorts are unique properties that have very limited competition. In addition, the Company believes that the other remaining Hospitality Properties experience limited or no direct competition due to their high replacement costs and unique concepts or locations. The Hospitality Properties do compete, to a limited extent, against business class hotels or middle-market resorts in their geographic areas, as well as against luxury resorts nationwide and around the world.
The Company has a 5% economic interest, representing all of the voting stock of CRL. CRL has a 20% economic interest in CR License LLC ("CR License"), the entity which owns the rights to the future use of the "Canyon Ranch" name. CRL has the opportunity through July of 2000 to pay $3.0 million to obtain an additional 10% interest in CR License. CRL also has an effective 60% economic interest in the Canyon Ranch Spa Club located in the Venetian Hotel in Las Vegas. The Canyon Ranch Spa Club opened in June 1999 and is the first project to expand the franchise value of the "Canyon Ranch" name.
RECENT DEVELOPMENTS
Effective January 31, 2000, HCAC sold substantially all of its assets to an unrelated party. Through a wholly owned subsidiary, the Company received proceeds from the sale of $2.4 million resulting in an approximate $1.5 million gain which will be recognized by Crescent Operating in the first quarter of 2000.
In February 2000, Crescent Operating and its hospitality subsidiaries entered into a Master Asset Management and Administrative Services Agreement and property management agreements with Sonoma Management Company ("SMC") to manage the Company's hotel properties (excluding Canyon Ranch - Lenox, Canyon Ranch - Tucson and the Hyatt Regency Beaver Creek). At the same time, the Company's hospitality subsidiaries accepted assignment from the owners of the Sonoma Mission Inn and Spa, the Sonoma Mission Inn Golf and Country Club and the Ventana Inn and Spa of its property management agreements with Sonoma Management Company. The principles of Sonoma Management Company are Sanjay and Johanna Varma and Crescent Equities is an equity owner in Sonoma Management Company.
HOTELS AND DESTINATION HEALTH AND FITNESS RESORTS
The hotels and destination health and fitness resorts operated by the Company are as follows:
o Hyatt Regency Beaver Creek;
o Denver Marriott City Center;
o Hyatt Regency Albuquerque;
o Sonoma Mission Inn and Spa;
o Four Seasons Hotel Houston;
o Ventana Inn and Spa;
o Renaissance Houston Hotel;
o Canyon Ranch-Tucson; and
o Canyon Ranch-Lenox.
Crescent Partnership has committed over $40 million towards capital projects at certain of the Hospitality Properties to further enhance the guests' experience. The projects include:
o 30 new suites at the Sonoma Mission Inn and Spa which are expected to be completed during the second quarter of 2000 and the spa expansion, which was completed in December 1999;
o renovation of the guestrooms and common areas at the Four Seasons Hotel in Houston which are expected to be completed during the third quarter of 2000;
o renovation of the Renaissance Hotel in Houston which is expected to be completed during the third quarter of 2000; and
o four new suites and a new spa which were completed at the Ventana Inn and Spa during September 1999.
Certain of the above projects generate increased rent and the related construction of the projects causes a temporary reduction in the average daily rate of the hotel due to the negative impact on the guests' experience during construction.
Each of the Hospitality Properties is under lease with Crescent Equities, with terms that expire from December 2004 to June 2009 and generally provide for (i) base rent, with periodic rent increases, (ii) percentage rent based on a percentage of gross hotel revenues less food and beverage revenues above a specified amount and (iii) a percentage of gross food and beverage revenues above a specified amount. Under the leases, the Company's subsidiaries have assumed the rights and obligations of the property owner under the respective management agreement with the hotel operators (including the property management agreements with Sonoma Management Company for Sonoma Mission Inn and Spa, Sonoma Mission Inn Golf and Country Club and Ventana Inn and Spa), as well as the obligation to pay all property taxes and other charges against the property. As part of each of the lease agreements for eight of the Hospitality Properties, Crescent Equities has agreed to fund all capital expenditures relating to furniture, fixtures and equipment reserves required under the applicable management agreements. The only exception is Canyon Ranch-Tucson, in which instance the Company owns all furniture, fixtures and equipment associated with the property and will fund all related capital expenditures.
All of the Company's properties, except for the Sonoma Mission Inn and Spa, Sonoma Mission Inn Golf and Country Club and the Ventana Inn and Spa, are managed by third party operators. Through 1999, Sonoma Mission Inn and Spa, Sonoma Mission Inn Golf and Country Club and the Ventana Inn and Spa were managed by the Company with asset management oversight provided by The Varma Group. Crescent Operating, through its subsidiaries, had asset management agreements (the "Asset Management Agreements") with The Varma Group through 1999, such that The Varma Group was the exclusive asset manager of the Company's Hospitality Properties. Johanna Varma is a principal of The Varma Group and was President of the Hospitality division of the Company until February 2000.
As consideration for its services under the Asset Management Agreements, which became cancelable by the Company on January 30, 2000 and were terminated effective February 1, 2000, The Varma Group received an annual base fee in 1999 of approximately $0.7 million, plus annual cost of living adjustments for its asset management services related to the Hyatt Albuquerque, the Hyatt Beaver Creek, Sonoma Mission Inn and Spa and the Denver City Center Marriott. In addition, The Varma Group was reimbursed for its costs incurred in providing asset management to the other Hospitality Properties.
OPERATIONAL STATISTICS
The following table sets forth certain information about the Hospitality Properties, excluding the Sonoma Mission Inn Golf and Country Club, HCAC and CRL, for the years ended December 31, 1999 and 1998. The information below is based on available rooms, except for Canyon Ranch-Tucson and Canyon Ranch-Lenox, which are destination health and fitness resorts that measure performance based on available guest nights.
(1) In 1998, the number of rooms was reduced to 276 due to 19 rooms being converted into a 20,000 square foot spa.
(2) In February 1999, 20 rooms were taken out of commission during the construction of the spa, which is part of an approximately $20 million expansion scheduled to be completed in April 2000. The expansion will also include the construction of 30 additional guest rooms. Rates were discounted during the construction period, which resulted in a lower average daily rate and revenue per available room in 1999, as compared to 1998.
(3) Average occupancy and REVPAR decreased from the prior period due to the closing of the Ventana Inn and Spa for approximately three months as a result of the major access road leading to the property being washed out.
(4) Represents available guest nights, which is the maximum number of guests that the resort can accommodate per night.
(5) Represents the number of paying and complimentary guests for the period, divided by the maximum number of available guest nights for the period.
(6) Represents the average daily "all-inclusive" guest package charges for the period, divided by the average daily number of paying guests for the period.
(7) Represents the total "all-inclusive" guest package charges for the period, divided by the maximum number of available guest nights for the period.
(8) The lease related to the Sonoma Mission Inn Golf and Country Club expires in October 2008.
MARKET INFORMATION
The following is derived from various industry sources. Average hotel room rental rates grew 4.0%, 4.4%, 6.2% and 6.3%, in 1999, 1998, 1997, and 1996, respectively. Within the luxury and upscale segments of the industry, average room rental rates increased approximately 3.3% from 1998 to 1999.
Business and convention travel accounts for about two-thirds of overall room demand and has risen along with the improving economy and increased corporate profits. Domestic leisure travel has also increased, especially among the "baby boomers," who are not only at the prime age for leisure travel but also have a greater tendency to travel than previous generations. A healthier, more active senior population is also contributing to the increase in travel. With the aging of the "baby boomer" generation and the growing interest in quality of life activities, the resort/spa industry also is experiencing significant growth in the United States.
TEMPERATURE CONTROLLED LOGISTICS
OVERVIEW
The Temperature Controlled Logistics segment consisted primarily of a 40% interest in the operations of AmeriCold Logistics, and a 1% interest in the Temperature Controlled Logistics Partnerships. AmeriCold Logistics, headquartered in Atlanta, Georgia, has 6,900 employees and operates 104 temperature controlled storage facilities nationwide with an aggregate of approximately 519 million cubic feet of refrigerated, frozen and dry storage space. Of the 104 warehouses, AmeriCold Logistics leases 89 temperature controlled facilities with an aggregate of approximately 428 million cubic feet from the Temperature Controlled Logistics Partnerships, and manages 15 additional facilities containing approximately 91 million cubic feet of space. AmeriCold Logistics provides the frozen food industry with refrigerated storage and transportation management services.
AmeriCold Logistics entered into leases covering the refrigerated storage facilities used in its business. The leases, which commenced in March 1999, generally have a 15-year term with two five-year renewal options and provide for the payment of fixed base rent and percentage rent based on revenues AmeriCold Logistics receives from its customers. Fixed base rent is approximately $130 million per annum through 2003, $132.0 million per annum from 2004 through 2008 and $133.0 million per annum from 2009 through 2014. Percentage rent for each lease is based on a specified percentage of revenues in excess of a specified base amount. The aggregate base revenue amount under five of the six leases is approximately $321.0 million and the weighted average percentage rate is approximately 36% for the initial five-year period, approximately 39% for the period from 2004 through 2008 and approximately 41% for the period from 2009 through February 28, 2014. The aggregate base revenue amount under the sixth lease is approximately $32.0 million and the percentage rate is 24% for the initial two-year period, 37.5% for the period from 2002 through 2006, 40% from 2007 through 2011 and 41% from 2012 through February 28, 2014. AmeriCold Logistics recognized $135.8 million of rent expense from March 11, 1999 (acquisition date) through December 31, 1999. AmeriCold Logistics is required to pay for all costs arising from the operation, maintenance and repair of the properties, including all real estate taxes and assessments, utility charges, permit fees and insurance premiums, as well as property capital expenditures in excess of $5.0 million annually. AmeriCold Logistics has the right to defer the payment of 15% of the fixed base rent and all percentage rent for up to three years beginning on March 11, 1999 to the extent that available cash, as defined in the leases, is insufficient to pay such rent. AmeriCold Logistics deferred $5.4 million of rent payments for the period ending December 31, 1999.
Under the terms of the partnership agreement for AmeriCold Logistics, Vornado Operating, Inc.("Vornado Operating") has the right to make all decisions relating to the management and operations of AmeriCold Logistics other than certain major decisions that require the approval of both the Company and Vornado Operating. Vornado Operating must obtain Crescent Operating's approval for specified matters involving AmeriCold Logistics, including approval of the annual budget, requiring specified capital contributions, entering into specified new leases or amending existing leases, selling or acquiring specified assets and any sale, liquidation or merger of AmeriCold Logistics. If the partners fail to reach agreement on certain matters prior to October 30, 2000, Vornado Operating will be entitled to buy Crescent Operating's interest in the partnership at cost plus 10% per annum return. If the partners fail to reach an agreement on such matters during the period from November 1, 2000 through October 30, 2007, Vornado Operating may set a price at which it commits to either buy Crescent Operating's investment, or sell its own, and Crescent Operating will decide whether to buy or sell at that price. If the partners fail to reach agreement on such matters after October 30, 2007, either party may set a price at which it commits to either buy the other party's investment, or sell its own, and the other party will decide whether to buy or sell at that price. Neither partner may transfer its rights or interest in the partnership without the consent of the other partner. The partnership will continue for a term through October 30, 2027, except as the partners may otherwise agree.
RECENT DEVELOPMENTS
Effective March 12, 1999, the Company sold 80% of its 5% interest in the Temperature Controlled Logistics Partnerships to Crescent Partnership for $13.2 million and received the right to require Crescent Partnership to purchase the remaining 20% for approximately $3.4 million at any time during the next two years, subject to compliance with certain regulatory matters. This 5% interest represented a 2% interest in various corporations and limited liability companies owned by the Temperature Controlled Logistics Partnerships. Crescent Operating, through a wholly owned limited liability company, then became a 40% partner of AmeriCold Logistics, a newly formed partnership, the remaining 60% of which is owned by Vornado Operating. This transaction required a capital contribution of approximately $15.5 million from Crescent Operating. As a result of the restructuring transaction, the operations formerly associated with the Temperature Controlled Logistics Partnerships are now conducted by AmeriCold Logistics. Also a result of the transaction, Crescent Operating no longer consolidates, for financial reporting purposes, the Temperature Controlled Logistics Partnerships, which has resulted in a decrease for accounting purposes in the investment in the Temperature Controlled Logistics Partnerships of approximately $291 million.
The Company expects to form a new business venture with Vornado Operating on terms and conditions similar to the Company's existing partnership arrangements with Vornado Operating. The venture, which is to be named Transportal Network ("Transportal"), would pursue a business-to-business internet opportunity relating to the Temperature Controlled Logistics business. The Company expects Transportal to provide routing and load management services and to facilitate related purchases over the internet to independent truckers, shippers and receivers to enable them to increase efficiency. The Company's share of start-up costs for Transportal, which relate to market research, creating a business plan and related matters, was $0.4 million for the year ended December 31, 1999. These costs are included in the Company's consolidated statement of operations as "Investment Income (Loss)" for the year ended December 31, 1999. Although Transportal has not commenced operations or finalized its business plan, the Company expects Transportal to incur significant future losses and to require significant equity investments. The Company anticipates that it may have to dilute its ownership in Transportal to fund its share of Transportal's cash needs, which may be in excess of $2.0 million. Transportal is actively seeking additional equity investments from third parties, including venture capital firms. Early stage internet companies, such as Transportal, with new and unproven business models frequently encounter financial and other significant business risks and there can be no assurance that Transportal will be a successful business venture.
MARKET INFORMATION
Refrigerated storage facilities are comprised of production and distribution facilities. Production facilities typically serve one or a small number of customers, generally food processors, located nearby. These customers store large quantities of processed or partially processed products in the facility until they are shipped to the next stage of production or distribution. Distribution facilities primarily warehouse a wide variety of customers' finished products until future shipment to end-users. Each distribution facility primarily services the surrounding regional market. AmeriCold Logistics offers transportation management services including freight routing, dispatching, freight rate negotiation, backhaul coordination and distribution channel assessment. AmeriCold Logistics' temperature controlled logistics expertise and access to both frozen food storage facilities and distribution channels enable its customers to respond quickly and efficiently to time-sensitive orders from distributors and retailers. Additionally, AmeriCold Logistics mines limestone at two of its locations.
Customers of AmeriCold Logistics consist primarily of national, regional and local frozen food manufacturers, distributors, retailers and food service organizations including Con-Agra, Inc., H.J. Heinz & Co., McCain Foods, Pillsbury, Sara Lee, Philip Morris, J.R. Simplot, Farmland Industries and Unilever. AmeriCold Logistics is the largest operator of public refrigerated storage space in the country in terms of public storage space operated. The Company believes that AmeriCold Logistics does not have any competitors of comparable size, however, there is competition that is national, regional and local in nature. Breadth of service, facility locations, customer mix, warehouse size, service performance and price are major competitive factors.
OPERATIONAL INFORMATION
The following table shows the location and size of facility for each of the properties operated by AmeriCold Logistics as of December 31, 1999:
(1) Missouri has one underground facility. This underground facility approximates 33.1 million cubic feet.
LAND DEVELOPMENT
OVERVIEW
The Land Development segment consisted primarily of:
o a 4.65% economic interest in Desert Mountain, a master planned, luxury residential and recreational community in northern Scottsdale, Arizona;
o a 42.5% general partner interest in Woodlands Operating, which provides management, advisory, landscaping and maintenance services to The Woodlands, Texas and is the lessee of The Woodlands Resort and Conference Center;
o a 2.125% economic interest in Landevco, which owns approximately 7,500 acres for commercial and residential development as well as a realty office, an athletic center, and interests in both a title company and a mortgage company;
o a 50% economic interest in COPI Colorado, a company that has a 10% economic interest in CDMC, which invests in entities that develop or manage residential and resort properties (primarily in Colorado) and provides support services to such properties.
The Land Development segment competes against a variety of other housing alternatives including other planned developments, homes, condominiums and townhouses. The Company believes that Desert Mountain, The Woodlands and the entities in which CDMC has investments possess certain features that provide competitive advantages to these developments. Both Desert Mountain and The Woodlands have golf courses where major tournaments are played, The Tradition and The Shell Houston Open, respectively, as well as clubhouses, multiple golf courses and other amenities.
The Woodlands is unique among developments in the Houston area because it functions as a self-contained community. Desert Mountain does not have any significant direct competitors due in part to the high-end amenities that it offers. The Company believes that the entities in which CDMC has investments do not have any direct competitors because the locations of the projects are unique, the land is limited and the entities in which CDMC has investments own most of the land in each location. Management believes that these attributes help to distinguish Desert Mountain, The Woodlands and the entities in which CDMC has investments from their competition. The Woodlands could be adversely affected by downturns in the Houston economy. Management believes that Desert Mountain and the most significant investments made by CDMC are not directly affected by their local economies, as they are luxury developments and most of the purchases are not made by local residents.
RECENT DEVELOPMENTS
The Woodlands Operating partnership agreement provides that distributions are to be made to partners in accordance with specified payout percentages which change based upon whether certain established cumulative preferred returns have been earned. As cumulative preferred returns reach certain thresholds, distributions to the Company increase from 42.5% to 49.5% and then from 49.5% to 52.5%. Beginning in 2000, both the 42.5% and the 49.5% thresholds have been met; therefore, the payout percentage to the Company has increased to 52.5%.
On May 29, 1999, legislation was passed that would keep The Woodlands as an unincorporated area free from annexation from Houston for a period of at least twelve years. Also during 1999, Anadarko Petroleum commenced construction of its new 32 story headquarters in The Woodlands, and the $24.0 million, 1.25-mile waterway in The Woodlands is under construction and anticipated to be completed in early 2001. In addition, the new Carlton Woods Country Club, featuring an 18-hole Jack Nicklaus signature golf course is under construction in The Woodland's first gated community.
In accordance with an agreement between Gerald Haddock and the Company, Mr. Haddock, the Company's former Chief Executive Officer and President, had his limited partnership interest in COPI Colorado redeemed by COPI Colorado in January 2000. COPI Colorado paid Mr. Haddock approximately $2.6 million for his approximate 16.67% limited partner interest (determined from an independent appraisal of the value of COPI Colorado). Mr. Haddock reserved the right to challenge the valuation performed by the independent appraiser. As a result of the redemption of Mr. Haddock's interest, the Company has an approximate 58% interest in COPI Colorado.
On April 29, 1999, a partnership in which CDMC has a 64% economic interest finalized the purchase of Riverfront Park (previously known as "The Commons"), a master planned residential development on 23 acres in the Central Platte Valley near downtown Denver, Colorado, for approximately $25.0 million. The development of Riverfront Park is expected to begin in the spring of 2000. The first phase will consist of condominiums and lofts with prices ranging from $0.2 million to $2.5 million. The acreage is in close proximity to several major entertainment and recreational facilities, including, Coors Field (home to the Major League Baseball's Colorado Rockies), Elitch Gardens (an amusement park), the new Pepsi Center (home to the National Hockey League's Colorado Avalanche and the National Basketball Association's Denver Nuggets) and the new downtown Commons Park. An adjacent 28 acres is expected to be commercially developed by another company, thus providing a major mixed-use community adjacent to the lower downtown area of Denver.
On August 27, 1999 and October 27, 1999, the Company sold its investments in Hillwood and Corporate Arena, respectively, for an aggregate sales price of approximately $1.4 million. Together, the sales resulted in an approximate $0.2 million gain in 1999.
DESERT MOUNTAIN
Desert Mountain includes The Desert Mountain Club, a private golf, tennis and fitness club which serves over 2,100 members and offers five Jack Nicklaus signature 18-hole golf courses and four clubhouses. One of these courses is Cochise, the site of the Senior PGA Tour's The Tradition golf tournament. Lyle Anderson, the original developer of Desert Mountain, provides advisory services in connection with the operation and development of Desert Mountain. Pursuant to the terms of a limited partnership agreement, Desert Mountain Development Corporation ("Desert Mountain Development") is entitled to receive 93% of the net cash flow of Desert Mountain after certain payments
to the sole limited partner, Sonora Partners Mountain Partnership which owns the remaining 7% interest, have been made.
THE WOODLANDS OPERATING COMPANY
The Woodlands, an approximately 27,000-acre master-planned residential and commercial community located approximately 27 miles north of Houston, Texas, includes a shopping mall, retail centers, office buildings, a conference center and country club and other amenities. The Greater Houston Builders Association chose The Woodlands as its 1999 Developer of the Year.
Woodlands Operating was formed to provide management, advisory, landscaping and maintenance services to entities affiliated with Crescent Operating and Crescent Equities as well as to third parties. Pursuant to the terms of service agreements, Woodlands Operating performs general management, landscaping and maintenance, construction, design, sales, promotional and other marketing services for certain properties in which Crescent Equities owns a direct or indirect interest. In addition, Woodlands Operating monitors certain of the real estate investments of, and provides advice regarding real estate and development issues to, such entities. As compensation for its management and advisory services, Woodlands Operating is paid a monthly advisory fee in an amount equal to 3% of all costs and expenses incurred by Woodlands Operating in providing such services. As compensation for its landscaping and maintenance services, Woodlands Operating receives a monthly fee in an amount equal to 5% of the cost per month of performing the required landscaping and maintenance services. Each service agreement provides for an initial term of at least 12 months (subject to earlier termination under certain circumstances) and will be renewed automatically, unless terminated by either party upon giving prior notice as specified in each agreement.
Woodlands Operating also leases The Woodlands Conference Center and Country Club, a 364-room executive conference center with a private golf and tennis club serving approximately 1,800 members and offering 81 holes of golf, and certain related assets (the "Conference Center") from The Woodlands Commercial Properties Company, L.P. ("Woodlands Commercial"), a partnership, the interests of which are owned by Crescent Equities and certain Morgan Stanley Group funds. Woodlands Operating leases the Conference Center on a triple net basis and will pay base rent in the amount of $0.75 million per month during the eight-year term of the lease. The lease also provides for the payment of percentage rent for each calendar year in which gross receipts from the operation of the Conference Center exceed certain amounts.
THE WOODLANDS LAND COMPANY, INC.
The Company owns all of the voting stock representing a 5% economic interest, of The Woodlands Land Company, Inc. ("LandCo"), a residential and commercial development corporation which was formerly wholly owned by Crescent Partnership. LandCo holds a 42.5% general partner interest in, and is the managing general partner of, Landevco, a Texas limited partnership in which certain Morgan Stanley funds hold a 57.5% limited partner interest. LandCo's general partner interest in Landevco is subject to adjustment to up to 52.5%, in the event Landevco achieves certain levels of profitability and the Morgan Stanley funds receive certain rates of return on their investment in Landevco. Landevco primarily owns (i) approximately 5,400 acres of land capable of supporting the development of more than 15,500 lots for single-family homes, (ii) approximately 2,000 acres capable of supporting more than 16.6 million net rentable square feet of commercial development, (iii) a realty office, (iv) contract rights relating to the operation of its property, (v) an athletic center and (vi) a 50% interest in a title company.
CRESCENT DEVELOPMENT MANAGEMENT CORP.
CDMC's investments include direct and indirect economic interests that vary from 18% to 70% in the following: (i) two residential and commercial developments and eight residential developments in Colorado; (ii) a Texaco gasoline station and ancillary auto repair facility, car wash and convenience store in Colorado; (iii) a timeshare development in Colorado; (iv) a real estate company that markets and sells timeshare interests; (v) a real estate company that specializes in the management of resort properties in Colorado, Utah, South Carolina and Montana; (vi) two transportation companies that provide approximately 80% of the airport shuttle service to Colorado resort areas; and (vii) an interest in a partnership that owns an interest in the Ritz Carlton Hotel in Palm Beach, Florida.
Effective September 11, 1998, the Company and Gerald W. Haddock, John C. Goff and Harry H. Frampton, III (collectively, the "CDMC Sellers") entered into a partnership agreement (the "Partnership Agreement") to form COPI Colorado. COPI Colorado's purpose is to hold and manage the voting stock of CDMC (and, consequently, to manage CDMC) and to invest in shares of Crescent Operating common stock. In September, 1998, the Company contributed to COPI Colorado $9.0 million in cash in exchange for a 50% general partner interest in COPI Colorado, and each CDMC Seller contributed to COPI Colorado approximately 667 shares of CDMC voting stock, which the CDMC Sellers owned individually, in exchange for an approximately 16.67% limited partner interest in COPI Colorado; as a result and until January 2000, the Company owned a 50% managing interest in COPI Colorado and the CDMC Sellers collectively owned a 50% investment interest in COPI Colorado. See Land Development - Recent Developments. The operating results of CDMC since September 30, 1998 have been included in the consolidated results of the Company.
As of March 30, 2000, COPI Colorado had purchased approximately 1.1 million shares of Crescent Operating common stock at a total purchase price of $4.3 million. The average price paid for such shares, excluding brokers' commissions, was $3.88 per share.
OPERATIONAL STATISTICS
The following table sets forth certain information as of December 31, 1999 relating to the residential development properties.
(1) Based on lots/units closed during the Company's ownership period.
(2) Based on existing inventory of developed lots and lots to be developed.
(3) Includes golf membership, which for 1999, is $175,000.
OTHER INVESTMENTS
CHARTER BEHAVIORAL HEALTH SYSTEMS, LLC
OVERVIEW
CBHS is the largest provider of behavioral health care treatment in the United States and currently operates 37 behavioral health care facilities in 21 states. CBHS also operates outpatient clinics in several states and provides management services for about 15 behavioral health care treatment programs in general acute care hospitals in eight states. Many of CBHS' facilities offer a continuum of care including, inpatient hospitalization, partial hospitalization, intensive outpatient services, and, in some markets, residential treatment services.
The CBHS facilities provide structured and intensive treatment programs for mental health and alcohol and drug dependency disorders in children, adolescents and adults. The specialization of programs enables the clinical staff to provide care that is specific to the patients' needs and facilitates monitoring of patients' progress. A typical treatment program at a CBHS facility integrates physicians and other healthcare professionals through structured activities, patient testing, adjunctive therapies, group therapy, individual therapy and educational programs. Treatment programs typically include one or more types of treatment settings. For those patients who do not have a personal psychiatrist or other specialist, the hospital refers the patient to a member of its medical staff.
The Company has written-off its entire investment and has no obligation or commitment to fund CBHS' ongoing operations. As a result of the write-off, and irrespective of the transactions described in Note 3 to the Company's financial statements, the Company does not anticipate that it will recognize any additional losses from its investment in CBHS. Because the Company has written-off its CBHS investment and it is unlikely that the Company will recognize any material income from CBHS in the near future due to the operating losses currently being incurred by CBHS, the Company no longer reports its operations related to CBHS as a separate segment.
RECENT DEVELOPMENTS
On September 9, 1999, Crescent Operating, Magellan Health Services, Inc. ("Magellan"), Crescent Partnership and CBHS completed a recapitalization of CBHS and restructuring of the relationships among the parties. In connection with the restructuring, Magellan transferred its remaining hospital-based assets (including Charter Advantage, Charter Franchise Services, LLC, the call center assets, the Charter name and related intellectual property and certain other assets) to CBHS, and released CBHS from all accrued and future franchise fees. As a result of the transfer, Magellan is no longer obligated to provide franchise services to CBHS. Magellan also transferred 80% of its CBHS common membership interest and all of its CBHS preferred membership interest to CBHS, leaving Magellan with a 10% common membership interest. Simultaneously, Crescent Operating reorganized its holdings leaving Crescent Operating with a 25% common membership interest and 100% of the preferred membership interest in CBHS, and a limited partnership controlled by individual officers of Crescent Operating and in which Crescent Operating owns 100% of the economic interests, with a 65% common membership interest in CBHS. Prior to the restructuring, Crescent Operating and Magellan each held a 50% common membership interest, and a 50% preferred membership interest in CBHS.
In connection with the restructuring, Magellan, CBHS, Crescent Partnership and Crescent Operating also provided each other with mutual releases of all claims and disputes against each other (including, but not limited to, claims related to the operation of CBHS and agreements in respect of the purchase and sale of certain assets), with certain specified exceptions, and Crescent Partnership deferred the August 1999 rent due from CBHS to the last four months of 1999. In addition, in connection with the settlement and mutual release of claims between Magellan and Crescent Operating, $2.5 million that had been held in escrow was released to Crescent Operating.
In the fourth quarter of 1999, CBHS began significant downsizing, including the closure of 18 facilities in 1999 and 33 facilities in January 2000. The purpose of the downsizing is to close unprofitable facilities and eliminate overhead so that the remaining 37 facilities currently operating could be refinanced or sold. As a result of the downsizing, the Company anticipates that CBHS' annual revenues would be reduced from approximately $720 million to approximately $320 million. Closure of these facilities resulted in the filing by terminated employees of several lawsuits against CBHS for alleged violation of the Worker Adjustment and Retraining Notification Act ("WARN Act"). See Item III - Legal Proceedings.
The reader's attention is directed to the end of this discussion about CBHS, where information is given to the effect that COPI Healthcare does not expect to close the acquisition of CBHS's core business assets under the asset purchase agreement described below because the conditions to COPI Healthcare's obligation to close are not expected to be fulfilled.
Despite the downsizing of its operations, CBHS' operating results and cash flow were not improved sufficiently to support its current and long-term obligations. On February 16, 2000, CBHS petitioned for relief under Chapter 11 of the United States Bankruptcy Code. Under the protection of the bankruptcy court, CBHS intends to sell and liquidate, in a controlled fashion, all of its ongoing business. In conjunction with the filing by CBHS of the bankruptcy petition, COPI Healthcare, Inc. ("COPI Healthcare"), a wholly owned subsidiary of Crescent Operating, entered into an agreement with CBHS for the acquisition by COPI Healthcare of CBHS' core business ("Asset Purchase Agreement"), which consists of the assets used in the operation of 37 behavioral healthcare facilities for $24.5 million. The bankruptcy court could seek other bids for these assets from other interested parties and there is no assurance that COPI Healthcare's bid will be successful or that the conditions contained in its offer can be satisfied.
The closing of the transactions contemplated by the Asset Purchase Agreement is subject to bankruptcy court approval and other conditions, including among others, the conditions that (i) from February 16, 2000, through the date of the closing of the transactions described in the Asset Purchase Agreement, CBHS will have generated sufficient Earnings Before Interest Taxes Depreciation Amortization and Rent to cover $1.7 million per month of corporate overhead and $1.67 million per month of rent, (ii) COPI Healthcare will have obtained, as of the closing date, a loan agreement or credit facility, on terms acceptable to COPI Healthcare, for a working capital line of credit in the minimum amount of $40 million, (iii) various federal and state governmental agencies will have granted comprehensive releases to COPI Healthcare, Crescent Operating and Crescent Equities with respect to matters pertaining to CBHS prior to the acquisition and (iv) all contracts pertaining to operation of the assets that COPI Healthcare desires to assume shall have been assigned to it, with all breaches of those contracts cured, and COPI Healthcare shall have entered into acceptable leases of the facility properties. The Asset Purchase Agreement may be terminated at any time prior to the closing in the event that (i) the Bankruptcy Court fails to approve the Asset Purchase Agreement, (ii) certain of the conditions to closing set forth in the Asset Purchase Agreement are not met, or (iii) there is a material breach of the Asset Purchase Agreement that is not cured within 10 days. As part of the resolution of all matters that may arise in connection with the bankruptcy of CBHS, and under certain circumstances, Crescent Equities has indicated a willingness to negotiate and, if successful, enter into an amended master lease or a new lease with any qualified, credit-worthy bidder who purchases the core business of CBHS, including COPI Healthcare.
The Company has received a written commitment from Bank of America to make available to COPI Healthcare $25.0 million to finance the purchase of the core business of CBHS. Based upon preliminary discussions between the Company and Bank of America, the Company anticipates that it will issue a one-year note, at an annual interest rate equal to the 30-day LIBOR plus 1.0%, which will be secured by all of the assets of COPI Healthcare (whether currently existing or acquired subsequent to the date of the note) and all of the stock or other interests of Crescent Operating in COPI Healthcare. Richard Rainwater, Chairman of the Board of Directors and a significant shareholder of the Company, has agreed to guarantee (the "Guarantee") the borrowing in an amount not to exceed $25.0 million. The Guarantee is subject to certain specified conditions, including (i) the execution by COPI Healthcare of loan documents in respect of the $25.0 million loan that are reasonably satisfactory to Mr. Rainwater, (ii) the inclusion of provisions in the loan documents permitting Mr. Rainwater to acquire COPI Healthcare's $25.0 million debt to Bank of America in the event of a default under the loan documents, (iii) the acquisition by COPI Healthcare of the core assets of CBHS on substantially the terms as provided in the Asset Purchase Agreement, (iv) the execution by COPI Healthcare of an agreement to reimburse to Mr. Rainwater all amounts funded by him pursuant to the Guarantee, on terms that are reasonably satisfactory to Mr. Rainwater and that provide that any such amounts funded be secured by collateral, (v) CBHS' obtaining a working capital line of credit from a financial institution in the minimum amount of $40 million, and (vi) the payment by COPI Healthcare to Mr. Rainwater of a fee in the amount of $0.9 million upon the making of the Guarantee. The amount of the fee to be paid to Mr. Rainwater upon issuance of the Guaranty is based upon a range of reasonable fees calculated by an outside consulting firm at the request of the Company's Board of Directors. The Guarantee will expire in the event the transactions contemplated by the Asset Purchase Agreement are not closed on or before April 16, 2000. If COPI Healthcare is successful in acquiring the core business of CBHS, the Company will then seek to retire the $25.0 million facility through the sale of equity in COPI Healthcare or Crescent Operating to existing Crescent Operating shareholders.
On March 27, 2000, COPI Healthcare notified CBHS that because it appears that not all of the conditions to its obligation to consummate the acquisition under the Asset Purchase Agreement appear likely to be met before the agreement terminates by its own terms on April 16, 2000, COPI Healthcare does not expect to close the acquisition under the Asset Purchase Agreement.
MARKET INFORMATION
In general, the operation of behavioral healthcare programs is characterized by intense competition. The Company anticipates that competition will become more intense as pressure to contain the rising costs of health care continues to intensify, particularly as programs such as those operated by CBHS are perceived to help contain mental health care costs. Each of the CBHS facilities competes with other hospitals and behavioral healthcare facilities, some of which are larger and have greater financial resources than those operated by CBHS. Some competing facilities are owned and operated by governmental agencies, others by nonprofit organizations supported by endowments and charitable contributions. Facilities frequently draw patients from areas outside their immediate locale and, therefore, the CBHS facilities may, in certain markets, compete with both local and distant hospitals and other facilities. In addition, the CBHS facilities compete not only with other psychiatric hospitals, but also with psychiatric units in general hospitals. With respect to outpatient services, CBHS competes with private practicing mental health professionals, publicly funded mental health centers, and partial hospitalization and other intensive outpatient services programs and facilities. The competitive position of a particular facility is, to a significant degree, dependent upon the number and quality of physicians who practice at the facility and who are members of its medical staff. There can be no assurance that CBHS will be able to compete effectively with its present or future competitors, and any such inability could have a material adverse effect on the CBHS' business, financial condition and results of operations.
In an era of cost-containment and the reduction of dollars available for care, behavioral healthcare providers have focused attention on developing treatment approaches that respond to payors' increasing demands for shorter stays, lower costs, and expanded access to care. Changes in the mix of services, the prices of services, and the intensity of service are all part of this response. These changes have also been bolstered by a rapidly expanding science base, improved medications management, and the growing availability of non-hospital treatment settings in more and more communities that help to make it possible to manage complex and severe illnesses in less intensive treatment settings. One of the effects that the behavioral healthcare industry is experiencing is an increasing percentage of non-inpatient care.
Due to these changes in the behavioral healthcare industry, a hospital's position relative to its competitors may be affected by its ability to obtain contracts with HMOs, PPOs and other managed care plans for the provision of health care services. Although such contracts generally provide for discounted services, pre-admission certification and concurrent length of stay reviews, they also provide a strong patient referral base. The importance of entering into contracts with HMOs, PPOs and other managed care companies varies from market to market and depends upon the market strength of the particular managed care company.
HICKS MUSE TATE & FURST EQUITY FUND II, LP
On March 31, 1999, the Company sold its investment in Hicks-Muse Tate & Furst II, LP ("Hicks-Muse") for $8.1 million to an unrelated party. The sale resulted in a $0.3 million gain which was recognized in the first quarter of 1999. All of the sales proceeds were applied against the Company's indebtedness to Crescent Partnership.
MAGELLAN WARRANTS
In connection with the transaction in which the Company acquired its initial 50% membership interest in CBHS in 1997, the Company purchased, for $12.5 million, warrants to acquire 1,283,311 shares of Magellan common stock for an exercise price of $30 per share. The Magellan warrants are exercisable in varying increments beginning on May 31, 1998 and ending on May 31, 2009. Management has written down its investment in the warrants based on the estimated fair value of the warrants of $2.4 million at December 31, 1999, using the Black-Scholes pricing model.
TRANSACTIONS WITH CRESCENT PARTNERSHIP
Historically, Crescent Operating generally has been involved with Crescent Equities in two types of transactions: "LESSEE TRANSACTIONS" and "CONTROLLED SUBSIDIARY TRANSACTIONS".
o LESSEE TRANSACTIONS are those in which Crescent Operating enters into a transaction to lease and operate real property that is owned by Crescent Partnership but which cannot be operated by Crescent Partnership due to Crescent Equities status as a REIT. Lessee Transactions include the Company's leases of Hospitality Properties.
o CONTROLLED SUBSIDIARY TRANSACTIONS are those in which Crescent Operating invests alongside Crescent Partnership in acquisitions where Crescent Operating owns all of the voting stock, and Crescent Partnership owns all of the non-voting stock of a corporate acquisition vehicle which in turn acquires a target business which cannot be operated by Crescent Partnership due to Crescent Equities' status as a REIT. The voting stock represents the controlling interest of the entity being purchased, and due to its status as a REIT, Crescent Equities cannot hold a controlling interest in such entities. Controlled Subsidiary Transactions include investments in CRL, Desert Mountain, Landco, and the Temperature Controlled Logistics Partnerships.
Crescent Operating and Crescent Partnership have entered into the Intercompany Agreement to provide each other with rights to participate in the types of transactions mentioned above. The Intercompany Agreement provides, subject to certain terms, that Crescent Partnership will provide Crescent Operating with a right of first refusal to become the lessee of any real property acquired by Crescent Partnership if Crescent Partnership determines that, consistent with Crescent Equities' status as a REIT, it is required to enter into a "master" lease arrangement. Crescent Operating's right of first refusal under the Intercompany Agreement is conditioned upon the ability of Crescent Operating and Crescent Partnership to negotiate a mutually satisfactory lease arrangement and the determination of Crescent Partnership, in its sole discretion, that Crescent Operating is qualified to be the lessee. In general, a master lease arrangement is an arrangement pursuant to which an entire property or project (or a group of related properties or projects) is leased to a single lessee. If a mutually satisfactory agreement cannot be reached within a 30-day period (or such longer period to which Crescent Operating and Crescent Partnership may agree), Crescent Partnership may offer the opportunity to others.
Under the Intercompany Agreement, Crescent Operating has agreed not to acquire or make (i) investments in real estate which, for purposes of the Intercompany Agreement, includes the provision of services related to real estate and investment in hotel properties, real estate mortgages, real estate derivatives or entities that invest in real estate assets or (ii) any other investments that may be structured in a manner that qualifies under the federal income tax requirements applicable to REITs. Crescent Operating has agreed to notify Crescent Partnership of, and make available to Crescent Partnership, investment opportunities developed by Crescent Operating, or of which Crescent Operating becomes aware but is unable or unwilling to pursue.
The Company anticipates that the REIT Modernization Act will have a significant effect on the Intercompany Agreement in 2001. On December 17, 1999, President Clinton signed into law the REIT Modernization Act which will become effective after December 31, 2000, and contains a provision that would permit REITS, such as Crescent Equities, to own and operate certain types of investments that are currently owned and operated by Crescent Operating. The REIT Modernization Act is expected to reduce the number of business opportunities that Crescent Equities would otherwise offer to the Company pursuant to the Intercompany Agreement. Crescent Equities has expressed an interest in certain of the investments currently owned or operated by the Company that the REIT Modernization Act would allow Crescent Equities to own or operate. Crescent Operating is exploring alternatives with Crescent Equities regarding a potential future transaction with respect to certain of the Company's assets.
EMPLOYEES
As of December 31, 1999, Crescent Operating and the following consolidated subsidiaries had the number of employees indicated below:
The Company has excluded employees of CBHS, Woodlands Operating, Landevco and AmeriCold Logistics, as these subsidiaries represent equity investments for financial reporting purposes.
ITEM 2.
ITEM 2. PROPERTIES
At December 31, 1999, the Company, through its subsidiary, Crescent Machinery, owned fee simple interests in three properties. The properties are located in Dallas, Austin and Houston, Texas. The Company, directly or indirectly, also held leasehold interests in certain facilities, including the Hospitality Properties (collectively, the "Leased Properties"). Additionally, CHBS leases its hospital facilities. Management believes that each of the
owned and the Leased Properties is adequately maintained and suitable for use in its respective capacity. The Company or certain of its subsidiaries has entered into lease agreements in respect of the Leased Properties, pursuant to which each respective lessee is responsible for routine maintenance of the subject property.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
CBHS became the subject of Chapter 11 bankruptcy proceedings by filing a voluntary petition on February 16, 2000, in United States Bankruptcy Court for the District of Delaware. Although CBHS is not a subsidiary of Crescent Operating, Crescent Operating does own a majority (90%) economic interest in CBHS. Crescent Operating's claims against the estate of CBHS include (i) its interests as a direct and indirect equity holder of CBHS and (ii) and its claim for indemnification or contribution against third party lawsuits and claims where Crescent Operating is a named defendant with CBHS, such as lawsuits based upon alleged WARN Act violations purported to have been committed by CBHS and/or its subsidiaries in closing behavioral health care facilities in 1999 and 2000. To date Crescent Operating has not filed a proof of claim against CBHS with regard to any of these claims but would expect to file proofs of claim prior to the bar date.
Another claimant in the CBHS bankruptcy is expected to be Crescent Partnership (either individually, or together with its parent, Crescent Equities), which is the owner of certain facilities leased to and operated by CBHS and its subsidiaries and is also the secured lender of $10 million to CBHS. CBHS has an arrearage on its lease payments owed to Crescent Partnership accrued prior to the commencement of bankruptcy. While the claims of Crescent Partnership against CBHS are not necessarily adverse to the interests of Crescent Operating, the interests of Crescent Partnership are separate, distinguishable and at least nominally in conflict with the competing interests and claims of all other interested parties in the bankruptcy, including Crescent Operating. To the Company's knowledge, none of the directors, officers or security holders of Crescent Operating has, in his or its individual capacity, an interest adverse to Crescent Operating in connection with the CBHS bankruptcy; however, in their capacities as directors, officers and/or security holders of Crescent Partnership or Crescent Equities, certain persons may be deemed to hold interests adverse to the Company's interest in connection with the CBHS bankruptcy.
To date, four lawsuits, all of which seek class action certification, have been filed against CBHS alleging violations of the WARN Act in the closing of certain healthcare facilities. All of those lawsuits also name Crescent Operating as a defendant. Under the automatic stay provisions of federal bankruptcy law, lawsuits against CBHS or its subsidiaries would be stayed unless otherwise directed by the bankruptcy court, but the lawsuits against other defendants, including Crescent Operating, would not be stayed automatically. It is anticipated that those suits may be stayed because CBHS and its subsidiaries are indispensable parties. The Company anticipates that other similar lawsuits may be filed due to the closing of other facilities. With respect to the pending suits and possible future claims against Crescent Operating based on the closure by CBHS of facilities in 1999 and 2000, the Company believes that such actions are without basis under the WARN Act and should be dismissed; however, no assurance can be given that Crescent Operating will prevail.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of security holders during the fourth quarter of the Registrant's fiscal year ended December 31, 1999.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Effective June 12, 1997, shares of the Company's common stock were distributed to shareholders of Crescent Equities and unit holders of Crescent Partnership of record on May 30, 1997. For Crescent Equities shareholders, the distribution was made on the basis of one share of Crescent Operating common stock for every 10 common shares of beneficial interest of Crescent Equities held on the record date, and for limited partners of Crescent Partnership, the distribution was made on the basis of one share of Crescent Operating common stock for every 5 units of limited partnership interest held on the record date. The Company's common stock, $0.01 par value per share, began trading on the OTC Bulletin Board on June 13, 1997. Effective September 8, 1997, the Company's common stock was listed on the NASDAQ National Market under the symbol "COPI".
The following table reflects the high and low bid prices of the common stock for each calendar quarter indicated.
On October 25, 1999, the Company received notice from Nasdaq that, for the 30 consecutive trading days preceding such date, the Company's common stock failed to maintain a closing bid price of greater than or equal to $5.00 per share, the minimum closing bid price required for continued listing under NMS maintenance standard applicable to the Company. On March 3, 2000, the Company had a hearing before a Nasdaq panel to determine whether the Company will be permitted to maintain its NMS listing. Pending the outcome of the hearing, the Company's common stock will continue to be listed for trading on NMS. In the event of an unfavorable outcome of the hearing, the Company believes it would be able to apply for listing on the Nasdaq SmallCap Market. While the Company believes it satisfies the requirements for listing on the Nasdaq SmallCap Market, there can be no assurances that Nasdaq will approve listing of the Company's shares on such market.
As of March 28, 2000, there were approximately 252 holders of record of the common stock of Crescent Operating.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth certain summary historical financial information for the Company and for the Predecessor. For purposes of this table, the Predecessor consists of Moody-Day and Hicks-Muse. The following information should be read in conjunction with Management's Discussion and Analysis of Financial Condition and Results of Operations in Item 7
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
The following discussion should be read in conjunction with the "Selected Financial Data" and the financial statements and notes thereto, appearing elsewhere in this report. Historical results and percentage relationships set forth in "Selected Financial Data" should not be taken as indicative of future operations of the Company.
The following table sets forth financial data for the Company and the Predecessor. The year ended December 31, 1997 includes operations of the Predecessor from January 1, 1997 through May 8, 1997, and the operations of the Company from May 9, 1997 through December 31, 1997. The years ended December 31, 1998 and 1999 include only the operations of the Company.
YEAR ENDED DECEMBER 31, 1999, COMPARED TO THE YEAR ENDED DECEMBER 31, 1998
REVENUES
Total revenue increased $224.8 million, or 45.6%, to $718.0 million for the year ended December 31, 1999, compared with $493.2 million for the year ended December 31, 1998. The increase in total revenue is attributable to the following:
Equipment Sales and Leasing Segment
Equipment sales and leasing revenue increased $51.0 million, or 59.7% to $136.4 million, for the year ended December 31, 1999, compared with $85.4 million for the year ended December 31, 1998. Significant components of the overall increase were:
o the Company's acquisitions since January 1, 1998 and the opening of a new location on August 1, 1999, resulting in incremental revenue of $46.1 million during the year ended December 31, 1999; and
o same store revenue increased $4.9 million for the year ended December 31, 1999, as compared to the prior year primarily due to increased rental revenue.
Hospitality Segment
Hospitality revenue increased $17.3 million, or 7.5%, to $246.8 million for the year ended December 31, 1999, compared with $229.5 million for the year ended December 31, 1998. Significant components of the overall increase were:
o revenue derived from the operations of the Sonoma Mission Inn Golf and Country Club, which was not leased by the Company until October 1998, and the Renaissance Hotel, which was not leased by the Company until June 1999; offset by the elimination of the Austin Omni Hotel rental income, resulting from the termination of the lease effective December 31, 1998;
o revenue derived from the newly constructed Allegria Spa at the Hyatt Regency Beaver Creek, which conducted operations for the full year ended December 31, 1999, as compared to only four months during the year ended December 31, 1998; and
o increased rates at certain of the Hospitality Properties resulted in higher revenues during 1999 as compared to the corresponding period in 1998; partially offset by
o decreased revenues at Sonoma Mission Inn and Spa due to lower occupancy and average daily rate caused by construction at the property which necessitated taking 20 rooms out of inventory during 1999.
Land Development Segment
Land Development revenue, which represents revenue from Desert Mountain Development and COPI Colorado prior to the elimination of the Minority Interests, increased $156.5 million, or 87.7%, to $334.9 million for the year ended December 31, 1999, compared with $178.4 million for the year ended December 31, 1998. Significant components of the overall increase were:
o revenues of COPI Colorado, which the Company did not include during the first nine months of 1998, and which resulted in incremental revenues of $136.1 million for the year ended December 31, 1999; and
o a $20.4 million increase in revenue from Desert Mountain Development during the year ended December 31, 1999. The increase for the year can be attributed to overall higher sales prices for lots as compared to the prior year.
OPERATING EXPENSES
Total operating expenses increased $220.7 million, or 45.7%, to $704.1 million for the year ended December 31, 1999, compared with $483.4 million for the year ended December 31, 1998. The increase in operating expenses is attributable to the following:
Equipment Sales and Leasing Segment
Equipment sales and leasing expenses increased $52.6 million, or 66.6%, to $131.6 million for the year ended December 31, 1999, compared with $79.0 million for the year ended December 31, 1998. Significant components of the overall increase were:
o the Company's acquisitions since January 1, 1998 and the opening of a new location on August 1, 1999, resulting in incremental operating expenses of $45.8 million during year ended December 31, 1999; and
o increased costs of $6.8 million incurred during the year ended December 31, 1999, due mainly to an increase in rental inventory that is not attributable to acquisitions resulting in increased depreciation expense. Additionally, operating expenses were incurred during 1999 related to the implementation of a new computer system, integration of acquisitions as well as various costs incurred on acquisitions which did not come to fruition. Management anticipates that certain of these integration costs should not recur during 2000.
Hospitality Segment
Hospitality expenses increased $22.7 million, or 10.2%, to $245.5 million for the year ended December 31, 1999, compared with $222.8 million for the year ended December 31, 1998. Significant components of the overall increase were:
o rent and expenses associated with the Sonoma Mission Inn Golf and Country Club which was not leased by the Company until October 1998, and the Renaissance Hotel, which was not leased by the Company until June 1999;
o additional rent for the year ended December 31, 1999, resulting from increased revenue generated by the Hospitality Properties, partially offset by a decrease in rent for the year ended December 31, 1999, due to the termination of the lease of the Austin Omni Hotel effective December 31, 1998;
o rent and expenses associated with the newly constructed Allegria Spa at the Hyatt Regency Beaver Creek, which was leased for only four months for the period ended December 31, 1998; and
o additional rent associated with capital projects at the Hospitality Properties that were incurred during the year ended December 31, 1999.
Land Development Segment
Land development expenses, which primarily represent operating costs incurred by Desert Mountain Development and COPI Colorado prior to the elimination of the Minority Interests, increased $146.0 million, or 81.8%, to $324.4 million for the year ended December 31, 1999, compared with $178.4 million for the year ended December 31, 1998. Significant components of the overall increase were:
o operating expenses of COPI Colorado, which the Company did not include during the first nine months of 1998, and which resulted in incremental expenses of $123.5 million during the year ended December 31, 1999; and
o a $22.3 million increase in expenses incurred by Desert Mountain Development during the year ended December 31, 1999. The increase is primarily attributable to overall higher development costs associated with selling higher value lots as compared to the prior year.
Corporate General and Administrative Expenses
Corporate general and administrative expenses, totaling $2.6 million for the year ended December 31, 1999, were comparable with such costs for the year ended December 31, 1998. These expenses consisted of general corporate overhead costs, such as legal and accounting costs, insurance costs and corporate salaries.
INVESTMENT INCOME
Investment income decreased $6.8 million or 24.5%, to $20.9 million for the year ended December 31, 1999, compared with $27.7 million for the year ended December 31, 1998. Significant components of the overall decrease were:
o equity in loss of AmeriCold Logistics in the amount of $3.7 million due to the acquisition of AmeriCold Logistics in March 1999;
o a decrease in income of the Temperature Controlled Logistics Partnerships in the amount of $3.6 million due to the fact that the Company no longer consolidates the Temperature Controlled Logistics Partnerships as a result of the restructuring of the Temperature Controlled Logistics segment;
o a decrease in investment income from Hicks-Muse in the amount of $3.2 million as a result of the Company's sale of its investment in Hicks-Muse in March 1999;
o a decrease in equity in income of CDMC projects in the amount of $2.1 million; and
o equity in loss of CR Las Vegas, LLC in the amount of $1.1 million due to the pre-opening expenses related to the opening of the Venetian Spa in Las Vegas in June 1999; partially offset by
o no losses associated with CBHS for 1999 because the investment in CBHS was written off during 1998, as compared to $5.4 million of losses recognized in the prior year; and
o the gain on sale of 80% of the Company's interest in the Temperature Controlled Logistics Partnerships in the amount of $1.5 million.
OTHER (INCOME) EXPENSE
Other (income) expense increased $12.3 million, or 84.2%, to $26.9 million for the year ended December 31, 1999, compared with $14.6 million for the year ended December 31, 1998. The increase is primarily attributable to an increase in interest expense in the amount of $12.5 million for the year ended December 31, 1999, resulting from:
o an increase in outstanding indebtedness in connection with acquisitions;
o the inclusion of interest expense of COPI Colorado (in the amount of $6.7 million, for the first nine months of 1999) in the Company's operating results (operations of CDMC for the first nine months of 1998 were not included during the prior year); partially offset by
o a decrease in interest expense of approximately $1.1 million at Desert Mountain Development due to decreased indebtedness.
MINORITY INTERESTS
Minority interests decreased $2.2 million, or 13.5%, to $14.1 million for the year ended December 31, 1999, compared to $16.3 million for the year ended December 31, 1998. Minority Interests consist of the non-voting interests in the Land Development segment and in CRL Investments.
INCOME TAX PROVISION (BENEFIT)
Income tax benefit of $3.5 million for the year ended December 31, 1999 represents a change of $9.0 million from the year ended December 31, 1998. Income tax benefit consisted of a $8.7 million benefit at the corporate level, a $1.1 million benefit for the Equipment Sales and Leasing segment, a $0.9 million benefit for the Temperature Controlled Logistics segment, and a $0.1 million benefit for the Hospitality segment, offset by a $7.3 million provision for the Land Development segment.
The Company generally provides for taxes using a 40% effective rate on the Company's share of income or loss. Additionally, for the year ended December 31, 1999, the Company released $4.2 million of its net deferred tax asset valuation allowance, based on 1999 transactions and expected future taxable income. Management continues to evaluate its ability to realize the deferred tax assets quarterly by assessing the need for a valuation allowance. An inability of the Company to execute business plans for certain of the company's segments could affect the ultimate realization of the deferred tax assets.
YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997
REVENUES
Total revenue increased $331.7 million, or 205.4% to $493.2 million, for the year ended December 31, 1998, compared with $161.5 million for the year ended December 31, 1997. The increase in total revenue is attributable to the factors discussed in the following paragraphs.
Equipment Sales and Leasing Segment
Equipment sales and leasing revenues represent revenues from Crescent Machinery. Equipment Sales and Leasing revenues increased approximately $70.2 million, or 461.8%, to $85.4 million for the year ended December 31, 1998, compared to $15.2 million for the year ended December 31, 1997. Significant components of the overall increase were:
o approximately $65.4 million of the increase over the prior year relates to the Company's acquisitions of Preco, which was effective as of December 1, 1997, Central Texas, which was effective as of April 30, 1998, Machinery, Inc., which was effective as of June 8, 1998, Western Traction, which was effective as of July 1,
1998, Harvey, Inc., which was effective as of July 31, 1998 and 4-K, which was effective as of July 31, 1998; and
o same store revenues increased $4.8 million for the year ended December 31, 1998, as compared to the same period in the prior year, primarily as a result of increased rental revenue.
Hospitality Segment
Hospitality revenues represent revenues from Hospitality Properties leases. Hospitality revenues increased approximately $150.0 million, or 188.7%, to $229.5 million for the year ended December 31, 1998, compared to $79.5 million for the year ended December 31, 1997. The increase over the prior period is primarily due to the fact that the Company was not involved in the Hospitality segment prior to July 31, 1997.
Land Development Segment
Land development revenues represent revenues from Desert Mountain Development and COPI Colorado prior to the elimination of the 95% minority interest. Land Development revenues of $178.4 million for the year ended December 31, 1998 represent a $111.5 million, or 166.7%, increase over the year ended December 31, 1997 revenues of $66.9 million. Significant components of the overall increase were:
o revenues of COPI Colorado, which the Company did not include prior to September 30, 1998, and which resulted in incremental revenues of $11.2 million for the year ended December 31, 1998; and
o revenues of Desert Mountain Development, of which the Company did not include prior to September 29, 1997, and which resulted in incremental revenues of $93.5 million for the year ended December 31, 1998.
OPERATING EXPENSES
Total operating expenses increased $321.0 million, or 197.7%, to $483.4 million for the year ended December 31, 1998, compared with $162.4 million for the year ended December 31, 1997. The increase in operating expenses is attributable to the factors discussed in the following paragraphs.
Equipment Sales and Leasing Segment
Equipment sales and leasing expenses increased $64.7 million to $79.0 million for the year ended December 31, 1998, compared to $14.3 million for the year ended December 31, 1997. Significant components of the overall increase were:
o approximately $62.2 million of the increase for the year ended December 31, 1998 relates to the Company's acquisitions in 1998; and
o the remaining increase relates to the additional costs incurred as a result of the increase in equipment sales and leasing revenue.
Hospitality Segment
Hospitality expenses represent costs incurred by the full-service hotels, as well as by the destination, health and fitness resorts and Hospitality Properties rent paid to Crescent Equities. Hospitality expenses increased $143.6 million, or 181.3%, to $222.8 million for the year ended December 31, 1998, compared to $79.2 million for the year ended December 31, 1997. The increase of Hospitality expenses over the prior period amount is due to the fact that Crescent Operating was not involved in the Hospitality segment until July 31, 1997.
Land Development Segment
Land development expenses represent operating costs incurred by Desert Mountain Development and COPI Colorado prior to the elimination of the 95% minority interest. Land Development expenses of $178.4 million for the year ended December 31, 1998, represent a $111.3 million, or 165.9%, increase over the year ended December 31, 1997 Land Development direct expenses of $67.1 million. Significant components of the overall increase were:
o operating expenses of COPI Colorado, which the Company did not include prior to September 30, 1998, and which resulted in incremental expenses of $11.8 million for the year ended December 31, 1998; and
o operating expenses of Desert Mountain Development, which the Company did not include prior to September 29, 1997, and which resulted in incremental expenses of $97.3 million for the year ended December 31, 1998.
Corporate General and Administrative Expenses
Corporate general and administrative expenses of $3.1 million for the year ended December 31, 1998, consists of general corporate overhead costs such as legal and accounting costs, insurance costs and corporate salaries. The increase in general and administrative expenses of $1.3 million over the year ended December 31, 1997 is due to additional costs incurred as a result of the substantial growth of the Company since the prior year as well as 1998 being the first full year of operations.
INVESTMENT INCOME (LOSS)
Investment income increased $44.1 million, or 268.9%, to $27.7 million for the year ended December 31, 1998, compared to a loss of $16.4 million for the year ended December 31, 1997. The overall increase in investment income over the prior year is due to the Company owning the majority of its investments for less than half of the year in 1997, as well as the fact that the CBHS investment was written off in early 1998 resulting in no further losses being recognized in connection with CBHS in 1998. Significant components of the overall increase were:
o an increase in investment income from Hicks-Muse in the amount of $2.5 million;
o an increase in equity in income of Landevco in the amount of $16.8 million;
o an increase in equity in income of Woodlands Operating in the amount of $1.0 million;
o equity in income of CDMC projects in the amount of $5.6 million;
o equity in income of the Temperature Controlled Logistics Partnerships in the amount of $4.0 million; and
o decreased equity in losses of CBHS in the amount of $14.2 million.
OTHER (INCOME) EXPENSE
Other (income) expense increased $10.9 million, or 294.6%, to $14.6 million for year ended December 31, 1998, compared to $3.7 million for the year ended December 31, 1997. Significant components of the overall increase were:
o an increase in interest expense in the amount of $12.6 million due primarily to increased debt levels at Crescent Operating and Crescent Machinery as a result of acquisitions late in 1997 and in 1998, as well as the inclusion of a full year of interest for Desert Mountain Development in 1998 as compared to only three months in 1997; partially offset by
o an increase in interest income in the amount of $2.1 million due primarily to interest income from lot sale notes receivable at Desert Mountain Development and interest income on the notes receivable from Landevco neither of which was acquired until September 29, 1997.
MINORITY INTERESTS
Minority interests of approximately $16.3 million for the year ended December 31, 1998 consisted primarily of the 95% minority interest in the Temperature Controlled Logistics and the Land Development segments. The increase of $15.8 million over the year ended December 31, 1997 amount of $0.6 million is due to the acquisitions of the Temperature Controlled Logistics and Land Development segments occurring in October 1997 and September 1997, respectively.
INCOME TAX (PROVISION) BENEFIT
Income tax provision of approximately $5.5 million for the year ended December 31, 1998 consisted of a $2.7 million tax provision for the Hospitality segment, a $7.4 million tax provision for the Land Development segment and a $1.5 million tax provision for the Equipment Sales and Leasing segment, offset by a $2.2 million benefit for the Healthcare segment and a $4.1 million benefit at the corporate level. The Company generally provides for taxes using an assumed 40% effective rate on the Company's share of income or loss. The effective rate presented in the statement of operations is skewed primarily due to the minority interests in the Company's operations.
LIQUIDITY AND CAPITAL RESOURCES
Recognizing that cash flow from its assets would not be likely to provide the Company with adequate capital to meet its requirements during 2000, the Company during the first quarter of 2000 extended certain payment obligations by reaching agreements with Crescent Equities to defer until 2001 payments on certain of Crescent Operating's obligations to Crescent Equities otherwise scheduled to be made in 2000. With these agreements, the Company believes that it will be able to meet its capital requirements during 2000 with the recurring cash flow of its assets.
CASH FLOWS
Cash and cash equivalents include amounts from all consolidated subsidiaries, including subsidiaries not wholly owned. Changes, therefore, do not necessarily represent increases or decreases in cash directly available to the Company.
Cash and cash equivalents were $39.0 million and $42.8 million at December 31, 1999 and December 31, 1998, respectively. The 8.9% decrease is attributable to $9.4 million and $34.5 million of cash used in operating and investing activities, respectively, offset by $40.1 million of cash provided by financing activities.
OPERATING ACTIVITIES
Net cash flows used in operating activities for the year ended December 31, 1999 were $9.4 million compared with the net cash provided by operating activities of $36.1 million and $45.6 million for the years ended December 31, 1998 and 1997, respectively. The Company's outflow of cash used in operating activities of $9.4 million was primarily attributable to outflows from:
o net loss of $2.7 million;
o a decrease in deferred income taxes of $24.6 million;
o equity in income from unconsolidated subsidiaries of $19.0 million;
o an increase in real estate of $40.6 million; and
o increases in accounts receivable of $13.1 million.
The outflow of cash used in operating activities was partially offset by inflows from:
o non-cash depreciation and amortization of $33.7 million;
o increases in accounts payable and accrued expenses of $17.9 million; and
o increases in deferred revenue of $36.5 million.
INVESTING ACTIVITIES
Net cash flows used in investing activities for the year ended December 31, 1999 were $34.5 million compared with the net cash used in investing activities of $121.7 million and $66.7 million for the years ended December 31, 1998 and 1997, respectively. The Company's outflow of cash used in investing activities of $34.5 million was primarily attributable to outflows from:
o acquisitions of business interests of $28.5 million;
o acquisitions of business interests by Controlled Subsidiaries of $3.8 million;
o purchases of property and equipment of $79.5 million;
o contributions to investments of Controlled Subsidiaries of $11.9 million.
The outflow of cash used in investing activities was partially offset by inflows from:
o proceeds from the sale of investments of $23.5 million;
o proceeds from the sale of property and equipment of $30.5 million;
o net proceeds from sale and collection of notes receivable of $8.3 million; and
o distributions from investments of Controlled Subsidiaries of $24.0 million.
FINANCING ACTIVITIES
Net cash flows provided by financing activities for the year ended December 31, 1999 were $40.1 million compared with the net cash provided by financing activities of $85.1 million and $64.7 million for the years ended December 31, 1998 and 1997, respectively. The Company's inflow of cash provided by financing activities of $40.1 million was primarily attributable to inflows from:
o proceeds of all long-term debt of $343.4 million; and
o capital contributions attributable to Minority Interests of $35.5 million.
The inflow of cash provided by financing activities was partially offset by outflows from:
o payments of all long-term debt of $313.5 million; and
o distributions to Minority Interests of $20.8 million.
FINANCING ATTRIBUTABLE TO CORPORATE AND WHOLLY OWNED SUBSIDIARIES
In August 1999, the Company renewed its $15.0 million unsecured bank line of credit from Bank of America. The line of credit bears interest at the LIBOR rate plus 1% per annum, payable monthly and all principal and unpaid interest on the line of credit will be payable in August 2001. The $15.0 million available under the line of credit from Bank of America was fully drawn as of December 31, 1999.
Effective March 12, 1999, the Company agreed to make a permanent reduction in its $30.4 million 12% line of credit with Crescent Partnership commensurate with the proceeds from the sale of 80% of the Company's 2% interest in the Temperature Controlled Logistics Partnerships. On March 12, 1999, the Company received $13.2 million of proceeds and correspondingly permanently reduced the availability under the line of credit from $30.4 million to $17.2 million. The line of credit bears interest at the rate of 12% per annum, compounded quarterly, payable on an interest-only basis during its term, which expires on the later of (i) May 21, 2002 or (ii) five years after the last draw under the line of credit (in no event shall the maturity date be later than June 2007). Draws may be made under the line of credit until June 22, 2002. The line of credit is a recourse obligation and amounts outstanding thereunder are collateralized, to the extent not prohibited by pre-existing arrangements, by a first lien on the assets which the Company now owns or may acquire in the future. The line of credit is cross-collateralized and cross-defaulted with the Company's other borrowings from Crescent Partnership. As of December 31, 1999, $17.2 million was outstanding under the line of credit.
Also effective March 12, 1999, the Company obtained from Crescent Partnership a $19.5 million term note bearing interest at a rate of 9% per annum. The term note is payable on an interest-only basis during its term, which expires in May 2002. The note is cross-collateralized and cross-defaulted with the Company's other borrowings from Crescent Partnership. Upon inception of this line of credit, the Company immediately borrowed the full $19.5 million with which it contributed approximately $15.5 million in connection with the formation of AmeriCold Logistics and used the remaining $4.0 million of proceeds to reduce the amount outstanding under the 12% line of credit with Crescent Partnership. As of December 31, 1999, $19.5 million was outstanding under the line of credit.
The Company funded its contribution to COPI Colorado using the proceeds from a $9 million term loan from Crescent Partnership. The loan bears interest at 12% per annum, with interest payable quarterly and the full original principal amount of $9.0 million, together with any accrued but unpaid interest, payable in May 2002. The Company's interest in COPI Colorado secures the loan, which is cross-collateralized and cross-defaulted with the Company's other borrowings from Crescent Partnership. As of December 31, 1999, $9.0 million was outstanding under the line of credit.
As a part of the acquisition of a two-thirds interest in the HCAC, the Company borrowed $0.8 million from Crescent Partnership at an interest rate of 8.5% per annum. The $0.8 million note was collateralized by the two-thirds interest in HCAC. Monthly principal and interest payments on the $0.8 million loan commenced in November 1997. As of December 31, 1999, there was $0.5 million outstanding on the $0.8 million note; the note was paid in full in January 2000 upon the sale by HCAC of its assets.
Crescent Machinery has various equipment notes payable and floor plan notes under credit facilities which are collateralized by the equipment financed. The equipment notes are payable in monthly principal and interest payments and bear interest at 6.0% to 10.9% per annum and mature between 2000 and 2007. The floor plan notes do not bear interest, do not require monthly principal or interest payments and generally have terms ranging from three to twelve months. As of December 31, 1999, the outstanding balance on the equipment notes was $102.5 million and on the floor plan notes was $21.5 million.
In connection with the formation and capitalization of Crescent Operating in the second quarter of 1997, Crescent Operating received approximately $14.1 million in cash from Crescent Partnership and Crescent Partnership loaned Crescent Operating approximately $35.9 million pursuant to a five-year term loan, maturing on May 8, 2002, of which approximately $13.8 million was outstanding as of December 31, 1999. The loan is a recourse loan that is collateralized, to the extent not prohibited by pre-existing arrangements, by a first lien on the assets which the Company now owns or may acquire in the future. The loan bears interest at the rate of 12% per annum, compounded quarterly, with required quarterly principal and interest payments limited by quarterly cash flow of the Company as defined in the applicable credit agreement.
FINANCING ATTRIBUTABLE TO NON WHOLLY OWNED SUBSIDIARIES
Desert Mountain Properties also has a credit agreement with Crescent Partnership pursuant to which Crescent Partnership has advanced funds to Desert Mountain Properties through a "Junior Note" and a "Senior Note". The Junior Note evidences a $60.0 million advance from Crescent Partnership to Desert Mountain Properties and accrues interest at 14% per annum. The Senior Note evidences a $110.0 million advance from Crescent Partnership to Desert Mountain Properties and accrues interest at 10% per annum. The principal and interest on both the Junior Note and the Senior Note are payable in quarterly installments, based on proceeds from the operations of Desert Mountain Properties. As of December 31, 1999, the outstanding balances of the Junior Note and Senior Note were $60.0 million and $6.1 million, respectively.
Desert Mountain Properties entered into a $45 million credit facility with National Bank of Arizona in May 1998. The facility is comprised of (i) a $35 million line of credit available for vertical financing related to new home construction and bears an annual interest at the prime rate and (ii) a $10 million line of credit available for borrowings against certain notes receivable issued by Desert Mountain Properties and bears an annual interest rate of prime plus 1%. The credit facility expires June 2000 with interest payable monthly, collateralized by land owned by Desert Mountain Properties, deeds of trust on lots sold and home construction. As of December 31, 1999, the outstanding balance on the line of credit with National Bank of Arizona was $13.8 million.
CDMC has three lines of credit with Crescent Partnership, one of which was increased from $40.2 million to $48.2 million effective January 1, 1999 and then from $48.2 million to $56.2 million in December 1999. The line of credit bears interest at 11.5% per annum, compounded annually. Principal and interest payments are due as distributions from projects are received, as defined by the applicable agreement. The line of credit is due August 2004. As of December 1999, $49.4 million was outstanding on the $56.2 million line of credit. The second line of credit of $22.9 million (which by mutual agreement of borrower and lender was effectively converted into a term loan of $16.4 million) bears interest at 12.0% per annum, compounded annually. Principal and interest payments are due as distributions from projects are received, as defined by the applicable agreement. The line of credit is due January 2003. As of December 31, 1999, $16.4 million was outstanding on the $22.9 million line of credit. The third line of credit with Crescent Partnership for $40.0 million bears interest at 11.5% per annum. Principal and interest payments are due as distributions are received, as defined by the applicable credit agreement. The line of credit is due December 2006. As of December 31, 1999, $14.5 million was outstanding on the $40.0 million line of credit. The lines of credit are collateralized by CDMC's interests in East West Resort Development partnerships, East West Resorts, LLC and other CDMC property. CDMC also has a term loan with Crescent Partnership for $3.1 million maturing June 2005. The note bears interest at 12%, with interest payable quarterly and principal payable annually in accordance with an increasing schedule. The note is collateralized by CDMC's interests in East West Resorts, LLC, the East West Development partnerships and CDMC's other property. As of December 31, 1999, $2.6 million was outstanding on the $3.1 million term note. Generally, CDMC's loans with Crescent Partnership are cross-collateralized and cross-defaulted.
The operating entities in which CDMC invests have various construction loans for East West projects which are collateralized by deeds of trust, security agreements and a first lien on the assets conveyed. The notes are payable in monthly principal and interest payments and bear interest at 8.0% to 13.9% per annum. The notes mature between 2000 and 2005. As of December 31, 1999, the outstanding balance on these construction notes was $45.0 million in the aggregate.
CRL has a line of credit with Crescent Partnership in the amount of $7.0 million bearing interest at a rate of 12% per annum. The line of credit is due August 2003. The principal and interest are payable as CRL receives distributions pursuant to the CR License Operating Agreement and the CR Las Vegas Operating Agreement. As of December 31, 1999, $5.7 million was outstanding under the line of credit.
YEAR 2000 ISSUES
The Company, along with an independent firm, assessed information technology systems (such as accounting systems and network operating systems) and non-information technology systems (such as microcontrollers). As the assessment phase was completed at each of the locations, the Company implemented a modification phase to address any issues discovered in the assessment phase. The modification phase was followed by a testing phase to determine that the appropriate corrective action had been taken. The testing phase was completed successfully in advance of December 31, 1999.
Through the date of this Form 10-K, the Company has experienced no material unresolved problems related to the Year 2000, including the changeover from December 31, 1999 to January 1, 2000, and the leap day, February 29, 2000. In addition, none of the Company's major suppliers has failed to meet its obligations as a result of Year 2000. The Company's share of total costs associated with its Year 2000 compliance efforts was less than $1.0 million.
The Company will continue to monitor its information technology systems and non-information technology systems, through the middle of the Year 2000, to ensure that any latent Year 2000 issues that may arise are promptly addressed. The Company does not anticipate any additional material expenditures related to Year 2000 compliance.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company has fixed and variable rate notes payable and lines of credit which are subject to market risk related to changes in interest rates. The Company manages its market risk by attempting to match anticipated inflow of cash from its operating, investing and financing activities with anticipated outflow of cash to fund debt payments, investments and other cash requirements. The Company does not use derivative financial instruments to manage interest rate risk.
As of December 31, 1999, the Company had amounts outstanding under variable rate notes payable and lines of credit totaling $128.4 million, with a weighted average interest rate of 9.0% per annum. A hypothetical 10% increase in the weighted average interest rate on the Company's variable rate notes and lines of credit would cause a $1.2 million increase in interest expense and a decrease in the Company's earnings and cash flows of $0.9 million, based on the amount of variable rate debt outstanding as of December 31, 1999. In the event that interest rates increase significantly and the Company continues to have significant amounts outstanding under variable rate notes and credit lines, depending upon market conditions, the Company may be able to substitute fixed rate notes for some of its variable rate notes and credit lines to minimize its exposure to interest rate risk. There can be no assurance, however, that any such substitution could be arranged on terms that are satisfactory to the Company.
As of December 31, 1999, the Company had amounts outstanding under fixed rate notes payable and lines of credit totaling $293.4 million, with a weighted average interest rate of 10.5% per annum. In the event that interest rates decrease significantly, and market interest rates are substantially lower than the rates on the Company's fixed rate notes and credit lines, the Company would be able to reduce interest expense if it were able to prepay and/or refinance these instruments. There can be no assurance, however, that the Company would be able to prepay or refinance its debt on terms that are satisfactory to the Company in a declining interest rate environment.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Information with respect to this Item is contained in the Company's Consolidated Financial Statements as indicated in the Index on Page of this Annual Report on Form 10-K, and is incorporated herein by reference.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None
PART III
Certain information required by Part III is omitted from this report in that the Company will file a definitive proxy statement with the Securities and Exchange Commission (the "Commission") pursuant to Regulation 14A ("Proxy Statement") not later than 120 days after the end of the fiscal year covered by this report, and certain information to be included therein is incorporated herein by reference. Only those sections of the Proxy Statement which specifically address the items set forth herein are incorporated by reference.
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item is incorporated by reference to the Company's Proxy Statement to be filed with the Commission for its annual shareholders' meeting to be held in June 2000.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is incorporated by reference to the Company's Proxy Statement to be filed with the Commission for its annual shareholders' meeting to be held in June 2000.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item is incorporated by reference to the Company's Proxy Statement to be filed with the Commission for its annual shareholders' meeting to be held in June 2000.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item is incorporated by reference to the Company's Proxy Statement to be filed with the Commission for its annual shareholders' meeting to be held in June 2000.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) Documents filed as part of the Annual Report on Form 10-K:
1. Financial Statements
Information with respect to this Item is contained on pages to of this Annual Report on Form 10-K.
2. Financial Statement Schedules
Information with respect to this Item is listed on page of this Annual Report on Form 10-K.
3. Exhibits
EXHIBIT NUMBER DESCRIPTION OF EXHIBITS ------ -----------------------
3.1 First Amended and Restated Certificate of Incorporation (filed as Exhibit 3.3 to the Company's registration statement on Form S-1 dated July 12, 1997 ("Form S-1") and incorporated by reference herein)
3.2 First Amended and Restated Bylaws (filed as Exhibit 3.4 to Form S-1 and incorporated by reference herein)
3.3 Amendment of Article V of First Amended and Restated Bylaws (filed as Exhibit 3.3 to the Company's June 30, 1998 Form 10-Q ("June 30, 1998 Form 10-Q") and incorporated by reference herein)
3.4 Repeal of Amendment of Article V of First Amended and Restated Bylaws (filed as Exhibit 3.4 to the Company's September 30, 1998 Form 10-Q ("September 30, 1998 Form 10-Q") and incorporated by reference herein)
4.1 Specimen stock certificate (filed as Exhibit 4.1 to Form S-1 and incorporated by reference herein)
4.2 Preferred Share Purchase Rights Plan (filed as Exhibit 4.2 to Form S-1 and incorporated by reference herein)
4.3 First Amendment to Preferred Share Purchase Rights Agreement dated as of September 25, 1998, between Crescent Operating, Inc. and Bank Boston, N.A., as Rights Agent (filed as Exhibit 4.3 to September 30, 1998 Form 10-Q and incorporated by reference herein)
4.4 Second Amendment to Preferred Share Purchase Rights Agreement dated as of March 4, 1999, between Crescent Operating, Inc. and Bank Boston, N.A., as Rights Agent (filed as Exhibit 4.4 to March 31, 1999 Form 10-Q ("March 31, 1999 Form 10-Q") and incorporated by reference herein)
10.1 Amended Stock Incentive Plan (filed as Exhibit 10.1 to Form S-1 and incorporated by reference herein)
10.2 Intercompany Agreement between Crescent Operating, Inc. and Crescent Real Estate Equities Limited Partnership (filed as Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for the Quarter Ended June 30, 1997 ("June 30, 1997 Form 10-Q") and incorporated by reference herein)
10.3 Amended and Restated Operating Agreement of Charter Behavioral Health Systems, LLC (filed as Exhibit 10.3 to June 30, 1997 Form 10-Q and incorporated by reference herein)
10.5 Amended and Restated Credit and Security Agreement, dated as of May 30, 1997, between Crescent Real Estate Equities Limited Partnership and Crescent Operating, Inc., together with related Note (filed as Exhibit 10.5 to the Company's September 30, 1997 Form 10-Q ("September 30, 1997 Form 10-Q") and incorporated by reference herein)
10.6 Line of Credit and Security Agreement, dated as of May 21, 1997, between Crescent Real Estate Equities Limited Partnership and Crescent Operating, Inc., together with related Line of Credit Note (filed as Exhibit 10.6 to September 30, 1997 Form 10-Q and incorporated by reference herein)
10.7 Acquisition Agreement, dated as of February 10, 1997, between Crescent Real Estate Equities Limited Partnership and Carter-Crowley Properties, Inc. (filed as Exhibit 10.7 to Form S-1 and incorporated by reference herein)
10.10 Security Agreement dated September 22, 1997 between COI Hotel Group, Inc., as debtor, and Crescent Real Estate Equities Limited Partnership, as lender, together with related $1 million promissory note (filed as Exhibit 10.10 to September 30, 1997 Form 10-Q and incorporated by reference herein)
10.11 Security Agreement dated September 22, 1997 between COI Hotel Group, Inc., as debtor, and Crescent Real Estate Equities Limited Partnership, as lender, together with related $800,000 promissory note (filed as Exhibit 10.11 to September 30, 1997 Form 10-Q and incorporated by reference herein)
10.12 Amended and Restated Asset Management dated August 31, 1997, to be effective July 31, 1997, between Wine Country Hotel, LLC and The Varma Group, Inc. (filed as Exhibit 10.12 to September 30, 1997 Form 10-Q and incorporated by reference herein)
10.13 Amended and Restated Asset Management Agreement dated August 31, 1997, to be effective July 31, 1997, between RoseStar Southwest, LLC and The Varma Group, Inc. (filed as Exhibit 10.13 to September 30, 1997 Form 10-Q and incorporated by reference herein)
10.14 Amended and Restated Asset Management Agreement dated August 31, 1997, to be effective July 31, 1997, between RoseStar Management LLC and The Varma Group, Inc. (filed as Exhibit 10.14 to September 30, 1997 Form 10-Q and incorporated by reference herein)
10.15 Agreement for Financial Services dated July 1, 1997, between Crescent Real Estate Equities Company and Petroleum Financial, Inc. (filed as Exhibit 10.15 to September 30, 1997 Form 10-Q and incorporated by reference herein)
10.16 Credit Agreement dated August 27, 1997, between Crescent Operating, Inc. and NationsBank of Texas, N.A. together with related $15.0 million promissory note (filed as Exhibit 10.16 to September 30, 1997 Form 10-Q and incorporated by reference herein)
10.17 Support Agreement dated August 27, 1997, between Richard E. Rainwater, John Goff and Gerald Haddock in favor of Crescent Real Estate Equities Company and NationsBank of Texas, N.A. (filed as Exhibit 10.17 to September 30, 1997 Form 10-Q and incorporated by reference herein)
10.18 1997 Crescent Operating, Inc. Management Stock Incentive Plan (filed as Exhibit 10.18 to the Company's Annual Report on Form 10-K for the year ended December 31, 1997 ("December 31, 1997 Form 10-K") and incorporated by reference herein)
10.19 Memorandum of Agreement executed November 16, 1997, among Charter Behavioral Health Systems, LLC, Charter Behavioral Health Systems, Inc. and Crescent Operating, Inc. (filed as Exhibit 10.19 to December 31, 1997 Form 10-K and incorporated by reference herein)
10.20 Purchase Agreement dated August 31, 1997, by and among Crescent Operating, Inc., RoseStar Management LLC, Gerald W. Haddock, John C. Goff and Sanjay Varma (filed as Exhibit 10.20 to December 31, 1997 Form 10-K and incorporated by reference herein)
10.21 Stock Purchase Agreement dated August 31, 1997, by and among Crescent Operating, Inc., Gerald W. Haddock, John C. Goff and Sanjay Varma (filed as Exhibit 10.21 to December 31, 1997 Form 10-K and incorporated by reference herein)
10.22 Amended and Restated Lease Agreement, dated June 30, 1995 between Crescent Real Estate Equities Limited Partnership and RoseStar Management LLC, relating to the Denver Marriott City Center (filed as Exhibit 10.17 to the Annual Report on Form 10-K of Crescent Real Estate Equities Company for the Fiscal Year Ended December 31, 1995 (the "1995 CEI 10-K") and incorporated by reference herein)
10.23 Lease Agreement, dated December 19, 1995 between Crescent Real Estate Equities Limited Partnership and RoseStar Management LLC, relating to the Hyatt Regency Albuquerque (filed as Exhibit 10.16 to the 1995 CEI 10-K and incorporated by reference herein)
10.24 Form of Amended and Restated Lease Agreement, dated January 1, 1996, among Crescent Real Estate Equities Limited Partnership, Mogul Management, LLC and RoseStar Management LLC, relating to the Hyatt Regency Beaver Creek (filed as Exhibit 10.12 to the 1995 CEI 10-K and incorporated by reference herein)
10.25 Lease Agreement, dated July 26, 1996, between Canyon Ranch, Inc. and Canyon Ranch Leasing, L.L.C., assigned by Canyon Ranch, Inc. to Crescent Real Estate Equities Limited Partnership pursuant to the Assignment and Assumption Agreement of Master Lease, dated July 26, 1996 (filed as Exhibit 10.24 to the Quarterly Report on Form 10-Q/A of Crescent Real Estate Equities Company for the Quarter Ended June 30, 1997 (the "1997 CEI 10-Q") and incorporated by reference herein)
10.26 Lease Agreement, dated November 18, 1996 between Crescent Real Estate Equities Limited Partnership and Wine Country Hotel, LLC (filed as Exhibit 10.25 to the Annual Report on Form 10-K of Crescent Real Estate Equities Company for the Fiscal Year Ended December 31, 1996 and incorporated by reference herein)
10.27 Lease Agreement, dated December 11, 1996, between Canyon Ranch-Bellefontaine Associates, L.P. and Vintage Resorts, L.L.C., as assigned by Canyon Ranch-Bellefontaine Associates, L.P. to Crescent Real Estate Funding VI, L.P. pursuant to the Assignment and Assumption Agreement of Master Lease, dated December 11, 1996 (filed as Exhibit 10.26 to the 1997 CEI 10-Q and incorporated by reference herein)
10.28 Master Lease Agreement, dated June 16, 1997, between Crescent Real Estate Funding VII, L.P. and Charter Behavioral Health Systems, LLC and its subsidiaries, relating to the Facilities (filed as Exhibit 10.27 to the 1997 CEI 10-Q and incorporated by reference herein)
10.29 Form of Indemnification Agreement (filed as Exhibit 10.29 to December 31, 1997 Form 10-K and incorporated by reference herein)
10.30 Purchase Agreement, dated as of September 29, 1997, between Crescent Operating, Inc. and Crescent Real Estate Equities Limited Partnership, relating to the purchase of Desert Mountain Development Corporation (filed as Exhibit 10.30 to December 31, 1997 Form 10-K and incorporated by reference herein)
10.31 Lease Agreement dated December 19, 1997, between Crescent Real Estate Equities Limited Partnership, as Lessor, and Wine Country Hotel, as Lessee, for lease of Ventana Inn (filed as Exhibit 10.31 to the Company's March 31, 1998 Form 10-Q ("March 31, 1998 Form 10-Q") and incorporated by reference herein)
10.32 Lease Agreement dated September 22, 1997, between Crescent Real Estate Equities Limited Partnership, as Lessor, and COI Hotel Group, Inc., as lessee, for lease of Four Seasons Hotel, Houston (filed as Exhibit 10.32 to March 31, 1998 Form 10-Q and incorporated by reference herein)
10.33 Asset Purchase Agreement dated December 19, 1997, among Crescent Operating, Inc., Preco Machinery Sales, Inc., and certain individual Preco shareholders (filed as Exhibit 10.33 to March 31, 1998 Form 10-Q and incorporated by reference herein)
10.34 Asset Purchase Agreement dated April 30, 1998, among Crescent Operating, Inc., Central Texas Equipment Company, and certain individual Central Texas shareholders (filed as Exhibit 10.34 to March 31, 1998 Form 10-Q and incorporated by reference herein)
10.35 Credit Agreement dated August 29, 1997 between Crescent Real Estate Equities Limited Partnership, as lender, and Desert Mountain Properties Limited Partnership, as borrower, together with related Senior Note, Junior Note and deed of trust (filed as Exhibit 10.35 to March 31, 1998 Form 10-Q and incorporated by reference herein)
10.36 Buy-Out Agreement dated April 24, 1998, between Crescent Operating, Inc. and Crescent Real Estate Equities Limited Partnership (filed as Exhibit 10.36 to March 31, 1998 Form 10-Q and incorporated by reference herein)
10.37 Stock Acquisition Agreement and Plan of Merger dated June 4, 1998, among Machinery, Inc., Oklahoma Machinery, Inc., Crescent Machinery Company, Crescent Operating, Inc. and certain individual Machinery shareholders (filed as Exhibit 10.37 to June 30, 1998 Form 10-Q and incorporated by reference herein)
10.38 Master Revolving Line of Credit Loan Agreement (Borrowing Base and Warehouse) dated May 14, 1998, between Desert Mountain Properties Limited Partnership and National Bank of Arizona (filed as Exhibit 10.38 to June 30, 1998 Form 10-Q and incorporated by reference herein)
10.39 1997 Management Stock Incentive Plan (filed as Exhibit 10.39 to June 30, 1998 Form 10-Q and incorporated by reference herein)
10.40 Credit and Security Agreement, dated as of September 21, 1998, between Crescent Real Estate Equities Limited Partnership and Crescent Operating, Inc., together with related Note (filed as Exhibit 10.40 to September 30, 1998 Form 10-Q and incorporated by reference herein)
10.41 First Amendment to Amended and Restated Pledge Agreement, dated as of September 21, 1998, between Crescent Real Estate Equities Limited Partnership and Crescent Operating, Inc. (filed as Exhibit 10.41 to September 30, 1998 Form 10-Q and incorporated by reference herein)
10.42 First Amendment to Line of Credit and Security Agreement, dated as of August 11, 1998, between Crescent Real Estate Equities Limited Partnership and Crescent Operating, Inc., together with related Note (filed as Exhibit 10.42 to September 30, 1998 Form 10-Q and incorporated by reference herein)
10.43 First Amendment to Amended and Restated Credit and Security Agreement, dated as of August 11, 1998, between Crescent Real Estate Equities Limited Partnership and Crescent Operating, Inc. (filed as Exhibit 10.43 to September 30, 1998 Form 10-Q and incorporated by reference herein)
10.44 Second Amendment to Amended and Restated Credit and Security Agreement, dated as of September 21, 1998, between Crescent Real Estate Equities Limited Partnership and Crescent Operating, Inc. (filed as Exhibit 10.44 to September 30, 1998 Form 10-Q and incorporated by reference herein)
10.45 Second Amendment to Line of Credit and Security Agreement, dated as of September 21, 1998, between Crescent Real Estate Equities Limited Partnership and Crescent Operating, Inc. (filed as Exhibit 10.45 to September 30, 1998 Form 10-Q and incorporated by reference herein)
10.46 Agreement of Limited Partnership of COPI Colorado, L.P. (filed as Exhibit 10.1 to that Schedule 13D Statement dated September 28, 1998, filed by COPI Colorado, L.P., Crescent Operating, Inc., Gerald W. Haddock, John C. Goff and Harry H. Frampton, III, and incorporated by reference herein)
10.47 Contribution Agreement effective as of September 11, 1998, by and among Crescent Operating, Inc., Gerald W. Haddock, John C. Goff and Harry H. Frampton, III (filed as Exhibit 10.2 to that Schedule 13D Statement dated September 28, 1998, filed by COPI Colorado, L.P., Crescent Operating, Inc., Gerald W. Haddock, John C. Goff and Harry H. Frampton, III, and incorporated by reference herein)
10.48 Agreement Regarding Schedules and Other Matters made as of September 11, 1998, by and among Crescent Operating, Inc., Gerald W. Haddock, John C. Goff and Harry H. Frampton, III (filed as Exhibit 10.3 to that Schedule 13D Statement dated September 28, 1998, filed by COPI Colorado, L.P., Crescent Operating Inc., Gerald W. Haddock, John C. Goff and Harry H. Frampton, III, and incorporated by reference herein)
10.49 Stock Purchase Agreement dated as of August 7, 1998 by and among Western Traction Company, The Carlston Family Trust, Ronald D. Carlston and Crescent Operating, Inc. (filed as Exhibit 10.49 to September 30, 1998 Form 10-Q and incorporated by reference herein)
10.50 Stock Purchase Agreement dated as of July 31, 1998 by and among Harvey Equipment Center, Inc., L and H Leasing Company, William J. Harvey, Roy E. Harvey, Jr., Betty J. Harvey and Crescent Operating, Inc. (filed as Exhibit 10.50 to September 30, 1998 Form 10-Q and incorporated by reference herein)
10.51 Credit Agreement dated as of July 28, 1998, between Crescent Real Estate Equities Limited Partnership and CRL Investments, Inc., together with the related Note (filed as Exhibit 10.51 to September 30, 1998 Form 10-Q and incorporated by reference herein)
10.52 Security Agreement dated as of July 28, 1998, between Crescent Real Estate Equities Limited Partnership and CRL Investments, Inc. (filed as Exhibit 10.52 to September 30, 1998 Form 10-Q and incorporated by reference herein)
10.53 First Amendment to Credit Agreement effective as of August 27, 1998, among Crescent Operating, Inc., NationsBank, N. A., and the Support Parties identified therein (filed as Exhibit 10.53 to September 30, 1998 Form 10-Q and incorporated by reference herein)
10.54 Lease Agreement dated as of October 13, 1998, between Crescent Real Estate Equities Limited Partnership and Wine Country Golf Club, Inc., relating to Sonoma Golf Club (filed as Exhibit 10.54 to September 30, 1998 Form 10-Q and incorporated by reference herein)
10.55 First Amendment to Lease Agreement effective December 31, 1998, between Canyon Ranch Leasing, L.L.C., and Crescent Real Estate Equities Limited Partnership, relating to Canyon Ranch - Tucson (filed as Exhibit 10.55 to the Company's Annual Report on Form 10-K for the year ended December 31, 1998 ("December 31, 1998 Form 10-K") and incorporated by reference herein)
10.56 First Amendment to Lease Agreement effective April 1, 1996; Second Amendment to Lease Agreement effective November 22, 1996; Third Amendment to Lease Agreement effective August 12, 1998; and Fourth Amendment to Lease Agreement effective December 31, 1998 between RoseStar Southwest, LLC, and Crescent Real Estate Funding II L.P., relating to Hyatt Regency Albuquerque (filed as Exhibit 10.56 to December 31, 1998 Form 10-K and incorporated by reference herein)
10.57 First Amendment to Lease Agreement effective December 31, 1998, between Wine Country Hotel, LLC, and Crescent Real Estate Equities Limited Partnership, relating to Sonoma Mission Inn & Spa (filed as Exhibit 10.57 to December 31, 1998 Form 10-K and incorporated by reference herein)
10.58 First Amendment to Amended and Restated Lease Agreement effective December 31, 1998, between RoseStar Management, LLC, and Crescent Real Estate Equities Limited Partnership, relating to Marriott City Center, Denver (filed as Exhibit 10.58 to December 31, 1998 Form 10-K and incorporated by reference herein)
10.59 First Amendment to Lease Agreement effective December 31, 1998, between Wine Country Hotel, LLC, and Crescent Real Estate Equities Limited Partnership, relating to Ventana Inn (filed as Exhibit 10.59 to December 31, 1998 Form 10-K and incorporated by reference herein)
10.60 First Amendment to Amended and Restated Lease Agreement effective April 1, 1996 and Second Amendment to Amended and Restated Lease Agreement effective December 31, 1998, between RoseStar Southwest, LLC, and Crescent Real Estate Funding II, L.P., relating to Hyatt Regency Beaver Creek (filed as Exhibit 10.60 to December 31, 1998 Form 10-K and incorporated by reference herein)
10.61 First Amendment to Lease Agreement effective December 31, 1998, between COI Hotel Group, Inc. and Crescent Real Estate Equities Limited Partnership, relating to Four Seasons - Houston (filed as Exhibit 10.61 to December 31, 1998 Form 10-K and incorporated by reference herein)
10.62 First Amendment to Lease Agreement effective December 31, 1998, between Wine Country Hotel, LLC and Crescent Real Estate Funding VI, L.P., relating to Canyon Ranch - Lenox (filed as Exhibit 10.62 to March 31, 1999 Form 10-Q and incorporated by reference herein)
10.63 Master Guaranty effective December 31, 1998, by Crescent Operating, Inc. for the benefit of Crescent Real Estate Equities Limited Partnership, Crescent Real Estate Funding II, L.P., and Crescent Real Estate Funding VI, L.P., relating to leases for Hyatt Regency Albuquerque, Hyatt Regency Beaver Creek, Canyon Ranch-Lenox, Sonoma Mission Inn & Spa, Canyon Ranch - Tucson, and Marriott City Center Denver (filed as Exhibit 10.63 to December 31, 1998 Form 10-K and incorporated by reference herein)
10.64 Guaranty of Lease effective December 19, 1997, by Crescent Operating, Inc. for the benefit of Crescent Real Estate Equities Limited Partnership, relating to Ventana Inn (filed as Exhibit 10.64 to December 31, 1998 Form 10-K and incorporated by reference herein)
10.65 Amended and Restated Guaranty of Lease effective December 31, 1998, by Crescent Operating, Inc. for the benefit of Crescent Real Estate Equities Limited Partnership, relating to Four Seasons Hotel - Houston (filed as Exhibit 10.65 to December 31, 1998 Form 10-K and incorporated by reference herein)
10.66 Amended and Restated Guaranty of Lease effective December 31, 1998, by Crescent Operating, Inc. for the benefit of Crescent Real Estate Equities Limited Partnership, relating to Sonoma Golf Club (filed as Exhibit 10.66 to December 31, 1998 Form 10-K and incorporated by reference herein)
10.67 Credit Agreement dated August 11, 1995, between Crescent Development Management Corp., as borrower, and Crescent Real Estate Equities Limited Partnership, as lender; First Amendment to Credit Agreement dated as of April 15, 1997; Second Amendment to Credit Agreement dated as of May 8, 1998; and related Note and Security Agreement (filed as Exhibit 10.67 to December 31, 1998 Form 10-K and incorporated by reference herein)
10.68 Credit Agreement dated January 1, 1998, between Crescent Development Management Corp., as borrower, and Crescent Real Estate Equities Limited Partnership, as lender, and related Note and Security Agreement (filed as Exhibit 10.68 to December 31, 1998 Form 10-K and incorporated by reference herein)
10.69 $3,100,000 Note dated February 29, 1996, made by Crescent Development Management Corp. payable to Crescent Real Estate Equities Limited Partnership (filed as Exhibit 10.69 to December 31, 1998 Form 10-K and incorporated by reference herein)
10.70 Credit Agreement dated January 1, 1999, between Crescent Development Management Corp., as borrower, and Crescent Real Estate Equities Limited Partnership, as lender, and related Line of Credit Note and Security Agreement (filed as Exhibit 10.70 to March 31, 1999 Form 10-Q and incorporated by reference herein)
10.71 Amended and Restated Credit Agreement dated January 1, 1999, between Crescent Development Management Corp., as borrower, and Crescent Real Estate Equities Limited Partnership, as lender, and related Line of Credit Note and Amended and Restated Security Agreement (filed as Exhibit 10.71 to March 31, 1999 Form 10-Q and incorporated by reference herein)
10.72 Purchase Agreement dated March 12, 1999, between Crescent Operating, Inc. and Crescent Real Estate Equities Limited Partnership, relating to sale of interests in Crescent CS Holdings Corp., and Crescent CS Holdings II Corp., and related Put Agreement of same date (filed as Exhibit 10.72 to March 31, 1999 Form 10-Q and incorporated by reference herein)
10.73 Second Amendment to Lease Agreement effective April 1, 1999, between Wine Country Hotel, LLC, and Crescent Real Estate Funding VI, L.P., relating to Canyon Ranch-Lenox (filed as Exhibit 10.73 to March 31, 1999 Form 10-Q and incorporated by reference herein)
10.74 Master Revolving Line of Credit Loan Agreement (Borrowing Base and Warehouse) dated May 14, 1998, between Desert Mountain Properties Limited Partnership, as borrower, and National Bank of Arizona, as lender; Modification Agreement dated December 30, 1998; second Modification Agreement dated March 31, 1999; and related Promissory Note (Borrowing Base), Promissory Note (Warehouse), Pledge Agreement, Deed of Trust, and Amendment to Deed of Trust (filed as Exhibit 10.74 to March 31, 1999 Form 10-Q and incorporated by reference herein)
10.75 Lease Agreement dated as of June 15, 1999, between Crescent Real Estate Funding III, L.P. and COI Hotel Group, Inc., relating to the Renaissance Houston Hotel (filed as Exhibit 10.75 to June 30, 1999 Form 10-Q and incorporated by reference herein)
10.76 Guaranty of Lease dated June 15, 1999, by Crescent Operating, Inc. for the benefit of Crescent Real Estate Funding III, L.P., relating to Renaissance Houston Hotel (filed as Exhibit 10.76 to June 30, 1999 Form 10-Q and incorporated by reference herein)
10.77 Asset Management Agreement dated as of January 1, 1999, between Crescent Real Estate Equities Limited Partnership and COI Hotel Group, Inc., relating to the Omni Austin Hotel (filed as Exhibit 10.77 to June 30, 1999 Form 10-Q and incorporated by reference herein)
10.78 Agreement dated June 11, 1999, by and between Gerald W. Haddock and Crescent Operating, Inc. and its subsidiaries and affiliates (filed as Exhibit 10.78 to June 30, 1999 Form 10-Q and incorporated by reference herein)
10.79 Stock Purchase Agreement dated as of July 15, 1999, by and among E. L. Lester & Company, Incorporated, E. L. Lester, Jr., Howard T. Tellepsen II, Karen Tellepsen, Tom Tellepsen II, Linda Lester Griffen, Crescent Operating, Inc. and Crescent Machinery Company (filed as Exhibit 10.79 to the Company's September 30, 1999 Form 10-Q ("September 30, 1999 Form 10-Q") and incorporated by reference herein)
10.80 Stock Purchase Agreement dated as of July 8, 1999, by and among Solveson Crane Rental, Inc., Solveson Family Revocable Trust, and Crescent Machinery Company (filed as Exhibit 10.80 to September 30, 1999 Form 10-Q and incorporated by reference herein)
10.81 Second Amendment to Credit Agreement effective as of August 27, 1999, among Crescent Operating, Inc., Bank of America, N. A. (formerly NationsBank, N. A.), and the Support Parties identified therein (filed as Exhibit 10.81 to September 30, 1999 Form 10-Q and incorporated by reference herein)
10.82 First Amendment to 1997 Crescent Operating, Inc. Management Stock Incentive Plan (filed herewith)
10.83 Form of Sales and Service Agreement between BLAW KNOX Construction Equipment Corporation and certain of Crescent Machinery Company and its subsidiaries (filed herewith)
10.84 Form of Heavy Equipment Distributor Agreement between Compaction America, Inc. and certain of Crescent Machinery Company and its subsidiaries (filed herewith)
10.85 Form of Gradall Equipment Distributor Agreement between The Gradall Company and certain of Crescent Machinery Company and its subsidiaries (filed herewith)
10.86 Form of Distributor Selling Agreement between Ingersoll-Rand Company and certain of Crescent Machinery Company and its subsidiaries (filed herewith)
10.87 Form of JCB Dealership Agreement between JCB Inc. and certain of Crescent Machinery Company and its subsidiaries (filed herewith)
10.88 Form of Distributor Agreement between LBX Company, LLC, and certain of Crescent Machinery Company and its subsidiaries (filed herewith)
10.89 Form of Distributor Agreement between Liebherr Construction Equipment Co. and certain of Crescent Machinery Company and its subsidiaries (filed herewith)
10.90 Form of Distributor Agreement between Link-Belt Construction Equipment Company and certain of Crescent Machinery Company and its subsidiaries (filed herewith)
10.91 Form of Dealer Floor Plan Financing and Security Agreement between General Electric Capital Corporation and certain of Crescent Machinery Company and its subsidiaries (filed herewith)
10.92 Taxable REIT Subsidiary Election Agreement dated December 17, 1999, among Crescent Real Estate Equities Company, Crescent Real Estate Equities Limited Partnership, Crescent Operating, Inc. and Crescent Development Management Corp. (filed herewith)
10.93 Taxable REIT Subsidiary Election Agreement dated December 17, 1999, among Crescent Real Estate Equities Company, Crescent Real Estate Equities Limited Partnership, Crescent Operating, Inc. and Crescent CS Holdings II Corp. (filed herewith)
10.94 Taxable REIT Subsidiary Election Agreement dated December 17, 1999, among Crescent Real Estate Equities Company, Crescent Real Estate Equities Limited Partnership, Crescent Operating, Inc. and Crescent CS Holdings Corp. (filed herewith)
10.95 Taxable REIT Subsidiary Election Agreement dated December 17, 1999, among Crescent Real Estate Equities Company, Crescent Real Estate Equities Limited Partnership, Crescent Operating, Inc. and Desert Mountain Development Corp. (filed herewith)
10.96 Taxable REIT Subsidiary Election Agreement dated December 17, 1999, among Crescent Real Estate Equities Company, Crescent Real Estate Equities Limited Partnership, Crescent Operating, Inc. and The Woodlands Land Company, Inc. (filed herewith)
10.97 $19.5 Million Credit and Security Agreement effective as of March 11, 1999, between Crescent Real Estate Equities Limited Partnership and Crescent Operating, Inc. with related Promissory Note (filed herewith)
10.98 First Amendment to Credit and Security Agreement effective as of March 11, 1999, between Crescent Real Estate Equities Limited Partnership and Crescent Operating, Inc. (filed herewith)
10.99 Third Amendment to Amended and Restated Credit and Security Agreement effective as of March 11, 1999, between Crescent Real Estate Equities Limited Partnership and Crescent Operating, Inc. (filed herewith)
10.100 Third Amendment to Line of Credit Credit and Security Agreement effective as of March 11, 1999, between Crescent Real Estate Equities Limited Partnership and Crescent Operating, Inc. (filed herewith)
10.101 Agreements for Wholesale Financing (with Addendum) between Deutsche Financial Services Corporation and, respectively, Western Traction Company, Machinery Inc., Solveson Crane Rentals Inc., Harvey Equipment Center Inc., and Crescent Machinery Company, with Guarantees (filed herewith)
10.102 Master Security Agreements between Associates Commercial Corporation and, respectively, Crescent Machinery Company and Western Traction Company; Security Agreement between Associates Commercial Corporation and Western Traction Company; Addendum; and Continuing Guaranty by Crescent Machinery Company (filed herewith)
10.103 First Amendment to Amended and Restated Credit Agreement dated as of December 20, 1999, between Crescent Real Estate Equities Limited Partnership and Crescent Development Management Corp. with related Line of Credit Note and letter amendment to related security agreement (filed herewith)
21 List of Subsidiaries of Crescent Operating, Inc.
23.1 Consent of Ernst & Young LLP
23.2 Consent of Deloitte & Touche LLP
23.3 Consent of Arthur Andersen LLP - Denver
23.4 Consent of Arthur Andersen LLP - Atlanta
23.5 Consent of Arthur Andersen LLP - Houston
27 Financial Data Schedule
(b) Reports on Form 8-K:
No reports on Form 8-K were filed during the last quarter of the year ended December 31, 1999.
(c) Exhibits Required by Item 601 of Regulation S-K:
Exhibits required are listed under Item 14(a)(3).
(d) Financial Statement Schedules Required by Regulation S-X:
Information with respect to this Item is contained on Pages to of this Annual Report on Form 10-K.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on the 30th day of March, 2000.
CRESCENT OPERATING, INC. (Registrant)
By /s/ John C. Goff ------------------------------------- John C. Goff President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934 as amended, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
CRESCENT OPERATING, INC.
The following Consolidated Financial Statements of the Registrant are submitted herewith in response to Item 8 and Item 14(a)1:
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.
REPORT OF INDEPENDENT AUDITORS
Board of Directors and Shareholders Crescent Operating, Inc.
We have audited the accompanying consolidated balance sheets of Crescent Operating, Inc. and subsidiaries as of December 31, 1999 and 1998, and the related consolidated statements of operations, shareholders' equity (deficit), and cash flows for the years then ended and the period from May 9, 1997 through 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 did not audit the financial statements of The Woodlands Land Development Company, L.P., The Woodlands Operating Company, L.P., Crescent Development Management Corporation or Vornado Crescent Logistics Operating Partnership, which statements reflect total assets constituting 34.9%, and total revenues constituting 19.2%, of the related consolidated totals in 1999. Those statements were audited by other auditors whose reports have been furnished to us, and our opinion, insofar as it relates to data included for The Woodlands Land Development Company, L.P., The Woodlands Operating Company, L.P., Crescent Development Management Corporation and Vornado Crescent Logistics Operating Partnership, is based solely on the reports of the other auditors.
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits and the reports of other auditors provide a reasonable basis for our opinion.
In our opinion, based on our audits and, for 1999, the reports of other auditors, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Crescent Operating, Inc. and subsidiaries at December 31, 1999 and 1998, and the consolidated results of their operations and their cash flows for the years ended December 31, 1999 and 1998 and the period from May 9, 1997 through December 31, 1997, in conformity with accounting principles generally accepted in the United States.
Ernst & Young LLP
Dallas, Texas March 22, 2000
REPORT OF INDEPENDENT AUDITORS
Board of Directors and Shareholders Crescent Operating, Inc.
We have audited the accompanying combined statements of operations, changes in shareholder's equity, and cash flows of Carter-Crowley Asset Group as described in Note 2 for the period from January 1, 1997 through May 8, 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 audit.
We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the combined results of operations and cash flows for the period from January 1, 1997 through May 8, 1997 of Carter-Crowley Asset Group in conformity with generally accepted accounting principles.
ERNST & YOUNG LLP
Dallas, Texas March 2, 1998
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Executive Committee of The Woodlands Land Development Company, L.P.:
We have audited the accompanying balance sheets of The Woodlands Land Development Company, L.P. as of December 31, 1999 and 1998 and the related statements of earnings, changes in partners' equity and cash flows for the years then ended (not included herein). These financial statements are the responsibility of The Woodlands Land Development Company, L.P.'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 financial position of The Woodlands Land Development Company, L.P. as of December 31, 1999 and 1998 and the results of its operations and cash flows for the years then ended in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Houston, Texas January 14, 2000
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Executive Committee of The Woodlands Operating Company, L.P.:
We have audited the accompanying consolidated balance sheets of The Woodlands Operating Company, L.P. and subsidiary as of December 31, 1999 and 1998 and the related consolidated statements of earnings, changes in partners' equity (deficit) and cash flows for the years then ended (not included herein). These financial statements are the responsibility of The Woodlands Operating Company, L.P.'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 financial position of The Woodlands Operating Company, L.P. and subsidiary as of December 31, 1999 and 1998 and the results of its operations and cash flows for the years then ended in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Houston, Texas January 14, 2000
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Shareholders of Crescent Development Management Corp.:
We have audited the accompanying consolidated balance sheets of CRESCENT DEVELOPMENT MANAGEMENT CORP. (a Delaware corporation) AND SUBSIDIARIES as of December 31, 1999 and 1998 and the related consolidated statements of operations, shareholders' equity and cash flows for the years then ended (not included herein). These financial statements and the schedules referred to below are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Crescent Development Management Corp. and Subsidiaries at December 31, 1999 and 1998, and the results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States.
Our audits were made for the purpose of forming an opinion on the consolidated financial statements taken as a whole. Schedules I through VII are presented for purposes of additional analysis and are not a required part of the basic financial statements. This information has been subjected to the auditing procedures applied in our audit of the basic consolidated financial statements and, in our opinion, is fairly stated in all material respects in relation to the consolidated financial statements taken as a whole.
ARTHUR ANDERSEN LLP
Denver, Colorado January 28, 2000.
CRESCENT OPERATING, INC. CONSOLIDATED BALANCE SHEETS (Amounts in thousands)
See accompanying notes to the consolidated financial statements.
CRESCENT OPERATING, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (Amounts in thousands, except per share data)
See accompanying notes to the consolidated financial statements.
CRESCENT OPERATING, INC. CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (DEFICIT) (Amounts in thousands)
See accompanying notes to the consolidated financial statements.
CRESCENT OPERATING, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (AMOUNTS IN THOUSANDS)
See accompanying notes to the consolidated financial statements.
CRESCENT OPERATING, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND NATURE OF BUSINESS:
Crescent Operating, Inc. ("Crescent Operating" or "COPI") was formed on April 1, 1997, by Crescent Real Estate Equities Company ("Crescent Equities" or "CEI") and its subsidiary Crescent Real Estate Equities Limited Partnership ("Crescent Partnership") to be the lessee and operator of certain assets owned or to be acquired by Crescent Partnership and perform an agreement ("Intercompany Agreement") between Crescent Operating and Crescent Partnership, pursuant to which each has agreed to provide the other with rights to participate in certain transactions. On May 8, 1997, Crescent Partnership contributed $14.1 million in cash to Crescent Operating. Effective June 12, 1997, Crescent Equities distributed shares of Crescent Operating common stock to shareholders of Crescent Equities and unit holders of Crescent Partnership of record on May 30, 1997.
Crescent Operating is a diversified management company that, through various subsidiaries and affiliates (collectively with Crescent Operating, the "Company"), currently operates primarily in four business segments: Equipment Sales and Leasing, Hospitality, Temperature Controlled Logistics (formerly Refrigerated Warehousing) and Land Development. Through these segments, Crescent Operating does business throughout the United States.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
BASIS OF PRESENTATION AND PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements of Crescent Operating include the accounts of the Company and all subsidiaries controlled by the Company after elimination of material intercompany accounts and minority interests. Subsidiaries not controlled by the Company, but for which the Company has the ability to exercise significant influence, are accounted for on the equity method.
The financial results of the Company include the following:
o Subsidiaries which are wholly owned and consolidated: o Crescent Machinery Company ("Crescent Machinery"); o Rosestar Management LLC ("Rosestar"); and o COI Hotel Group, Inc. ("COI Hotel").
o Subsidiaries which are not wholly owned but the Company controls and therefore consolidates ("Controlled Subsidiaries"): o A 5% economic interest in: - The Woodlands Land Company, Inc. ("LandCo") which has a 42.5% general partner interest in The Woodlands Land Development Company, L.P. ("Landevco"); - Desert Mountain Development Corporation ("Desert Mountain Development") which consolidates its 93% general partner interest in Desert Mountain Properties Limited Partnership ("DMPLP"); and - CRL Investments, Inc. ("CRL"), which beneficially owns 60% of CR Las Vegas, LLC ("CR Las Vegas") and 20% of CR License, LLC ("CR License").
o A 50% general partner interest in COPI Colorado, L.P. ("COPI Colorado") which owns 10% of Crescent Development Management Corp. ("CDMC"). The 10% interest in CDMC represents 100% of the voting stock, and therefore, CDMC is consolidated into COPI Colorado.
o Subsidiaries which the Company reports on the equity method of accounting: o A 42.5% interest in the Woodlands Operating Company, L.P. ("TWOC"); o A 40% interest in Vornado Crescent Logistics Operating Partnership ("AmeriCold Logistics"); o A direct 25% common membership interest in Charter Behavioral Health Systems, LLC ("CBHS"); o An indirect 65% common membership interest in CBHS held through a limited partner interest in COPI CBHS Holdings, L.P.; and o A 1% interest in each of Crescent CS Holdings Corporation ("CS I") and Crescent CS Holdings II Corporation ("CS II"), (collectively, "Temperature Controlled Logistics Partnerships").
The combined financial statements of the "Predecessor" include Moody-Day and Hicks-Muse (collectively, the "Carter-Crowley Asset Group"). As the Company did not have any activity prior to May 9, 1997, the data included relating to the period in 1997 prior to May 9, 1997 is only with regard to the Predecessor.
USE OF ESTIMATES
The financial statements include estimates and assumptions made by management that affect the carrying amounts of assets and liabilities, reported amounts of revenues and expenses and the disclosure of contingent assets and liabilities. Actual results may differ from these estimates.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments with a maturity of three months or less to be cash equivalents. Cash of $12.1 million resides with certain subsidiaries and restrictions limit transfers to the parent company.
INVENTORIES
Inventories consist of new and used equipment held for sale, equipment parts, food, beverages and supplies, all of which are stated at the lower of cost or market using the first-in, first-out (FIFO) or specific identification methods.
PROPERTY AND EQUIPMENT
Property and equipment is recorded at cost. The Company uses the straight-line method of depreciation for financial statement purposes. The estimated useful lives used in computing depreciation are as follows:
Expenditures for maintenance and repairs are charged to expense as incurred. Expenditures for renewals or betterments are capitalized. The cost of property replaced, retired, or otherwise disposed of is removed from the asset account along with the related accumulated depreciation.
Long-lived assets are evaluated when indications of impairment are present, and provisions for possible losses are recorded when undiscounted cash flows estimated to be generated by those assets are less than the assets' carrying value. The Company did not recognize any losses from impairment during 1997, 1998 or 1999.
REAL ESTATE
Real estate represents raw land, developed land, homes constructed or under construction, repurchased lots, applicable capitalized interest, and applicable capitalized general and administrative costs. Real estate is recorded at cost.
Interest is capitalized based on the average yearly interest rate applied to cumulative capital expenditures for property under development. Approximately $13.7 million and $13.2 million of interest was capitalized for the years ended December 31, 1999 and 1998, respectively. Payroll and related costs associated with the development of a specific subdivision of land are capitalized. Once sales of property begin in a specific subdivision, capitalized costs are expensed as cost of sales.
INTANGIBLE ASSETS
Intangible assets consist of goodwill and membership intangibles. Goodwill represents the excess of the acquisition costs over the fair value of net identifiable assets of businesses acquired and is amortized on a straight-line basis over 6-30 years. Membership intangibles represent the purchase price values allocated to club memberships to be sold. Intangibles are evaluated periodically as events or circumstances indicate a possible inability to recover their carrying amounts. Such evaluation is based on various analyses, including cash flow and profitability projections. The analyses involve significant management judgment to evaluate the capacity of an acquired operation to perform within projections. Management believes that no significant impairment of goodwill or membership intangibles has occurred.
DEFERRED COMPENSATION ON RESTRICTED SHARES
Deferred compensation on restricted shares issued to employees is being amortized to expense over the vesting period.
REVENUE RECOGNITION
Revenues from equipment rentals under operating leases are recognized as the revenue becomes receivable according to the provisions of the lease. Revenues from full-service hotels and luxury health resorts are recognized as services are provided. Club initiation fees and membership conversion fees at Desert Mountain Development are deferred and recognized on a straight-line basis over the expected life of the membership. Deposits for future services are deferred and recognized as revenue in the period services are provided.
MINORITY INTERESTS
Minority Interests represent the non-voting common stock interests owned by shareholders in LandCo, Desert Mountain Development, COPI Colorado and CRL.
INCOME TAXES
Income taxes are provided for the tax effects of transactions reported in the financial statements and consist of taxes currently due plus deferred taxes related primarily to differences between the treatment of certain items for financial statement purposes and the treatment of those items for tax purposes. The deferred tax assets and liabilities represent the future tax return consequences of those differences, which will either be taxable or deductible when the assets and liabilities are recovered or settled.
RECLASSIFICATIONS
Certain prior year information has been reclassified to conform to current year presentation.
STOCK BASED COMPENSATION
The Company measures compensation costs associated with the issue of share options using the intrinsic method under which compensation costs related to share options issued pursuant to compensatory plans are measured based on the difference between the quoted market price of the shares at the measurement date (originally the date of grant) and the exercise price and charged to expense over the periods during which the grantee performs the related services. All share options issued to date by the Company have exercise prices equal to the market price of the shares at the dates of grant.
RECENT ACCOUNTING PRONOUNCEMENTS
SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, provides that all derivative instruments be recognized as either assets or liabilities depending on the rights or obligations under the contract and that all derivative instruments be measured at fair value. This pronouncement is effective for fiscal quarters and fiscal years beginning after June 15, 2000, and will require the Company to record the net comprehensive income or loss related to the Magellan warrants in the statement of operations as a reduction or addition to net income for the year ended December 31, 2001.
3. ACQUISITIONS AND DISPOSITIONS:
Initial Capitalization
On May 9, 1997, the Company acquired (i) all of the stock of Moody-Day, a construction equipment sales, leasing and servicing company located in Dallas, Texas, (ii) a 1.21% interest in Hicks-Muse Tate & Furst II, LP ("Hicks-Muse"), a private venture capital fund and (iii) a 12.38% interest in Dallas Basketball Limited, a partnership that holds the National Basketball Association franchise for the Dallas Mavericks. The allocation of purchase price was approximately $4.1 million for Moody-Day, approximately $9.6 million for the Hicks-Muse interest and approximately $12.4 million for the interest in the Dallas Basketball partnership. The interest in the Dallas Basketball partnership was subsequently sold to Crescent Partnership for approximately $12.5 million.
Equipment Sales & Leasing
Effective December 1, 1997, Crescent Operating acquired certain assets of Preco Machinery Sales, Inc. ("Preco"), a company that is engaged in equipment sales, leasing and servicing, located in Houston, Texas. The purchase price of Preco was approximately $4 million and consisted of a cash payment of approximately $1.7 million and the issuance of 130,000 restricted shares of Crescent Operating common stock. The transaction was structured such that Preco became a division of Crescent Machinery.
Effective April 30, 1998, the Company acquired certain assets of Central Texas Equipment Co. ("Central Texas"), a company which is engaged in equipment sales, leasing and servicing, located in Austin, Texas. The purchase price of approximately $9.7 million was comprised of $3.0 million in cash, 128,551 shares of Crescent Operating common stock and the assumption of $4.1 million of liabilities.
Effective June 8, 1998, the Company acquired all of the stock of Machinery, Inc., a company that is engaged in equipment sales, leasing and servicing, with locations in Tulsa and Oklahoma City, Oklahoma. The purchase price of approximately $2.8 million was comprised of $0.6 million in cash, 38,170 shares of Crescent Operating common stock and the assumption of $1.5 million of liabilities.
Effective July 1, 1998, the Company acquired all of the stock of Western Traction Company ("Western Traction"), a company that is engaged in equipment sales, leasing and servicing, with locations in Sacramento, California, Union City, California, Fresno, California, Sparks, Nevada and Honolulu, Hawaii. The purchase price of approximately $52.0 million was comprised of $6.5 million in cash, a note payable of $7.5 million and the assumption of liabilities of $38.0 million.
Effective July 31, 1998, the Company acquired all of the stock of Harvey Equipment Center, Inc. ("Harvey"), a company which is engaged in equipment sales, leasing and servicing, located in Van Wert, Ohio. The purchase price of approximately $8.4 million was comprised of $2.7 million in cash, notes payable of $1.2 million and the assumption of $4.5 million of liabilities.
Effective July 31, 1998, the Company acquired certain assets of 4-K Equipment Company ("4-K"), a company which is engaged in equipment sales, leasing and servicing, located in Franklin, Indiana. The purchase price of $0.2 million was comprised of $0.1 million in cash and the assumption of $0.1 million of liabilities.
Effective March 4, 1999, the Company acquired certain assets of Westco Tractor & Equipment, Inc. ("Westco"), a company engaged in equipment sales, leasing and servicing, located in Santa Rosa, California. The purchase price of approximately $2.6 million was comprised of $0.5 million cash and the assumption of liabilities of $2.1 million.
Effective July 1, 1999, the Company acquired all of the stock of E. L. Lester and Company ("Lester"), a company engaged in equipment sales, leasing and servicing, located in Houston, Texas. The purchase price of approximately $17.2 million was comprised of $8.9 million cash, the issuance of notes payable by Crescent Operating in the amount of $6.0 million and the assumption of liabilities of $2.3 million.
Effective July 1, 1999, the Company acquired all of the stock of Solveson Crane Rental, Inc. ("Solveson"), a company engaged in equipment sales, leasing and servicing, located in Tracy, California. The purchase price of approximately $7.3 million was comprised of $3.0 million cash and the assumption of liabilities of $4.3 million.
Hospitality
Effective July 31, 1997, Crescent Operating acquired for $2.0 million in cash the following assets: (i) 100% of the membership interests in Rosestar and (ii) all of the common stock, $.01 par value, of each of RSSW Corp. and RSCR Arizona Corp., affiliates of RoseStar. RoseStar and its subsidiaries are the lessees of 6 hotels owned by Crescent Equities or its affiliates. These hotels are the Denver Marriott City Center and the Hyatt Regency Beaver Creek in Colorado, the Hyatt Regency in Albuquerque, New Mexico, Canyon Ranch in Tucson, Arizona, Canyon Ranch in Lenox, Massachusetts and The Sonoma Mission Inn & Spa in California.
On September 22, 1997, COI Hotel, became the lessee of the Four Seasons Hotel in Houston, Texas, which is owned by Crescent Equities. The lease is for a term of 10 years and provides for base rent and percentage rent. Additionally, on September 22, 1997, COI Hotel acquired for $2.4 million (i) a two-thirds interest in the Houston Center Athletic Club Venture ("HCAC"), a joint venture that owns the HCAC and (ii) a $5.0 million note receivable executed by the Houston Center Athletic Club Venture. The note bears interest at LIBOR plus one percent and interest is payable in arrears at the end of each twenty-eight (28) day period. The Company partially financed these transactions with proceeds of $1.8 million in loans from Crescent Partnership. The Company recorded the note on its books at its estimated fair value of $5.0 million. The note was collected during 1998.
On January 23, 1998, a subsidiary of the Company signed a 10-year lease agreement with Crescent Partnership for the Austin Omni Hotel. The Austin Omni Hotel is a 314-room full-service hotel located approximately four blocks from the state capitol building in Austin, Texas. A subsidiary of the company and Crescent Partnership mutually agreed to terminate the Austin Omni Hotel lease effective December 31, 1998, and the Company received a $75,000 break-up fee in accordance with the terms of the lease. Effective January 1, 1999, the Company began providing limited asset management services related to the Austin Omni Hotel for $50,000 per year.
Effective October 13, 1998, Wine Country Golf Club, Inc., a wholly-owned subsidiary of the Company, became the lessee of the Sonoma Golf Course in California, which is owned by Crescent Equities. This 18-hole championship golf course is a strategic amenity to the Sonoma Mission Inn and Spa, which will allow the Company to expand its marketing focus to the golf-oriented guest. The lease is for a term of 10 years and provides for base rent and percentage rent.
Effective June 19, 1999, the Company entered into a lease with Crescent Real Estate Funding III, L.P. ("Funding III") for the 389-room Renaissance Hotel located in Houston, Texas. The lease is for a term of 10 years and provides for base rent and percentage rent. Under the lease, Funding III may terminate the lease, at its option, for a period of one year under certain conditions. The other terms of the lease are generally consistent with those in hospitality leases with Crescent Partnership.
Effective July 27, 1998, to enable the Company to invest in the future use of the "Canyon Ranch" name, the Company contributed $50,500 to obtain a 5% economic interest, representing all of the voting stock, of CRL. Immediately following such contribution, CRL exercised its purchase option by
paying $1 million to obtain a 10% economic interest in CR License. Contemporaneously, CRL acquired a 50% interest in CR Las Vegas LLC, an entity that built a Canyon Ranch day spa in the Venetian Hotel in Las Vegas which opened on June 20, 1999. On July 23, 1999, CRL exercised its option to purchase an additional 10% economic interest in CR License by paying $2.0 million, bringing CRL's total economic interest in CR License to 20%. CR License is the entity which owns the rights to the future use of the "Canyon Ranch" name. CRL has the opportunity prior to July 2000 to pay an additional $3.0 million to obtain an additional 10% interest in CR License. Through CRL and CR License, the Company has an effective 3.0% economic interest in the Canyon Ranch day spa project.
Temperature Controlled Logistics
Effective October 31, 1997, Crescent Operating acquired, from Crescent Partnership, for approximately $8.0 million, 100% of the voting stock, representing a 5% equity interest, of CS I and CS II. CS I holds a 40% general partner interest in Vornado Crescent Atlanta Partnership ("Atlanta Partnership"), which owns URS Logistics, Inc., a company that operates and manages public refrigerated warehouses in the continental United States. CS II holds a 40% general partner interest in Vornado Crescent Portland Partnership ("Portland Partnership"), which owns AmeriCold Corporation, a company providing integrated logistics services for the frozen food industry, consisting of warehousing and transportation. The Atlanta Partnership and the Portland Partnership represent the business venture among Crescent Operating, Crescent Equities and Vornado Realty Trust ("Vornado") which owns and operates public refrigerated warehouses.
On June 1, 1998, the Temperature Controlled Logistics Partnerships, acquired nine refrigerated storage properties from Freezer Services, Inc. for approximately $134 million, which required a capital contribution from Crescent Operating of $2.3 million. On July 1, 1998, the Temperature Controlled Logistics Partnerships acquired five refrigerated storage properties from Carmar Group, Inc. for approximately $158 million, which required a capital contribution from Crescent Operating of $2.7 million. These properties contain approximately 90 million cubic feet of refrigerated storage space.
Effective March 12, 1999, the Company sold 80% of its 5% interest in the Temperature Controlled Logistics Partnerships to Crescent Partnership for $13.2 million and received the right to require Crescent Partnership to purchase the remaining 20% for approximately $3.4 million at any time during the next two years, subject to compliance with certain regulatory matters. This 5% interest represented a 2% interest in various corporations and limited liability companies owned by the Temperature Controlled Logistics Partnerships. Crescent Operating, through a wholly owned limited liability company, then became a 40% partner of AmeriCold Logistics, a newly formed partnership, the remaining 60% of which is owned by Vornado Operating, Inc. ("Vornado Operating"). This transaction required a capital contribution of approximately $15.5 million from Crescent Operating. As a result of the restructuring transaction, the operations formerly associated with the Temperature Controlled Logistics Partnerships are now conducted by AmeriCold Logistics. Also a result of the transaction, Crescent Operating no longer consolidates, for financial reporting purposes, the Temperature Controlled Logistics Partnerships, which has resulted in a decrease for accounting purposes in the investment in the Temperature Controlled Logistics Partnerships of approximately $291 million.
AmeriCold Logistics entered into leases covering the refrigerated storage facilities used in its business. The leases, which commenced in March 1999, generally have a 15-year term with two five-year renewal options and provide for the payment of fixed base rent and percentage rent based on revenues AmeriCold Logistics receives from its customers. Fixed base rent is approximately $130 million per annum through 2003, $132.0 million per annum from 2004 through 2008 and $133.0 million per annum from 2009 through 2014. Percentage rent for each lease is based on a specified percentage of revenues in excess of a specified base amount. The aggregate base revenue amount under five of the six leases is approximately $321.0 million and the weighted average percentage rate is approximately 36% for the initial five-year period, approximately 39% for the period from 2004 through 2008 and approximately 41% for the period from 2009 through February 28, 2014. The aggregate base revenue amount under the sixth lease is approximately $32.0 million and the percentage rate is 24% for the initial two-year period, 37.5% for the period from 2002 through 2006, 40% from 2007 through 2011 and 41% from 2012 through February 28, 2014. AmeriCold Logistics recognized $135.8 million of rent expense from March 11, 1999 (acquisition date) through December 31, 1999. AmeriCold Logistics is required to pay for all costs arising from the operation, maintenance and repair of the properties, including all real estate taxes and
assessments, utility charges, permit fees and insurance premiums, as well as property capital expenditures in excess of $5.0 million annually. AmeriCold Logistics has the right to defer the payment of 15% of the fixed base rent and all percentage rent for up to three years beginning on March 11, 1999 to the extent that available cash, as defined in the leases, is insufficient to pay such rent. AmeriCold Logistics deferred $5.4 million of rent payments for the period ending December 31, 1999.
Under the terms of the partnership agreement for AmeriCold Logistics, Vornado Operating has the right to make all decisions relating to the management and operations of AmeriCold Logistics other than certain major decisions that require the approval of both the Company and Vornado Operating. Vornado Operating must obtain Crescent Operating's approval for specified matters involving AmeriCold Logistics, including approval of the annual budget, requiring specified capital contributions, entering into specified new leases or amending existing leases, selling or acquiring specified assets and any sale, liquidation or merger of AmeriCold Logistics. If the partners fail to reach agreement on certain matters prior to October 30, 2000, Vornado Operating will be entitled to buy Crescent Operating's interest in the partnership at cost plus 10% per annum return. If the partners fail to reach an agreement on such matters during the period from November 1, 2000 through October 30, 2007, Vornado Operating may set a price at which it commits to either buy Crescent Operating's investment, or sell its own, and Crescent Operating will decide whether to buy or sell at that price. If the partners fail to reach agreement on such matters after October 30, 2007, either party may set a price at which it commits to either buy the other party's investment, or sell its own, and the other party will decide whether to buy or sell at that price. Neither partner may transfer its rights or interest in the partnership without the consent of the other partner. The partnership will continue for a term through October 30, 2027, except as the partners may otherwise agree.
The Company expects to form a new business venture with Vornado Operating on terms and conditions similar to the Company's existing partnership arrangements with Vornado Operating. The venture, which is to be named Transportal Network ("Transportal"), would pursue a business-to-business internet opportunity relating to the Temperature Controlled Logistics business. The Company expects Transportal to provide routing and load management services and to facilitate related purchases over the internet to independent truckers, shippers and receivers to enable them to increase efficiency. The Company's share of start-up costs for Transportal, which relate to market research, creating a business plan and related matters, was $0.4 million for the year ended December 31, 1999. These costs are included in the Company's consolidated statement of operations as "Investment Income (Loss)" for the year ended December 31, 1999. Although Transportal has not commenced operations or finalized its business plan, the Company expects Transportal to incur significant future losses and to require significant equity investments. The Company anticipates that it may have to dilute its ownership in Transportal to fund its share of Transportal's cash needs, which may be in excess of $2.0 million. Transportal is actively seeking additional equity investments from third parties, including venture capital firms. Early stage internet companies, such as Transportal, with new and unproven business models frequently encounter financial and other significant business risks and there can be no assurance that Transportal will be a successful business venture.
Land Development
On July 31, 1997, Crescent Operating, through its newly-formed subsidiary, WOCOI, acquired for $0.4 million, a 42.5% general partner interest in The Woodlands Operating Company, L.P. ("Woodlands Operating"). Woodlands Operating was formed to provide management, advisory, landscaping and maintenance services to entities affiliated with the Company and Crescent Equities. Woodlands Operating is reimbursed for the costs it incurs plus a 3% or 5% management fee, depending on the type of service provided. The acquisition of Woodlands Operating was part of a larger transaction pursuant to which Crescent Equities and Crescent Partnership, together with certain Morgan Stanley funds, acquired The Woodlands Corporation. The Woodlands Corporation is the principal owner, developer and operator of The Woodlands, an approximately 27,000-acre master-planned residential and commercial community located approximately 27 miles north of Houston, Texas. The Woodlands includes a shopping mall, retail centers, office buildings, conference center and country club and other amenities. WOCOI serves as the managing general partner of Woodlands Operating.
On September 29, 1997, Crescent Operating acquired 100% of the voting stock, representing a 5% equity interest, of Desert Mountain Development for $2.2 million. Desert Mountain Development is the sole general
partner of Desert Mountain Properties Limited Partnership ("DMPLP"). DMPLP owns Desert Mountain, a master planned, luxury residential and recreational community in northern Scottsdale, Arizona. DMPLP also owns and operates The Desert Mountain Club that offers five Jack Nicklaus signature 18 hole golf courses, including Cochise, site of the Senior PGA Tour's The Tradition tournament.
On September 29, 1997, Crescent Operating acquired 100% of the voting stock, representing a 5% equity interest, of LandCo, for approximately $1.9 million. LandCo is a residential development corporation which formerly was owned by Crescent Equities. LandCo holds a 42.5% general partner interest in, and is the managing general partner of, The Woodlands Land Development Company, L.P. ("Landevco"), which owns approximately 9,000 acres for commercial and residential development, a realty office, an athletic center, and interests in a title company and a mortgage company.
Effective September 11, 1998, the Company and Gerald W. Haddock, John C. Goff and Harry H. Frampton, III (collectively, the "CDMC Sellers") entered into a partnership agreement (the "Partnership Agreement") to form COPI Colorado. COPI Colorado's purpose is to hold and manage the voting stock of CDMC (and, consequently, to manage CDMC) and to invest in shares of Crescent Operating common stock. In September, 1998, the Company contributed to COPI Colorado $9.0 million in cash in exchange for a 50% general partner interest in COPI Colorado, and each CDMC Seller contributed to COPI Colorado approximately 667 shares of CDMC voting stock, which the CDMC Sellers owned individually, in exchange for an approximately 16.67% limited partner interest in COPI Colorado; as a result and until January 2000, the Company owned a 50% managing interest in COPI Colorado and the CDMC Sellers collectively owned a 50% investment interest in COPI Colorado. The operating results of CDMC since September 30, 1998 have been included in the consolidated results of the Company. CDMC's investments include direct and indirect economic interests that vary from 18% to 70% in the following: (i) two residential and commercial developments and eight residential developments in Colorado; (ii) a Texaco gasoline station and ancillary auto repair facility, car wash and convenience store in Colorado; (iii) a timeshare development in Colorado; (iv) a real estate company that markets and sells timeshare interests; (v) a real estate company that specializes in the management of resort properties in Colorado, Utah, South Carolina and Montana; (vi) two transportation companies that provide approximately 80% of the airport shuttle service to Colorado resort areas; and (vii) an interest in a partnership that owns an interest in the Ritz Carlton Hotel in Palm Beach, Florida. The operating results of CDMC from September 30, 1998 to December 31, 1999 have been included in the consolidated results of the Company.
On April 29, 1999, a partnership in which CDMC has a 64% economic interest finalized the purchase of Riverfront Park (previously known as "The Commons"), a master planned residential development on 23 acres in the Central Platte Valley near downtown Denver, Colorado, for approximately $25.0 million. The development of Riverfront Park is expected to begin in the spring of 2000. The first phase will consist of condominiums and lofts with prices ranging from $0.2 million to $2.5 million. The acreage is in close proximity to several major entertainment and recreational facilities, including, Coors Field (home to the Major League Baseball's Colorado Rockies), Elitch Gardens (an amusement park), the new Pepsi Center (home to the National Hockey League's Colorado Avalanche and the National Basketball Association's Denver Nuggets) and the new downtown Commons Park. An adjacent 28 acres is expected to be commercially developed by another company, thus providing a major mixed-use community adjacent to the lower downtown area of Denver.
On August 27, 1999 and October 27, 1999, the Company sold its investments in Hillwood and Corporate Arena, respectively, for an aggregate sales price of approximately $1.4 million. Together, the sales resulted in an approximate $0.2 million gain in 1999.
Healthcare
On June 17, 1997, Crescent Operating acquired, for $5.0 million, a 50% member interest in CBHS and issued warrants to acquire 282,508 shares of Crescent Operating common stock with an exercise price of $18.29 per share to Magellan Health Services, Inc. ("Magellan"). As required by CBHS' operating agreement, the Company contributed an additional $2.5 million to CBHS. CBHS operates approximately 90 behavioral healthcare facilities throughout the United States. Crescent Operating also purchased as part of this acquisition warrants to acquire 1,283,311 shares of Magellan common
stock for $12.5 million. The exercise price of the Magellan warrants is $30 per share, exercisable in varying increments beginning on May 31, 1998 and ending on May 31, 2009. In August and September of 1997, Crescent Operating made loans (evidenced by promissory notes) to CBHS in the aggregate principal amount of $17.5 million (the "Initial Amount"). On November 16, 1997, effective September 30, 1997, each of the promissory notes was exchanged for cumulative redeemable preferred interests (the "Redeemable Preferred Interests") in CBHS. The Redeemable Preferred Interest entitles its holder to a preferred return on the profits of CBHS, which is to be calculated at the rate of 10% per annum of the Initial Amount, compounded monthly. CBHS, upon approval of at least 80% of the members of its Governing Board, may redeem all, but not less than all, of the Redeemable Preferred Interests, at its option, on or after April 1, 1998, for cash or promissory notes, or a combination thereof.
On September 9, 1999, Crescent Operating, Magellan, Crescent Partnership and CBHS completed a recapitalization of CBHS and restructuring of the relationships among the parties. In connection with the restructuring, Magellan transferred its remaining hospital-based assets (including Charter Advantage, Charter Franchise Services, LLC, the call center assets, the Charter name and related intellectual property and certain other assets) to CBHS, and released CBHS from all accrued and future franchise fees. As a result of the transfer, Magellan is no longer obligated to provide franchise services to CBHS. Magellan also transferred 80% of its CBHS common membership interest and all of its CBHS preferred membership interest to CBHS, leaving Magellan with a 10% common membership interest. Simultaneously, Crescent Operating reorganized its holdings leaving Crescent Operating with a 25% common membership interest and 100% of the preferred membership interest in CBHS, and a limited partnership controlled by individual officers of Crescent Operating and in which Crescent Operating owns 100% of the economic interests, with a 65% common membership interest in CBHS. Prior to the restructuring, Crescent Operating and Magellan each held a 50% common membership interest, and a 50% preferred membership interest in CBHS.
Other
On March 31, 1999, the Company sold its investment in Hicks-Muse for $8.1 million to an unrelated party. The sale resulted in a $0.3 million gain which was recognized in the first quarter of 1999. All of the sales proceeds were applied against the Company's indebtedness to Crescent Partnership.
All of the acquisitions during 1998 and 1999 were accounted for as purchases and operations have been included in the consolidated financial statements of the Company from the date that management took over the operational control of the acquired entity.
4. PROPERTY & EQUIPMENT, NET:
Property and equipment consisted of the following (in thousands):
5. INVESTMENTS:
Investments consisted of the following (in thousands):
Investment income (loss) consisted of the following (in thousands):
A summary of financial information for the Company's investments in TWOC and Landevco, each of which represents a significant unconsolidated investment, is presented below (amounts in thousands).
6. INTANGIBLE ASSETS:
Intangible assets consisted of the following (in thousands):
7. ACCOUNTS PAYABLE AND ACCRUED EXPENSES:
Accounts payable and accrued expenses consisted of the following (in thousands):
8. OTHER LIABILITIES:
Other liabilities consisted of the following (in thousands):
9. LONG-TERM DEBT:
The Company's long-term debt facilities are composed of (i) corporate and wholly owned debt, and (ii) non wholly owned debt. Corporate and wholly owned debt relates to debt facilities at the Crescent Operating level or owed by entities which are owned 100% by Crescent Operating. Non wholly owned debt represents non-recourse debt owed by entities which are consolidated in the Company's financial statements but are not 100% owned by the Company; the Company's economic investment in these entities is 5% or less. Following is a summary of the Company's debt financing (amounts in thousands):
The weighted average interest rate on long-term debt at December 31, 1999 was approximately 10.0%. Substantially all of the Company's assets are pledged as collateral under various debt agreements. Payment of dividends on Crescent Operating common stock is prohibited under certain of the debt agreements. The debt agreements contain certain reporting requirements and financial covenants, including requirements that the Company maintain certain financial ratios. As of December 31, 1999, the Company had complied with all debt covenants. In February 2000, the Company modified certain debt agreements with Crescent Equities extending the timing of principal and interest payments by one year.
As of December 31, 1999, combined aggregate principal maturities of all long-term debt were as follows (in thousands):
10. SHAREHOLDERS' EQUITY:
Common Stock
The Company's authorized capital stock consists of 10 million shares of preferred stock, par value $0.01 per share and 22.5 million shares of common stock, par value $0.01 per share. At December 31, 1999, there were 11,414,963 shares of common stock issued and no shares of preferred stock issued.
Preferred Share Purchase Rights
The Board of Directors has adopted a rights plan that provides that each holder of Crescent Operating common stock also receives a right to purchase from the Company one-hundredth of a share of Series A Junior Preferred Stock, par value $0.01, at a price of $5 per share, subject to adjustment. These rights can only be exercised in certain events and are intended to provide the Company certain anti-takeover protection. The Company had reserved 225,000 shares of Series A Junior Preferred Stock for this plan.
Warrants
In conjunction with the acquisition of a 50% member interest in CBHS, the Company issued warrants to acquire 282,508 shares of Crescent Operating common stock at an exercise price of $18.29 per share.
Treasury Stock
As of December 31, 1999, COPI Colorado had purchased 1,102,530 shares of Crescent Operating common stock, which has been recorded as treasury stock, at a total purchase price of $4.3 million. The average price paid, including broker commissions, was $3.88 per share.
11. STOCK OPTION PLANS:
The Company has two stock incentive plans, the 1997 Amended Stock Incentive Plan (the "Amended Plan") and the 1997 Management Stock Incentive Plan (the "Management Plan").
The Amended Plan, effective May 8, 1997, initially established the maximum number of options and/or shares of restricted stock that the Company may grant at 1.0 million shares. The maximum aggregate number of shares issuable under the Amended Plan shall increase automatically on January 1 of each year by an amount equal to 8.5% of the increase in the number of shares of common stock outstanding since January 1 of the preceding year, subject to certain adjustment provisions. As of December 31, 1999, the number of shares the Company may have outstanding under the Amended Plan is 1,016,183.
On May 13, 1997, each holder of shares of restricted stock in Crescent Equities or options in Crescent Equities or Crescent Partnership was granted an equivalent number of shares of restricted stock or options in Crescent Operating, based on a ratio of one share of restricted stock or option to purchase Crescent Operating common stock for each 10 shares of restricted stock in Crescent Equities or options for Crescent Equities common shares, and one option to purchase Crescent Operating common stock for each 5 options for
units in Crescent Partnership. Under the Amended Plan, the Company has granted 867,153 options and 10,000 restricted shares, net of forfeitures, through December 31, 1999.
The Management Plan provides that the maximum number of options and/or shares of restricted stock that the Company may grant to employees, officers, directors or consultants is 1.0 million shares. Under the Management Plan, the Company has granted 554,000 options and 6,276 restricted shares, net of forfeitures, through December 31, 1999.
Under both Plans, options are granted at a price no less than the market value of the shares on the date of grant, vest over a period determined by the Board of Directors, and expire ten years from the date of grant. The Company has reserved 578,754 shares for future options, warrants and restricted shares.
A summary of the stock option status of the Company's Amended and Management Plans as of December 31, 1999 and changes during the periods then ended is presented in the table below:
Exercise prices, number of shares and the weighted-average remaining contractual life ("Average Life") at December 31, 1999 were as follows:
The Company applies APB No. 25 in accounting for options granted pursuant to the Amended Plan and the Management Plan (collectively, the "Plans"). Accordingly, no compensation cost has been recognized for the Plans. Had compensation cost for the Plans been determined based on the fair market value at the grant dates for awards under the Plans consistent with SFAS No. 123, the Company's net income (loss) and earnings (loss) per share would have been the following pro forma amounts. The following pro forma amounts may not be representative of the effects on reported net income for future years.
For the years ended December 31, 1999 and 1998, and the period ended December 31, 1997, the weighted average grant date fair value of each option granted was $2.29, $14.66 and $0.87, respectively.
The fair value of each option was estimated at the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions for 1999, 1998 and 1997, respectively: risk-free interest rates of 5.6%, 5.4% and 6.7%; expected volatility of 91.6%, 88.3% and 94.7%; expected dividend yields of 0%; expected lives of 5 years.
12. EARNINGS PER SHARE:
Earnings per share ("EPS") is calculated as follows (in thousands, except per share data):
The Company had 1,344,792, 70,600 and 847,579 options in 1999, 1998 and 1997, respectively, which were not included in the calculation of diluted EPS as they were anti-dilutive. Earnings per share for the Predecessor is not meaningful as the capital structure of the Predecessor was not comparable to that of the Company.
13. INCOME TAXES:
The components of the Company's income tax provision (benefit) were as follows (in thousands):
Reconciliations of the federal statutory income tax rate to the effective tax rate were as follows:
Significant components of the Company's deferred tax assets and liabilities were as follows (in thousands):
At December 31, 1999, the Company had net operating loss carryforwards ("NOL") of approximately $9.6 million, which will expire in years 2003 through 2019. A portion of this NOL was acquired subject to restrictive tax limitations. In 1999, a tax law change occurred which allowed the company to realize a tax benefit of $0.7 million associated with this NOL. The Company has reserved $0.4 million of the future available NOL due to the tax law limitations still in effect. The Company also has a minimum tax credit of $0.3 million, which does not expire. The Company released $4.2 million of its net deferred tax asset valuation allowance, based on 1999 transactions and expected future taxable income. In December 1999, the investments held by the Company that are considered to be Controlled Subsidiary Transactions entered into agreements to elect to become Taxable REIT Subsidiaries ("TRS") of Crescent Equities for federal income tax reporting purposes effective January 1, 2001.
14. MAGELLAN WARRANTS:
In connection with the transaction in which Crescent Operating acquired its 50% membership interest in CBHS, the Company purchased, for $12.5 million, warrants to acquire 1,283,311 shares of Magellan common stock for an exercise price of $30 per share. The Magellan warrants are exercisable in varying increments over the period which began on May 31, 1998 and ends on May 31, 2009. Management estimates the fair value of the warrants, using the Black-Scholes pricing model, to be $2.4 million at December 31, 1999. As a result, the $10.1 million difference between the cost and the estimated fair value of the warrants has been included in the consolidated financial statements as other comprehensive income (loss).
15. COMMITMENTS AND CONTINGENCIES:
Lease Commitments
The Hospitality segment leases nine hotel and resort properties (the "Hospitality Properties") from Crescent Equities. Generally, the leases are on a triple net basis during 120-month terms and expire from December 2004 to October 2008. The leases provide for the payment to Crescent Partnership or its subsidiaries of (i) base rent, with periodic rent increases, (ii) percentage rent based on a percentage of gross room revenues above a specified amount, and (iii) a percentage of gross food and beverage revenues above a specified amount. Base rental expense under the leases is recognized on a straight-line basis over the terms of the respective leases. The Land Development segment leases office space, model homes, housekeeping and laundry facilities and certain equipment. The Equipment Sales and Leasing segment leases rental delivery and service trucks and land and buildings at various locations.
Total lease expense for all segments during the periods ended December 31, 1999, 1998 and 1997 was approximately $62.5 million, $55.4 million and $16.7 million, respectively. Included in lease expense was percentage rent for the Hospitality Properties for the periods ended December 31, 1999, 1998 and 1997 of $14.7 million, $13.8 million and $4.6 million, respectively. Future minimum lease payments due under such leases as of December 31, 1999, were as follows (in thousands):
Contingencies
CBHS became the subject of Chapter 11 bankruptcy proceedings by filing a voluntary petition on February 16, 2000, in United States Bankruptcy Court for the District of Delaware. Although CBHS is not a subsidiary of Crescent Operating, Crescent Operating does own a majority (90%) economic interest in CBHS. Crescent Operating's claims against the estate of CBHS include (i) its interests as a direct and indirect equity holder of CBHS and (ii) its claim for indemnification or contribution against third party lawsuits and claims where Crescent Operating is a named defendant with CBHS, such as lawsuits based upon alleged WARN Act violations purported to have been committed by CBHS and/or its subsidiaries in closing behavioral health care facilities in 1999 and 2000. To date Crescent Operating has not filed a proof of claim against CBHS with regard to any of these claims but would expect to file proofs of claim prior to the bar date.
To date, four lawsuits, all of which seek class action certification, have been filed against CBHS alleging violations of the WARN Act in the closing of certain healthcare facilities. All of those lawsuits also name Crescent Operating as a defendant. Under the automatic stay provisions of federal bankruptcy law, lawsuits against CBHS or its subsidiaries would be stayed unless otherwise directed by the bankruptcy court, but the lawsuits against other defendants, including Crescent Operating, would not be stayed automatically. It is anticipated that those suits may be stayed because CBHS and its subsidiaries are indispensable parties. The Company anticipates that other similar lawsuits may be filed due to the closing of other facilities. With respect to the pending suits and possible future claims against Crescent Operating based on the closure by CBHS of facilities in 1999 and 2000, the Company believes that such actions are without basis under the WARN Act and should be dismissed; however, no assurance can be given that Crescent Operating will prevail.
16. SUPPLEMENTAL CASH FLOW INFORMATION:
Supplemental cash flow information is summarized as follows (in thousands):
17. FAIR VALUES OF FINANCIAL INSTRUMENTS:
The carrying amount of cash and cash equivalents, accounts receivable, inventories, notes receivable, prepaid expenses and other current assets, and accounts payable and accrued expenses approximates fair value as of December 31, 1999 because of the short maturity of these instruments. Similarly, the carrying value of line of credit borrowings approximates fair value as of that date because the applicable interest rates fluctuate based on published market rates. In the opinion of management, the interest rates associated with the long-term debt approximates the market interest rates for this type of instrument, and as such, the carrying values approximate fair value at December 31, 1999.
18. BUSINESS SEGMENT INFORMATION:
Crescent Operating's assets and operations are located entirely within the United States and are comprised of four business segments: (i) Equipment Sales and Leasing, (ii) Hospitality, (iii) Temperature Controlled Logistics and (iv) Land Development. In addition to these four business segments, the Company has grouped its investment in Magellan warrants, investment in Hicks-Muse (sold in March 1999), investment in CBHS, interest expense on corporate debt and general corporate overhead costs such as legal and accounting costs, insurance costs and corporate salaries as "Other" for segment reporting purposes. The Company has written-off its entire investment and has no obligation or commitment to fund CBHS' ongoing operations. As a result of the write-off, and irrespective of the transactions described in Note 3 to the Company's financial statements, the Company does not anticipate that it will recognize any additional CBHS losses for accounting purposes. The Company does incur costs of ownership related to the CBHS investment, such as legal and accounting costs, and COPI Healthcare incurs costs related to due diligence on the assets it has offered to purchase out of bankruptcy. Because the Company has written-off its CBHS investment and did not recognize income or loss from CBHS in 1999, the Company no longer reports its operations related to CBHS as a separate segment. The Company uses net income as the measure of segment profit or loss.
The Equipment Sales and Leasing segment is engaged in the sale, leasing and service of construction equipment and accessories to the construction and utility industries located primarily in seven states. Crescent Machinery's leasing activities consist principally of leasing construction equipment and accessories under various leases, which are primarily short-term operating leases.
The Hospitality segment generally consists of the operations of the Hospitality Properties. Each of such properties is owned by Crescent Partnership or its affiliates and all are leased to subsidiaries of the Company under long term leases. In addition to these properties, the Company also has other investments in the HCAC and in CRL.
The Temperature Controlled Logistics segment consists primarily of a 40% interest in the operations of Vornado Crescent Operations, LP. Prior to reorganization of this segment effective March 12, 1999, this segment consisted of a 2% economic interest in the operations of The Temperature Controlled Logistics Partnerships. The Temperature Controlled Logistics Partnerships are the largest operators of public refrigerated storage space in the country in terms of public storage space operated.
The Land Development segment consists of (i) a 4.65% economic interest in Desert Mountain, a master planned, luxury residential and recreational community in northern Scottsdale, Arizona, (ii) a 42.5% general partner interest in Woodlands Operating, which provides management, advisory, landscaping and maintenance services to entities affiliated with Crescent Operating and Crescent Equities, (iii) a 2.125% economic interest in Landevco, which owns approximately 7,500 acres for commercial and residential development as well as a realty office, an athletic center, and interests in both a title company and a mortgage company and (iv) a 5% economic interest in CDMC, whose operations consist principally of investing in partnerships and other entities that directly or indirectly develop and manage residential and resort properties (primarily in Colorado) or provide services to such properties.
Business segment information is summarized as follows (in thousands):
19. RELATED PARTY TRANSACTIONS:
INTERCOMPANY AGREEMENT
Generally, Crescent Operating is involved with Crescent Equities in two types of transactions: "Lessee Transactions" and "Controlled Subsidiary Transactions". Lessee Transactions are those in which Crescent Operating enters into a transaction to lease and operate real property that is owned by Crescent Partnership but which cannot be operated by Crescent Partnership due to Crescent Equities status as a REIT. Controlled Subsidiary Transactions are those in which Crescent Operating invests alongside Crescent Partnership in acquisitions where Crescent Operating owns all of the voting stock, and Crescent Partnership owns all of the non-voting stock of a corporate acquisition vehicle which in turn acquires a target business which cannot be operated by Crescent Partnership due to Crescent Equities' status as a REIT. The voting stock represents the control of the entity being purchased and due to its status as a REIT, Crescent Equities cannot have such ownership.
Crescent Operating and Crescent Partnership have entered into the Intercompany Agreement to provide each other with rights to participate in the types of transactions mentioned above. The Intercompany Agreement provides, subject to certain terms, that Crescent Partnership will provide Crescent Operating with a right of first refusal to become the lessee of any real property acquired by Crescent Partnership if Crescent Partnership determines that, consistent with Crescent Equities' status as a REIT, it is required to enter into a "master" lease arrangement. Crescent Operating's right of first refusal under the Intercompany Agreement is conditioned upon the ability of Crescent Operating and Crescent Partnership to negotiate a mutually satisfactory lease arrangement and the determination of Crescent Partnership, in its sole discretion, that Crescent Operating is qualified to be the lessee. In general, a master lease arrangement is an arrangement pursuant to which an entire property or project (or a group of related properties or projects) is leased to a single lessee. If a mutually satisfactory agreement cannot be reached within a 30-day period (or such longer period to which Crescent Operating and Crescent Partnership may agree), Crescent Partnership may offer the opportunity to others.
Under the Intercompany Agreement, Crescent Operating has agreed not to acquire or make (i) investments in real estate which, for purposes of the Intercompany Agreement, includes the provision of services related to real estate and investment in hotel properties, real estate mortgages, real estate derivatives or entities that invest in real estate assets or (ii) any other investments that may be structured in a manner that qualifies under the federal income tax requirements applicable to REITs. Crescent Operating has agreed to notify Crescent Partnership of, and make available to Crescent Partnership, investment opportunities developed by Crescent Operating, or of which Crescent Operating becomes aware but is unable or unwilling to pursue.
OTHER TRANSACTIONS
The Company leases full service hotels and destination health and fitness resorts from Crescent Partnership, or other subsidiaries of Crescent Equities, under operating leases. Crescent Partnership has agreed to fund all capital expenditures relating to furniture, fixtures and equipment reserves required under applicable management agreements on all properties except for Canyon Ranch-Tucson. Total rent expense related to these leases totaled approximately $54.0 million for the year ended December 31, 1999.
The Company has various debt instruments payable to Crescent Partnership with an aggregate amount outstanding at December 31, 1999 of $216.7 million. See Note 9 for additional information.
Included in notes receivable is a note from Landevco payable to Landco in the amount of $10.6 million as of December 31, 1999. The note bears interest at 15.0% per annum with quarterly interest payments and principal due upon maturity of July 2007. Interest income recognized for the year ended December 31, 1999 was $1.7 million.
20. SUBSEQUENT EVENTS:
Effective January 31, 2000, HCAC sold substantially all of its assets to an unrelated party. Through a wholly owned subsidiary, the Company received proceeds from the sale of $2.4 million resulting in an approximate $1.5 million gain which will be recognized by Crescent Operating in the first quarter of 2000.
In accordance with an agreement between Gerald Haddock and the Company, Mr. Haddock, the Company's former Chief Executive Officer and President, had his limited partnership interest in COPI Colorado redeemed
by COPI Colorado in January 2000. COPI Colorado paid Mr. Haddock approximately $2.6 million for his approximate 16.67% limited partner interest (determined from an independent appraisal of the value of COPI Colorado). Mr. Haddock reserved the right to challenge the valuation performed by the independent appraiser. As a result of the redemption of Mr. Haddock's interest, the Company has an approximate 58% interest in COPI Colorado.
In February 2000, Crescent Operating and its hospitality subsidiaries entered into a Master Asset Management and Administrative Services Agreement and property management agreements with Sonoma Management Company ("SMC") to manage the Company's hotel properties (excluding Canyon Ranch - Lenox, Canyon Ranch - Tucson and the Hyatt Regency Beaver Creek). At the same time, the Company's hospitality subsidiaries accepted assignment from the owners of the Sonoma Mission Inn and Spa, the Sonoma Mission Inn Golf and Country Club and the Ventana Inn and Spa of its property management agreements with Sonoma Management Company. The principles of Sonoma Management Company are Sanjay and Johanna Varma and Crescent Equities is an equity owner in Sonoma Management Company.
On February 16, 2000, CBHS petitioned for relief under Chapter 11, of the United States Bankruptcy Code. Under the protection of the bankruptcy court, CBHS intends to sell and liquidate, in a controlled fashion, all of its ongoing business. In conjunction with the filing by CBHS of the bankruptcy petition, COPI Healthcare, Inc. ("COPI Healthcare"), a wholly owned subsidiary of Crescent Operating, entered into an agreement with CBHS for the acquisition by COPI Healthcare of CBHS' core business ("Asset Purchase Agreement"), which consists of the assets used in the operation of 37 behavioral healthcare facilities for, $24.5 million. The bankruptcy court could seek other bids for these assets from other interested parties and there is no assurance that COPI Healthcare's bid will be successful or that the conditions contained in its offer can be satisfied.
On March 27, 2000, COPI Healthcare notified CBHS that because it appears that not all of the conditions to its obligation to consummate the acquisition under the Asset Purchase Agreement appear likely to be met before the agreement terminates by its own terms on April 16, 2000, COPI Healthcare does not expect to close the acquisition under the Asset Purchase Agreement.
21. QUARTERLY FINANCIAL INFORMATION (UNAUDITED):
Amounts in thousands, except per share amounts:
INDEPENDENT AUDITORS' REPORT
To the Partners Vornado Crescent Logistics Operating Partnership and Subsidiary:
We have audited the accompanying consolidated balance sheet of Vornado Crescent Logistics Operating Partnership and Subsidiary (the "Partnership") as of December 31, 1999, and the related consolidated statements of operations, partners' capital, and cash flows for the period from March 11, 1999 (date of inception) to December 31, 1999. These financial statements are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, such financial statements present fairly, in all material respects, the consolidated financial position of Vornado Crescent Logistics Operating Partnership and Subsidiary at December 31, 1999, and its consolidated results of operations and cash flows for the period from March 11, 1999 (date of inception) to December 31, 1999 in conformity with generally accepted accounting principles.
DELOITTE & TOUCHE LLP
Atlanta, Georgia March 2, 2000 (March 8, 2000 as to Note 6)
VORNADO CRESCENT LOGISTICS OPERATING PARTNERSHIP AND SUBSIDIARY
CONSOLIDATED BALANCE SHEET AS OF DECEMBER 31, 1999 (amounts in thousands) - --------------------------------------------------------------------------------
See notes to consolidated financial statements.
VORNADO CRESCENT LOGISTICS OPERATING PARTNERSHIP AND SUBSIDIARY
CONSOLIDATED STATEMENT OF OPERATIONS FOR THE PERIOD FROM MARCH 11, 1999 (DATE OF INCEPTION) TO DECEMBER 31, 1999 (amounts in thousands) - --------------------------------------------------------------------------------
See notes to consolidated financial statements.
VORNADO CRESCENT LOGISTICS OPERATING PARTNERSHIP AND SUBSIDIARY
CONSOLIDATED STATEMENT OF PARTNERS' CAPITAL FOR THE PERIOD FROM MARCH 11, 1999 (DATE OF INCEPTION) TO DECEMBER 31, 1999 (AMOUNTS IN THOUSANDS) - --------------------------------------------------------------------------------
See notes to consolidated financial statements.
VORNADO CRESCENT LOGISTICS OPERATING PARTNERSHIP AND SUBSIDIARY
CONSOLIDATED STATEMENT OF CASH FLOWS FOR THE PERIOD FROM MARCH 11, 1999 (DATE OF INCEPTION) TO DECEMBER 31, 1999 (AMOUNTS IN THOUSANDS) - --------------------------------------------------------------------------------
See notes to consolidated financial statements.
VORNADO CRESCENT LOGISTICS OPERATING PARTNERSHIP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AS OF DECEMBER 31, 1999 AND FOR THE PERIOD FROM MARCH 11, 1999 (DATE OF INCEPTION) TO DECEMBER 31, 1999 (AMOUNTS IN THOUSANDS) - --------------------------------------------------------------------------------
1. ORGANIZATION AND BUSINESS
Vornado Crescent Logistics Operating Partnership (the "Partnership") was formed on March 11, 1999. The Partnership holds its assets and conducts its business through its wholly owned subsidiary AmeriCold Logistics, LLC (collectively "AmeriCold Logistics"). AmeriCold Logistics, headquartered in Atlanta, Georgia, has 6,900 employees and operates 104 temperature controlled warehouse facilities nationwide with an aggregate of approximately 519 million cubic feet of refrigerated, frozen, and dry storage space. Of the 104 warehouses, AmeriCold Logistics leases 89 temperature controlled warehouses with an aggregate of approximately 428 million cubic feet and manages 15 additional warehouses containing approximately 91 million cubic feet of space. AmeriCold Logistics provides the frozen food industry with refrigerated warehousing and transportation management services. Refrigerated warehouses are comprised of production and distribution facilities. Production facilities typically serve one or a small number of customers, generally food processors, located nearby. These customers store large quantities of processed or partially processed products in the facility until they are shipped to the next stage of production or distribution. Distribution facilities primarily warehouse a wide variety of customers' finished products until future shipment to end-users. Each distribution facility primarily services the surrounding regional market. AmeriCold Logistics offers transportation management services including freight routing, dispatching, freight rate negotiation, backhaul coordination, and distribution channel assessment. AmeriCold Logistics temperature controlled logistics expertise and access to both frozen food warehouses and distribution channels enable its customers to respond quickly and efficiently to time-sensitive orders from distributors and retailers. Additionally, AmeriCold Logistics mines limestone at two of its locations.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation - The consolidated financial statements of the Partnership include the accounts of the Partnership and its subsidiary. The Partnership is owned 60% by Vornado Operating L.P. and 40% by COPI Cold Storage L.L.C. The partnership agreement provides that net income and losses are allocated to each partner's account in relation to their ownership interests. Subject to certain provisions, the Partnership continues for a term through October 2027. Management has made 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.
Cash and Cash Equivalents - Cash and cash equivalents consist of highly liquid investments purchased with original maturities of three months or less.
Restricted Cash - Cash restricted for uses related to payment of rent ($7,229 at December 31, 1999) and settlement of certain self-insured liabilities ($9,658 at December 31, 1999) is classified as restricted cash.
Property, Plant, and Equipment - Depreciation and amortization are computed on the straight-line method over the estimated useful lives of the respective assets. Depreciation and amortization begin the month in which the asset is placed into service.
Properties are reviewed for impairment if events or changes in circumstances indicate that the carrying amount of the property may not be recoverable. In such an event, a comparison is made of the current and projected operating cash flows of each such property into the foreseeable future on an undiscounted basis to the carrying amount of such property. Such carrying amount would be adjusted, if necessary, to estimated fair value to reflect an impairment in the value of the asset.
Revenue Recognition - Revenues include storage, transportation and handling fees, and management fees for locations managed on behalf of third parties. Storage revenues are generally invoiced daily and are recognized as billed. Transportation fees and expenses are recognized upon tender of product to common carriers, which is not materially different than if such revenues and expenses were recognized upon delivery. Management fees are recognized at the conclusion of each period in which the Company is contractually entitled to such fees. Costs related to managed facilities are included in operating expenses. AmeriCold Logistics charges customers for both inbound and outbound handling in advance but defers the outbound handling revenue until the product has been shipped. Revenues from the sale of limestone are recognized upon delivery to customers.
Income Taxes - AmeriCold Logistics has elected to be treated as a partnership for income tax purposes. Taxable income or loss of AmeriCold Logistics is reported in the income tax returns of the partners. Accordingly, no provision for income taxes is made in the financial statements of AmeriCold Logistics.
Recently Issued Accounting Standards - In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities. This statement establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. It is effective for all fiscal quarters of fiscal years beginning after June 15, 2000. Because the Company does not currently utilize derivatives or engage in significant hedging activities, management does not anticipate that implementation of this statement will have a material effect on the Company's financial statements.
3. ACQUISITION
In March 1999, AmeriCold Logistics purchased all of the non-real estate assets of a group of companies owned by Vornado Realty Trust and subsidiaries of Crescent Real Estate Equities Company and Crescent Operating, Inc. (the "Real Estate Companies").
The purchase price of the non-real estate assets was $48.7 million including the assumption of approximately $10 million of liabilities assumed in connection with the closure of one of the warehouse facilities. In addition, the Company acquired capitalized leased assets and assumed $3.2 million of capitalized lease obligations as a result of the purchase.
The purchase method of accounting was applied to this acquisition. Approximate fair values assigned to assets and liabilities acquired were as follows:
Results of operations are presented from the date of acquisition.
4. ACCRUED EXPENSES
Detail of accrued expense as of December 31, 1999 is as follows:
(amounts in thousands)
5. TRANSACTIONS WITH REAL ESTATE COMPANIES AND OWNERS
Amounts due to Real Estate Companies at December 31, 1999 consist of current rent payable of $19,232,000 and current portion of deferred rent of $10,000,000 (of which $6,000,000 was paid in March 2000). Working capital to be collected on behalf of Real Estate Companies of $12,951,000 has been classified as a reduction of these assets.
During 1999, AmeriCold Logistics received a management fee of $201,000 from the Real Estate Companies for administrative services performed.
Included in other assets is a $952,000 receivable from the Partnership's owners for expenditures made on their behalf for a new business venture.
6. LEASE COMMITMENTS
AmeriCold Logistics entered into leases with the Real Estate Companies covering the warehouses used in this business. The leases, which commenced in March 1999, generally have a 15-year term with two five-year renewal options and provide for the payment of fixed base rent and percentage rent based on revenues AmeriCold Logistics receives from its customers. Fixed base rent is approximately $130 million per annum through 2003, $132 million per annum from 2004 through 2008, and $133 million per annum from 2009 through 2014. Percentage rent for each lease is based on a specified percentage of revenues in excess of a specified base amount. The aggregate base revenue amount under five of the six leases is approximately $321 million, and the weighted average percentage rate is approximately 36% for the initial five-year period, approximately 39% for the period from 2004 through 2008, and approximately 41% for the period from 2009 through February 28, 2014. The aggregate base revenue amount under the sixth lease is approximately $32 million, and the percentage rate is 24% for the initial two-year period, 37.5% for the period from 2002 through 2006, 40% from 2007 through 2011, and 41% from 2012 through February 28, 2014.
AmeriCold Logistics has negotiated amendments to add four new properties, or expansions to existing properties, which were developed by the lessor during 1999. The aggregate rentals of the four new properties in the initial lease year is expected to be approximately $9,400,000.
The fixed base rent for each of the two five-year renewal options is equal, generally, to the greater of the then fair market value rent and the fixed base rent for the immediately preceding lease year plus 5%.
AmeriCold Logistics has the right to defer the payment of 15% of fixed base rent and all percentage rent for up to three years beginning in March 1999 to the extent that available cash, as defined in the leases, is insufficient to pay such rent. Pursuant to the agreement, AmeriCold Logistics exercised its deferral rights and deferred approximately $15.4 million in fixed and percentage rent. In March 2000, AmeriCold Logistics expects to pay $10.0 million of its deferred rent obligation (of which $6,000,000 was paid in March 2000).
Accordingly, at December 31, 1999, AmeriCold Logistics has $10.0 million classified as current deferred rent payable and $5.4 million classified as deferred rent obligation.
AmeriCold Logistics is also required to pay for all costs arising from the operation, maintenance and repair of the properties, including all real estate taxes and assessments, utility charges, permit fees, and insurance premiums, as well as property capital expenditures in excess of $5,000,000 annually.
AmeriCold Logistics also has operating lease agreements for equipment and other facilities. AmeriCold Logistics pays taxes, insurance, and maintenance costs on substantially all of the leased property. Lease terms generally range from 5 to 20 years with renewal or purchase options.
At December 31, 1999, future minimum fixed lease payments under these leases with the Real Estate Companies and future minimum lease payments under operating leases other than leases with the Real Estate Companies are as follows:
(amounts in thousands)
Rent expense under all lease obligations for the period was $113,899,000 for fixed rent and $26,780,000 for percentage rent.
7. EMPLOYEE BENEFIT PLANS
Defined Benefit Pension Plans - AmeriCold Logistics has defined benefit pension plans that cover substantially all employees, other than union employees covered by union pension plans under collective bargaining agreements. Benefits under AmeriCold Logistics' plans are based on years of credited service and compensation during the years preceding retirement, or on years of credited service and established monthly benefit levels.
Postretirement Benefits Other Than Pensions - During 1999, AmeriCold Logistics settled and curtailed postretirement healthcare and life insurance benefits for a substantial portion of its employees. As a result, AmeriCold Logistics recorded a gain of approximately $1,363.
Actuarial information regarding the defined benefit pension plans and postretirement benefits other than pensions as of December 31, 1999 is as follows:
Assumed health care cost trend rates have a significant effect on the amounts reported for the health care plans. A one-percentage point change in assumed health care cost-trend rates would have the following effects (amounts in thousands):
Profit Sharing - AmeriCold Logistics has defined contribution employee benefit plans which cover all eligible employees. The plans also allow contributions by plan participants in accordance with Section 401(k) of the Internal Revenue Code. Profit sharing expense for the period ended December 31, 1999 was approximately $4,060,000.
Deferred Compensation - AmeriCold Logistics has deferred compensation and supplemental retirement plan agreements with certain of its executives. The agreements provide for certain benefits at retirement or disability, and also provide for survivor benefits in the event of death of the employee. AmeriCold Logistics charges expense for the accretion of the liability each year.
The net expense for all deferred compensation and supplemental retirement plans for the period was approximately $164,000.
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
TO THE MEMBERS OF CHARTER BEHAVIORAL HEALTH SYSTEMS, LLC:
We have audited the accompanying consolidated balance sheets of Charter Behavioral Health Systems, LLC (a Delaware limited liability corporation) and subsidiaries as of September 30, 1997 and 1998, and the related consolidated statements of operations, changes in members' capital (deficit) and cash flows for the period June 17, 1997 to September 30, 1997 and for the year ended September 30, 1998. These consolidated financial statements and the schedule referred to below are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Charter Behavioral Health Systems, LLC and subsidiaries as of September 30, 1997 and 1998, and the results of their operations and their cash flows for the period June 17, 1997 to September 30, 1997 and for the year ended September 30, 1998, in conformity with generally accepted accounting principles.
The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the financial statements, the Company has incurred recurring losses from operations and has a net capital deficiency that raises substantial doubt about its ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 1. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.
Our audit was made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedule listed in the index to the consolidated financial statements is presented for purposes of complying with the Securities and Exchange Commission's rules and is not a required part of the basic financial statements. The schedule has been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, fairly states, in all material respects, the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.
ARTHUR ANDERSEN LLP
ATLANTA, GEORGIA DECEMBER 3, 1998 (except with respect to the matters discussed in Note 13, as to which date is March 30, 2000)
CHARTER BEHAVIORAL HEALTH SYSTEMS, LLC CONSOLIDATED BALANCE SHEETS (IN THOUSANDS)
The accompanying Notes to Consolidated Financial Statements are an integral part of these consolidated balance sheets.
CHARTER BEHAVIORAL HEALTH SYSTEMS, LLC CONSOLIDATED BALANCE SHEETS (IN THOUSANDS)
The accompanying Notes to Consolidated Financial Statements are an integral part of these consolidated balance sheets.
CHARTER BEHAVIORAL HEALTH SYSTEMS, LLC CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS)
The accompanying Notes to Consolidated Financial Statements are an integral part of these consolidated statements.
CHARTER BEHAVIORAL HEALTH SYSTEMS, LLC CONSOLIDATED STATEMENTS OF CHANGES IN MEMBERS' CAPITAL (DEFICIT) (IN THOUSANDS)
The accompanying Notes to Consolidated Financial Statements are an integral part of these consolidated statements.
CHARTER BEHAVIORAL HEALTH SYSTEMS, LLC CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
The accompanying Notes to Consolidated Financial Statements are an integral part of these consolidated statements.
CHARTER BEHAVIORAL HEALTH SYSTEMS, LLC NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 1997 AND 1998
1. ORGANIZATION AND BASIS OF PRESENTATION
The consolidated financial statements of Charter Behavioral Health Systems, LLC ("CBHS" or the "Company"), a Delaware limited liability corporation, include the accounts of the Company and its subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.
The Company provides behavioral healthcare services in the United States. The Company's principal services include group and individual inpatient treatment, day and partial hospitalization services, group and individual outpatient treatment and residential services.
On June 17, 1997 the Company began operations pursuant to a series of transactions (the "Crescent Transactions") between Magellan Health Services, Inc. ("Magellan"), Crescent Real Estate Equities Limited Partnership ("Crescent") and Crescent Operating, Inc. ("COI"). The Crescent Transactions provided for the following:
o Magellan sold to Crescent 80 behavioral healthcare facilities (76 operating and four held for sale) ("Purchased Facilities") and related medical office buildings formerly operated by Magellan.
o The Company operates the Purchased Facilities and the Contributed Facilities (defined below) (together the "Facilities"). The Company is owned equally by Magellan and COI.
o Magellan contributed to the Company certain property and intangible rights used in connection with the Facilities with a net book value of approximately $5.0 million in exchange for its equity interest in CBHS. The property that was contributed by Magellan included five acute care psychiatric hospitals and other ancillary facilities that Magellan leased from third parties (together the "Contributed Facilities"). The Company also purchased certain assets from Magellan relating to Magellan's information systems subsidiary for $5.0 million.
o COI contributed $5.0 million of cash as its initial equity investment in the Company.
o CBHS entered into a service agreement with Magellan pursuant to which the Company manages Magellan's interest in certain joint ventures with unaffiliated third parties, including joint ventures that operate or manage ten behavioral healthcare facilities. Magellan is the general partner or managing entity of such joint ventures.
o CBHS leased the Purchased Facilities from Crescent under an initial 12-year lease term with four renewal terms of five years each ("Crescent Lease"). CBHS pays annual base rent to Crescent, which was initially $41.7 million and increases at 5% compounded annually (See Note 5).
o CBHS and certain of its subsidiaries entered into franchise agreements with Magellan (the "Franchise Agreements") pursuant to which CBHS and such subsidiaries operate using the "CHARTER' name, services and protocols and pay Magellan annual franchise fees, subject to increase, of approximately $78.3 million (See Note 6). The franchise fees due Magellan are subordinate to the payment of rent due Crescent.
o Both Magellan and COI contributed an additional $2.5 million in cash to the capital of CBHS. In addition, each made a commitment to loan CBHS up to $17.5 million each, for a period of five years. Such loans were made to CBHS by each for $17.5 million ("Member Loans") and, effective September 30, 1997, were converted to cumulative redeemable preferred interests (See Note 8).
The Company's financial statements have been prepared assuming that the Company will continue as a going concern. As shown in the financial statements during the 106 days ended September 30, 1997 and the year ended September 30, 1998, the Company has incurred losses from operations, and therefore, the Company has a significant accumulated deficit at September 30, 1998. The financial statements do not include any adjustments relating to the recoverability and classification of liabilities that might be necessary should the Company be unable to continue as a going concern.
The Company's continuation as a going concern is dependent upon its ability to generate sufficient cash flows to meet its obligations on a timely basis. The Company believes its cash flows and profitability are influenced by the cyclical nature of the behavioral healthcare provider business, with a reduced demand for certain services generally occurring during the first fiscal quarter around major holidays and during the summer months comprising the fourth fiscal quarter. Management has formulated and implemented a business plan to reduce overhead and add new lines of business to improve the cash flows and the profitability of the Company. Additionally, the Company is actively pursuing additional sources of capital and/or borrowings.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.
NET REVENUE
Net revenue is based on established billing rates, less estimated allowances for patients covered by Medicare and other contractual reimbursement programs, and discounts from established billing rates. Amounts received by the Company for treatment of patients covered by Medicare and other contractual reimbursement programs, which may be based on cost of services provided or predetermined rates, are generally less than the established billing rates of the Company's hospitals. Final determination of amounts earned under contractual reimbursement programs is subject to review and audit by the applicable agencies. Net revenue in fiscal 1998 included a charge of $0.7 million for the settlement and adjustment of reimbursement issues related to the previous fiscal period. Management believes that adequate provision has been made for any adjustments that may result from such reviews.
ADVERTISING COSTS
The production costs of advertising are expensed as incurred. The Company does not consider any of its advertising costs to be direct-response and, accordingly, does not capitalize such costs. Advertising costs consist primarily of radio and television air time, which is amortized as utilized, and printed media services. Advertising expense was approximately $6.4 million and $20.3 million for the 106 days ended September 30,1997 and for the year ended September 30, 1998, respectively.
CHARITY CARE
The Company provides healthcare services without charge or at amounts less than its established rates to patients who meet certain criteria under its charity care policies. Because the Company does not pursue collection of amounts determined to be charity care, they are not reported as revenue. For the 106 days ended September 30, 1997 and for the year ended September 30, 1998, the Company provided, at its established billing rates, approximately $5.3 million and $28.4 million, respectively, of such care.
INTEREST, NET
The Company records interest expense net of interest income. Interest income for the 106 days ended September 30, 1997 and for the year ended September 30, 1998 was approximately $0.2 million and $0.3 million, respectively.
CASH AND CASH EQUIVALENTS
Cash equivalents are short-term, highly liquid interest-bearing investments with a maturity of three months or less when purchased, consisting primarily of money market instruments.
CONCENTRATION OF CREDIT RISK
Accounts receivable from patient revenue subject the Company to a concentration of credit risk with third-party payors that include insurance companies, managed healthcare organizations and governmental entities. The Company establishes an allowance for doubtful accounts based upon factors surrounding the credit risk of specific payors, historical trends and other information. Management believes the allowance for doubtful accounts is adequate to provide for normal credit losses.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Expenditures for renewals and improvements are charged to the property accounts. Replacements and maintenance and repairs that do not improve or extend the lives of the respective assets are expensed as incurred. Amortization of capital lease assets is included in depreciation expense. Depreciation is provided on a straight-line basis over the estimated useful lives of the assets, which is generally three to ten years for equipment. Leasehold improvements are amortized over the useful lives of the related assets or the terms of the leases, whichever is shorter. Depreciation and amortization expense was $0.7 million and $5.7 million for the 106 days ended September 30, 1997 and for the year ended September 30, 1998, respectively.
INTANGIBLE ASSETS
Intangible assets are composed principally of goodwill and deferred financing costs. Goodwill represents the excess of the cost of businesses acquired over the fair value of the net identifiable assets at the date of acquisition and is amortized using the straight-line method over 25 years. Deferred financing costs are the costs incurred by the Company to obtain and amend its credit agreement (See Note 5) and are amortized over the term of the related agreement (five years).
The Company continually monitors events and changes in circumstances which could indicate that carrying amounts of intangible assets may not be recoverable. When events or changes in circumstances are present that indicate that the carrying amount of intangible assets may not be recoverable, the Company assesses the recoverability of intangible assets by determining whether the carrying value of such intangible assets will be recovered through the future cash flows expected from the use of the asset and its eventual disposition. No impairment losses on intangible assets were recorded by the Company for the 106 days ended September 30, 1997 or for the year ended September 30, 1998.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company estimates that the carrying amounts of financial instruments including cash and cash equivalents, accounts receivable and accounts payable approximated their fair values as of the date of the balance sheets due to the relatively short maturity of these instruments.
3. ACQUISITIONS, JOINT VENTURES AND DIVESTITURES
ACQUISITIONS
On September 28, 1998, the Company acquired four inpatient behavioral healthcare facilities, two related transitional care businesses and a behavioral healthcare contract management business (collectively "Acquired Hospitals") from Ramsay Health Care, Inc. The purchase price for the Acquired Hospitals was approximately $5.3 million. The Company accounted for the acquisition using the purchase method of accounting. The operating results of the Acquired Hospitals are included in the Company's Consolidated Statements of Operations since the date of acquisition.
JOINT VENTURES
Effective September 2, 1998, the Company entered into a hospital-based behavioral healthcare joint venture ("Brentwood JV") with Brentwood Behavioral Healthcare, LLC. The Company contributed certain assets from an existing behavioral healthcare facility in Shreveport, Louisiana, to the joint venture in exchange for its 50% interest in the Brentwood JV. The Company subsequently closed its Shreveport, Louisiana, facility. The Company accounts for its investment in the Brentwood JV using the equity method.
DIVESTITURES
On September 30, 1997, the Company sold the operations of a 60-bed behavioral healthcare hospital in Sioux Falls, South Dakota, for $422,000. Proceeds from the sale were not received until October 2, 1997. The transaction resulted in a gain of $355,000.
4. UNUSUAL ITEMS
The following table summarizes the unusual items recorded during the year ended September 30, 1998 (in thousands):
PURCHASE TERMINATIONS
In the first quarter of fiscal 1998, the Company recorded a charge of approximately $2.1 million related to expenses incurred in connection with a terminated acquisition of an unrelated entity. In the fourth quarter of fiscal 1998, the Company recorded a charge of approximately $2.3 million related to expenses incurred in connection with terminated transactions with Magellan and COI that included (i) the purchase of Magellan's franchise operations relating to the "CHARTER" system and certain other assets, (ii) termination of the Franchise Agreements, (iii) the sale of Magellan's equity interest in CBHS to COI and (iv) review of the potential to obtain new capital for the Company (collectively the "Magellan Buyout"). See Note 12.
SEVERANCE
The Company recorded charges of approximately $3.0 million during fiscal 1998 related to severance and related benefits for employees who were terminated during fiscal 1998 pursuant to planned overhead reductions.
DIVESTITURES
In June 1998, the Company sold a 77-bed behavioral healthcare facility in Virginia for approximately $0.8 million which resulted in a loss of approximately $2.7 million.
OTHER
In the fourth quarter of fiscal 1998, the Company accrued approximately $0.8 million for estimated expenses incurred in connection with the settlement of various litigation matters. Also in the fourth quarter of fiscal 1998, the Company closed and consolidated one behavioral health care operation in Texas and recorded charges of approximately $0.2 million related to severance and related benefits and closure costs.
5. LONG-TERM DEBT AND LEASE OBLIGATIONS
Information with regard to the Company's long-term debt and capital lease obligations at September 30, 1997 and 1998 is as follows (in thousands):
The aggregate scheduled maturities of long-term debt during the five years subsequent to September 30, 1998 are as follows (in thousands): 1999--$2,800; 2000--$0; 2001--$0, 2002--$67,200; 2003--$0.
The Company's debt is carried at cost which approximates fair market value.
REVOLVING CREDIT AGREEMENTS
On June 17, 1997, the Company entered into a credit agreement (the "Revolving Credit Agreement") with certain financial institutions for a five-year senior secured revolving credit facility in an aggregate committed amount of $100 million. Effective September 30, 1998, the Revolving Credit Agreement was amended to provide for, among other things, modification of financial covenant levels and increases in interest rates.
The maximum amount allowed to be borrowed under the Revolving Credit Agreement is based on a working capital calculation. At September 30, 1998, the Company did not have any amounts available for borrowing under the Revolving Credit Agreement. The Revolving Credit Agreement is secured by the tangible and intangible personal property, including accounts receivable, owned by the Company.
The loans outstanding under the Revolving Credit Agreement bear interest (subject to certain potential adjustments) at a rate per annum equal to one, two, three or six-month LIBOR plus 2.75% or the Alternative Base Rate ("ABR"), as defined, plus 1.75%. Interest on ABR loans is payable at the end of each fiscal quarter. Interest on LIBOR-based loans is payable at the end of their respective terms, but at a minimum of every three months.
COVENANTS
The Revolving Credit Agreement contains a number of restrictive covenants which, among other things, limit the ability of the Company and certain of its subsidiaries to incur other indebtedness, engage in transactions with affiliates, incur liens, make certain restricted payments, and enter into certain business combinations. The Revolving Credit Agreement also requires the Company to maintain certain specified financial ratios. The Company was in compliance with all debt covenants under the Revolving Credit Agreement, as amended, at September 30, 1998. Budget projections prepared by management for the fiscal year ending September 30, 1999 estimate that the Company will be in compliance with all debt covenants under the Revolving Credit Agreement, as amended, during fiscal 1999. Management believes that its budget projections for fiscal 1999 are reasonable and achievable, however, there can be no assurances that such projections will be achieved. If the Company were to fail to achieve such budget projections during fiscal 1999, the Company could become in noncompliance with certain debt covenants resulting in an event of default under the Revolving Credit Agreement.
CRESCENT LEASE
Effective June 17, 1997, the Company entered into an agreement to lease the Purchased Facilities from Crescent under an initial 12-year lease term with four renewal terms of five years each. The Crescent Lease requires the Company to pay all maintenance, property tax and insurance costs.
The base rent for the first year of the initial term was $41.7 million and increases at 5% compounded annually. The Company accounts for the Crescent Lease as an operating lease and accordingly, records base rent expense on a straight-line basis over the lease term. Effective December 1, 1997, Crescent and the Company amended the Crescent Lease to delete the requirement for the Company to pay an additional annual rent of $20.0 million. This amendment has no impact on future commitments for the Company as it remains directly liable for the capital expenditures and other obligations under the Crescent Lease which were to be funded by the additional annual rent.
OTHER LEASES
The Company also leases certain of its operating facilities other than the Purchased Facilities. The leases, which expire at various dates through 2027, generally require the Company to pay all maintenance, property tax and insurance costs.
In connection with the purchase of the Acquired Hospitals, CBHS entered into an agreement to lease a behavioral healthcare facility under an initial eight-year lease term with two renewal terms of four years each. The lease requires the Company to pay all maintenance, property tax and insurance costs. The base rent is $270,000, subject to increases for inflation. The Company accounts for the lease as an operating lease.
At September 30, 1998, aggregate amounts of future minimum payments under operating leases were as follows (in thousands): 1999-$49,225; 2000-$49,719; 2001-$50,562; 2002-$52,597; 2003-$54,972; subsequent to 2003-$367,948.
Rent expense for the 106 days ended September 30, 1997 and for the year ended September 30, 1998 was $20.0 million and $67.4 million, respectively.
6. FRANCHISE FEES - MAGELLAN
Effective June 17, 1997, the Company and certain of its subsidiaries entered into franchise agreements with Magellan, pursuant to which CBHS and such subsidiaries operate using the "CHARTER" name, services and protocols. The franchise agreements provide, among other things, that:
o Magellan agrees to use its commercially reasonable best efforts, subject to applicable law, to cause CBHS and such subsidiaries to have "preferred provider" status in connection with Magellan's managed behavioral healthcare business on a basis substantially consistent with existing agreements for such business.
o Magellan agrees to operate or provide a toll free "800" telephone number and call center as a means of assisting customers to locate the places of business of franchisees.
o Franchisees were granted a right to a defined territory to engage in the business of providing behavioral healthcare business, as defined.
o Magellan will provide franchisees with the following assistance: (i) advertising and marketing assistance including consultation, access to media buying programs and access to broadcast and other advertising materials produced by Magellan from time to time for franchisees; (ii) risk management services, including risk financial planning, loss control and claims management; (iii) outcomes monitoring; (iv) national and regional contracting services; and (v) consultation by telephone or at the Magellan offices with respect to matters relating to the franchisee's business in which Magellan has expertise, including reimbursement, government relations, clinical strategies, regulatory matters, strategic planning and business development.
Franchise fees payable by the Company are the greater of (i) 78.3 million, subject to increases for inflation; or (ii) $78.3 million, plus 3% of gross revenues over $1 billion and not exceeding $1.2 billion and 5% of gross revenues over $1.2 billion. Pursuant to a subordination agreement, franchise fees generally are subordinated to base rent under the Crescent Lease and the 5% annual increase.
The initial term of the franchise agreements is 12 years with four renewal terms of five years each.
Pursuant to the provisions of the Franchise Agreements, the Company must pay additional franchise fees to Magellan on management contract agreements entered into during the term of the Franchise Agreements ("Managed Business"). Managed Business franchise fees payable by the Company are 15% or 30% of the Managed Business total fees less total direct costs for contract locations within or outside of the Company's existing franchise territories, respectively. Managed Business franchise fees expense was $0 and $0.3 million for the 106 days ended September 30, 1997 and for the year ended September 30, 1998, respectively.
On December 22, 1997, Magellan and the Company entered into a management agreement relating to the operation of the "call centers" formerly operated by Magellan. The Company received $5.9 million as consideration for performing the various obligations relating to the "call centers" for the 18-month period ended June 21, 1999.
The Company has not made total monthly franchise fee payments to Magellan since February 1998, and, as a result, is in default under the Franchise Agreements. Franchise fee arrearages are approximately $38.0 million at September 30, 1998. In addition to other remedies, whenever franchise fees are past due for any reason in the amount of $6.0 million or more, Magellan has the right to prohibit any incentive compensation to CBHS management and prohibit any vesting of CBHS management equity. Whenever fees are past due in the amount of $18.0 million or more, Magellan has the right to prohibit any salary increases for key personnel of CBHS, prohibit any additional hiring by CBHS, and prohibit any new direct or indirect hospital acquisitions or joint ventures participation. If franchise fees are past due in an amount greater than $24.0 million, Magellan has the right to require a 5% cutback on budgeted expenses under the then-current approved CBHS annual budget, require monthly approval of expenditures of CBHS, including capital and operating expenditures, and require the transfer of control and management of CBHS and CBHS franchisees to Magellan.
During the fourth quarter of fiscal 1998, due to the franchise fee arrearages, Magellan exercised its limited management rights under the franchise agreements and, with CBHS's board of directors' support, made operational and management changes at CBHS. Subsequent to September 30, 1998, Magellan notified the CBHS board of directors that it was relinquishing its exercise of limited management rights of CBHS.
7. BENEFIT PLAN
The Company has a defined contribution retirement plan (the "401(k) Plan"). Employee participants can elect to voluntarily contribute up to 15% of their compensation to the 401(k) Plan. The Company makes contributions to the 401(k) Plan based on employee compensation and contributions. The Company makes a discretionary contribution of 2% of each employee's compensation and matches 50% of each employee's contribution up to 3% of their compensation.
During the year ended September 30, 1998, the Company made contributions of approximately $2.7 million to the 401(k) Plan.
8. CUMULATIVE REDEEMABLE PREFERRED INTERESTS
Effective September 30, 1997, Magellan and COI each agreed to exchange their respective Member Loans for cumulative redeemable preferred interest ("Preferred Interests") in the Company. The Preferred Interests are callable in whole at the Company's option on or after April 1, 1998, at an amount equal to the initial amount plus all accrued dividends thereon. Each holder of Preferred Interests receives preferential allocation of the Company's profits computed at 10% per annum on a cumulative basis, compounded monthly. In addition, each Preferred Interests has a similar preferred position in the event of dissolution of the Company. The Company recorded approximately $3.7 million in fiscal 1998 relating to this dividend requirement, which is all unpaid and included in Other Long-Term Liabilities at September 30, 1998.
9. ACCRUED LIABILITIES
Accrued liabilities consist of the following (in thousands):
10. SUPPLEMENTAL CASH FLOW INFORMATION
Supplemental cash flow information for the 106 days ended September 30, 1997 and for the year ended September 30, 1998 is as follows (in thousands):
11. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
As part of the Crescent Transactions, (i) certain items of working capital were purchased from Magellan, (ii) the Company agreed to collect Magellan's patient accounts receivable outstanding as of the closing date for a fee of 5% of cash collections and (iii) the Company agreed to manage Magellan's interest in certain joint ventures for a management fee. Included in net revenues for the 106 days ended September 30, 1997 and for the year ended
September 30, 1998 are approximately $5.0 million and $2.0 million, respectively, of these collection fee revenues and approximately $2.1 million and $5.5 million, respectively, of these joint venture management fees.
The Company had a net receivable from Magellan as of September 30, 1997 of approximately $5.1 million and a net payable to Magellan as of September 30, 1998 of approximately $36.9 million. This receivable/payable results from (i) amounts due for the management of Magellan's joint ventures as of September 30, 1997 and 1998, (ii) amounts due for the collection fees on Magellan's patient account receivable as of September 30, 1997 and 1998, (iii) receivable for the settlement of working capital related matters as of September 30, 1997 and 1998, (iv) receivable for the reimbursement effect associated with the collection fees as of September 30, 1997 and 1998 and (v) payable for the franchise fees as of September 30, 1998.
Effective April 1, 1998, the Company entered into an agreement with Green Spring Health Services, Inc. ("Green Spring"), a wholly-owned subsidiary of Magellan, for managed mental health, substance abuse and employee assistance plan services for the Company's employees. During fiscal 1998, the Company paid approximately $0.1 million to Green Spring for these services.
John C. Goff was the Chairman of CBHS and the Vice Chairman of both Crescent and COI. During fiscal 1998, the Company paid approximately $0.4 million to John Goff for salary and related benefits. In November 1998, Mr. Goff resigned his position on the CBHS board. Richard P. Knight, the Chief Financial Officer of COI, was appointed to fill the vacancy on the CBHS board left by Mr. Goff's resignation. Jeffrey L. Stevens of COI was subsequently elected Chairman of CBHS.
12. COMMITMENTS AND CONTINGENCIES
The Company carries general and professional liability insurance from an unrelated commercial insurance carrier with a self insured retention of $1.5 million per occurrence and $8.0 million in the aggregate, on a claim made basis. In addition, the Company has an umbrella policy with coverage up to $75.0 million per occurrence and in the aggregate.
Magellan and the predecessor to the Company's Orlando, Florida facility (the "Orlando Facility") were named as defendants in a complaint entitled United States of America ex rel. Francine M. Mettevis and Rhea Rowan v. Charter Hospital of St. Louis, Inc. et al. The action was filed on November 6, 1994 as a qui tam action in the United States District court for the Middle District of Florida. Magellan, the Department of Justice, and the Company entered into a settlement of the action in August 1998. Pursuant to the settlement agreement, Magellan paid the government $4.75 million and the Company entered into a Corporate Integrity Agreement for the Orlando Facility whereby the Orlando Facility will be monitored for five years by the Department of Health and Human Services ("HHS) and the Office of the Inspector General ("OIG") as well as a concurrent reviewer. In the settlement agreement, the Company also agreed that the Orlando Facility would not bill Medicare for the treatment of Medicare patients for a period of 12 to 15 months beginning August 1, 1998 (the "Non-Billing Period"). The Company intends to seek indemnification from Magellan under the Crescent Transactions for all of the fees, costs, expenses and losses it incurs in connection with the settlement agreement and the Corporate Integrity Agreement. The Company has been reimbursed by Magellan for losses and costs it has incurred through October 1998 which relate to the services provided by the Orlando Facility to Medicare beneficiaries.
In connection with the Magellan Buyout, Magellan and COI entered into a Support Agreement pursuant to which COI agreed, under certain conditions, to assist the Company in obtaining the funds required to consummate the contemplated transactions and to pay expenses incurred in obtaining such funds. On August 19, 1998, Magellan and COI each announced the termination of negotiations regarding the Magellan Buyout. On November 5, 1998, Magellan notified COI that Magellan believes COI owes CBHS $2.3 million for the reimbursement of expenses incurred by the Company in connection with attempts to obtain financing for the contemplated transactions. COI disputes this matter which will be sent to arbitration. See Note 4.
In April 1998, following the death of a patient at the Company's Greensboro, North Carolina facility ("Greensboro Facility"), the North Carolina Department of Health and Human Services ("NC HHS") conducted a survey of that facility. On April 14, 1998, the Greensboro Facility received notice that as a result of the survey, NC HHS was recommending to the Health Care Financing Administration ("HCFA") that the Greensboro Facility be excluded
from participation in Medicare within 23 days. Similarly, on April 14, 1998, the Greensboro Facility received notice that as a result of the survey, NC HHS intended to revoke the Greensboro Facility's state license. In response to such notices, the Company submitted a plan of correction and refutation of deficiencies with HCFA and NC HHS, and NC HHS conducted a subsequent visit on May 4 through May 6, 1998. On May 7, 1998, the Greensboro Facility received notice from HCFA that based on the findings in the second visit, the date scheduled for involuntary termination was extended to July 7, 1998. On June 5, 1998, the Greensboro Facility entered into a settlement agreement with NC HHS which resolved all outstanding regulatory and operational issues with NC HHS and HCFA arising from the patient's death. The local District Attorney's office and the North Carolina Board of Nursing ("NCBN") have continued their separate investigations into this incident. An indictment of one of the Greensboro Facility's employees has been returned while the NCBN continues its investigation. At this stage, it is not possible to predict whether any future action will be taken against the Greensboro Facility or any of its other employees involved in the patient's death, the likelihood of an unfavorable outcome, or the amount of any potential loss associated with any such action.
The healthcare industry is subject to numerous laws and regulations. The subjects of such laws and regulations include, but are not limited to, matters such as licensure, accreditation, government healthcare program participation requirements, reimbursement for patient services, and Medicare and Medicaid fraud and abuse. Recently, government activity has increased with respect to investigations and / or allegations concerning possible violations of fraud and abuse and false claims statutes and regulations by healthcare providers. Entities that are found to have violated these laws and regulations may be excluded from participating in government healthcare programs, subjected to fines or penalties or required to repay amounts received from the government for previously billed patient services. The Office of the Inspector General of the Department of Health and Human Services and the United States Department of Justice and certain other governmental agencies are currently conducting inquiries and / or investigations regarding the compliance by the Company and certain of its subsidiaries with such laws and regulations. In addition, the Company is also subject to or party to litigation, claims and civil suits relating to its operations and business practices. In the opinion of management, the Company has recorded reserves that are adequate to cover litigation, claims or assessments that have been or may be asserted against the Company arising out of such litigation, civil suits and governmental inquires. Furthermore, management believes that the resolution of such litigation, civil suits and governmental inquiries will not have a material adverse effect on the Company's financial position or results of operations; however, there can be no assurance in this regard.
13. SUBSEQUENT EVENT
Subsequent to September 30, 1998, the Company has continued to incur significant losses from operations, is in default of its revolving credit and lease agreements, and has a significant accumulated deficit. The Company has announced plans to cease operations at a significant number of its facilities and to reduce its personnel levels. On February 16, 2000, the Company filed a voluntary bankruptcy petition in U.S. Bankruptcy Court in Wilmington, Delaware. These financial statements do not reflect any activities since September 30, 1998, including the impact relating to the bankruptcy filing.
Additionally, the United States Department of Justice has indicated that certain of its ongoing inquiries are based on its belief that the federal government has certain civil and administrative causes of action under the Civil False Claims Act, the Civil Monetary Penalties Law, other federal statutes, and the common law arising from the participation in federal health benefit programs of the Company's psychiatric facilities nationwide. Although the ultimate outcome of these inquiries cannot be determined, a material unfavorable outcome may have a material adverse effect on the financial position or future operating results of the Company.
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS (IN THOUSANDS)
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(A) Recoveries of amounts previously charged to income.
(B) Accounts written off.
(C) Allowance for doubtful accounts assumed in purchase of net assets from Magellan.
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Executive Committee of The Woodlands Operating Company, L.P.:
We have audited the accompanying consolidated balance sheets of The Woodlands Operating Company, L.P. and subsidiary as of December 31, 1998 and 1997, and the related consolidated statements of earnings, changes in partners' equity and cash flows for the year ended December 31, 1998, and the period from July 31, 1997 (inception) to December 31, 1997. These financial statements are the responsibility of The Woodlands Operating Company, L.P.'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 financial position of The Woodlands Operating Company, L.P. and subsidiary as of December 31, 1998 and 1997, and the results of its operations and its cash flows for the year ended December 31, 1998, and the period from July 31, 1997 (inception), to December 31, 1997, in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
HOUSTON, TEXAS JANUARY 15, 1999
THE WOODLANDS OPERATING COMPANY, L.P. AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS DECEMBER 31, 1998 AND 1997 (DOLLARS IN THOUSANDS)
See accompanying Notes
THE WOODLANDS OPERATING COMPANY, L.P. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF EARNINGS FOR THE YEAR ENDED DECEMBER 31, 1998 AND FOR THE PERIOD FROM JULY 31, 1997 (INCEPTION) TO DECEMBER 31, 1997 (DOLLARS IN THOUSANDS)
See accompanying Notes
THE WOODLANDS OPERATING COMPANY, L.P. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CHANGES IN PARTNERS' EQUITY FOR THE YEAR ENDED DECEMBER 31, 1998 AND FOR THE PERIOD FROM JULY 31, 1997 (INCEPTION) TO DECEMBER 31, 1997 (DOLLARS IN THOUSANDS)
See accompanying Notes
THE WOODLANDS OPERATING COMPANY, L.P. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEAR ENDED DECEMBER 31, 1998 AND FOR THE PERIOD FROM JULY 31, 1997 (INCEPTION) TO DECEMBER 31, 1997 (DOLLARS IN THOUSANDS)
See accompanying Notes
THE WOODLANDS OPERATING COMPANY, L.P. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
CONTROL. The Woodlands Operating Company, L.P. ("Woodlands Operating"), The Woodlands Land Development Company, L.P. ("Woodlands Development") and The Woodlands Commercial Properties Company, L.P. ("Woodlands Commercial") are owned by entities controlled by Crescent Real Estate Equities Limited Partnership or Crescent Operating, Inc. (together "Crescent") and Morgan Stanley Real Estate Fund II, L.P. ("Morgan Stanley"). Woodlands Development and Woodlands Commercial are successors to The Woodlands Corporation. Prior to July 31, 1997, The Woodlands Corporation was a wholly owned subsidiary of Mitchell Energy & Development Corp. On July 31, 1997 The Woodlands Corporation was acquired by Crescent and Morgan Stanley and merged into Woodlands Commercial, a Texas limited partnership. Woodlands Commercial was then divided into two partnerships: Woodlands Commercial and Woodlands Development. WECCR General Partnership ("WECCR GP") is a subsidiary of Woodlands Operating. Woodlands Operating manages assets owned by Woodlands Commercial and Woodlands Development.
PRINCIPLES OF CONSOLIDATION. The consolidated financial statements include the accounts of Woodlands Operating and WECCR GP. All significant transactions and accounts are eliminated in consolidation.
BUSINESS. Woodlands Operating's activities are concentrated in The Woodlands, a planned community located north of Houston, Texas. Consequently, these operations and the associated credit risks may be affected, either positively or negatively, by changes in economic conditions in this geographical area. Woodlands Operating provides services to Woodlands Development and Woodlands Commercial under management and advisory services agreements. These agreements have an initial term ending December 31, 1998 and are automatically renewable on an annual basis. Woodlands Development and Woodlands Commercial pay Woodlands Operating an advisory fee equal 3% above cost. In addition, they reimburse Woodlands Operating for all cost and expenses incurred on their behalf. For the year ended December 31, 1998 and the period from July 31, 1997 (inception) to December 31, 1997, Woodlands Operating recorded revenues of $11,050,000 and $4,598,000 for services provided to Woodlands Development and $7,343,000 and $4,235,000 for services provided to Woodlands Commercial.
WECCR GP leases The Woodlands Conference Center, Resort and Country Club ("the Facilities") from Woodlands Commercial. This agreement has an eight-year term ending July 31, 2005. WECCR GP operates the Facilities and pays Woodlands Commercial a base rent of $750,000 per month and a quarterly percentage rent based on the gross receipts of the Facilities. For the year ended December 31, 1998 and the period from July 31, 1997 (inception) to December 31, 1997, rent under the lease agreement totaled $12,799,000 and $5,063,000.
DEPRECIATION. Depreciation of operating assets is provided on the straight-line method over the estimated useful lives of the assets, which range from three to ten years.
INCOME TAXES. No liability for Federal income taxes is included in the accompanying financial statements since Woodlands Operating is not a tax-paying entity and all income and expenses are reported by the partners for tax reporting purposes.
The tax returns, the qualification of Woodlands Operating for tax purposes and the amount of distributable partnership income or loss are subject to examination by Federal taxing authorities. If such examinations result in changes with respect to partnership qualification or in changes to distributable partnership income or loss, the tax liability of the partners could be changed accordingly.
STATEMENTS OF CASH FLOWS. Short-term investments with maturities of three months or less are considered to be cash equivalents. There were no significant non-cash investing or financing activities for the year ended December 31, 1998 or for the period from July 31, 1997 (inception) to December 31, 1997.
USE OF ESTIMATES. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.
2. COMMITMENTS AND CONTINGENCIES
LEGAL ACTIONS. Woodlands Operating is a party to claims and legal actions arising in the ordinary course of business and to recurring examinations by the Internal Revenue Service and other regulatory agencies. Management believes, after consultation with outside counsel, that adequate financial statement accruals have been provided for all known litigation contingencies where losses are deemed probable. Since the ultimate cost will depend on the outcomes of these uncertainties, it is possible that additional future charges might be required that would be significant to the operating results of a particular period. Based on the status of the cases, Woodlands Operating is unable to determine a range of such possible additional losses, if any, that might be incurred in connection with this litigation. Woodlands Operating believes it is not probable that the ultimate resolution of this litigation will have a material adverse effect on its financial position and results of operations.
LEASES. Woodlands Operating has various facility and equipment lease agreements. Rental expenses for operating leases for the year ended December 31, 1998 and the period from July 31, 1997 (inception) to December 31, 1997 total $1,099,000 and $313,000. Minimum rentals for the five years subsequent to December 31, 1998 total approximately $724,000; $775,000; $756,000; $456,000 and $456,000.
INCENTIVE PLAN. Woodlands Operating instituted an incentive compensation plan for certain employees effective January 1, 1998. The plan is unfunded and while certain payments are made currently, a portion of the payment is deferred and paid only upon the occurrence of certain future events. Woodlands Development and Woodlands Commercial will reimburse any incentive plan payments made in the future.
3. PARTNERS' EQUITY
Crescent's entity in Woodlands Operating is WOCOI Investment Company. Morgan Stanley's entities are MS/TWC Joint Venture and MS TWC, Inc. The partners' percentage interests are summarized below:
The partnership agreement provides, among other things, the following:
(i) Woodlands Operating is governed by an Executive Committee composed of equal representation from its respective general partners.
(ii) Net income and losses from operations are currently allocated so that partners' capital accounts stand in the ratio of the percentage interest listed above.
(iii) Distributions are made to partners based on specified payout percentages and include cumulative preferred returns to Morgan Stanley's affiliates. The payout percentage to Morgan Stanley's affiliates is 57.5% until the affiliates receive distributions equal to their capital contributions and a 12% cumulative preferred return compounded quarterly. Then, the payout percentage to Morgan Stanley's affiliates is 50.5% until the affiliates receive distributions equal to their capital contributions and an 18% cumulative preferred return compounded quarterly. Thereafter the payout percentage to Morgan Stanley's affiliates is 47.5%.
(iv) Woodlands Operating will continue to exist until December 31, 2040 unless terminated earlier due to specified events.
(v) No additional partners may be admitted to Woodlands Operating unless specific conditions in the partnership agreements are met. Partnership interests may be transferred to affiliates of Crescent or Morgan Stanley. Crescent has the right of first refusal to buy the partnership interests of the Morgan Stanley affiliates at the same terms and conditions offered to a third party purchaser, or sell its affiliates' interests to the same third party purchaser.
(vi) Crescent and Morgan Stanley have the right to offer to purchase the other partner's affiliates' partnership interests in the event of failure to make specified capital contributions or a specified default by the other. Specified defaults include bankruptcy, breach of partnership covenants, transfer of partnership interests except as permitted by the partnership agreements, and fraud or gross negligence.
4. EMPLOYEE SAVINGS PLAN
Woodlands Operating has a 401(k) defined contribution plan that is available to all full-time employees who meet specified service requirements. The plan is administered by a third party. Contributions to the plan are based on a match of employee contributions up to a certain limit. For the year ended December 31, 1998 and the period from July 31, 1997 (inception) to December 31, 1997 Woodlands Operating contributions totaled $582,000 and $240,000.
5. YEAR 2000 COMPLIANCE (UNAUDITED)
Woodlands Operating utilizes and is dependent on computer systems to conduct its business. These systems include hardware and software developed and maintained by third parties and purchased software run on in-house networks. A third party manages the in-house systems under a contractual arrangement. Woodlands Operating is undertaking a project to determine whether its computer systems are year 2000 compliant. The project plan has been reviewed by senior management and involves an assessment of each software application and related hardware. Vendors will be contacted to assess year 2000 compliance and determine what corrective measures, if any, are needed. A plan has been developed to make the necessary corrections, or take some alternative action. The plan is being implemented and tested to ensure compliance. Systems that have the greatest impact will be given a higher priority.
Management has not determined the final cost of its year 2000 readiness efforts or the related potential impact on Woodlands Operating's results of operations. There can be no assurance that there will not be an adverse impact on Woodlands Operating's financial position or results of operations if Woodlands Operating's systems or the systems of other companies on which Woodlands Operating relies are not compliant in time. However, based on preliminary assessments management believes the risk of such adverse impact is low.
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Executive Committee of The Woodlands Land Development Company, L.P.:
We have audited the accompanying balance sheets of The Woodlands Land Development Company, L.P., as of December 31, 1998 and 1997, and the related statements of earnings, changes in partners' equity and cash flows for the year ended December 31, 1998, and the period from July 31, 1997 (inception), to December 31, 1997. These financial statements are the responsibility of The Woodlands Operating Company, L.P.'s management as manager for The Woodlands Land Development Company, L.P. 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 financial position of The Woodlands Land Development Company, L.P., as of December 31, 1998 and 1997, and the results of its operations and its cash flows for the year ended December 31, 1998, and the period from July 31, 1997 (inception), to December 31, 1997, in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
HOUSTON, TEXAS JANUARY 15, 1999
THE WOODLANDS LAND DEVELOPMENT COMPANY, L.P. BALANCE SHEETS DECEMBER 31, 1998 AND 1997 (DOLLARS IN THOUSANDS)
See accompanying Notes
THE WOODLANDS LAND DEVELOPMENT COMPANY, L.P. STATEMENTS OF EARNINGS FOR THE YEAR ENDED DECEMBER 31, 1998 AND FOR THE PERIOD FROM JULY 31, 1997 (INCEPTION) TO DECEMBER 31, 1997 (DOLLARS IN THOUSANDS)
See accompanying Notes
THE WOODLANDS LAND DEVELOPMENT COMPANY, L.P. STATEMENTS OF CHANGES IN PARTNERS' EQUITY FOR THE YEAR ENDED DECEMBER 31, 1998 AND FOR THE PERIOD FROM JULY 31, 1997 (INCEPTION) TO DECEMBER 31, 1997 (DOLLARS IN THOUSANDS)
See accompanying Notes
THE WOODLANDS LAND DEVELOPMENT COMPANY, L.P. STATEMENTS OF CASH FLOWS FOR THE YEAR ENDED DECEMBER 31, 1998 AND FOR THE PERIOD FROM JULY 31, 1997 (INCEPTION) TO DECEMBER 31, 1997 (DOLLARS IN THOUSANDS)
See accompanying Notes
THE WOODLANDS OPERATING COMPANY, L.P. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
CONTROL. The Woodlands Land Development Company, L.P. ("Woodlands Development"), The Woodlands Commercial Properties Company, L.P. ("Woodlands Commercial"), WECCR General Partnership ("WECCR GP"), and The Woodlands Operating Company, L.P. ("Woodlands Operating") are owned by entities controlled by Crescent Real Estate Equities Limited Partnership or Crescent Operating, Inc. (together "Crescent") and Morgan Stanley Real Estate Fund II, L.P. ("Morgan Stanley"). Woodlands Development and Woodlands Commercial are successors to The Woodlands Corporation. Prior to July 31, 1997, The Woodlands Corporation was a wholly owned subsidiary of Mitchell Energy & Development Corp. On July 31, 1997 The Woodlands Corporation was acquired by Crescent and Morgan Stanley and merged into Woodlands Commercial, a Texas limited partnership. Woodlands Commercial was then divided into two partnerships: Woodlands Commercial and Woodlands Development. Woodlands Operating manages assets owned by Woodlands Development as described in Note 8.
The following is a summary of the acquisition transaction on July 31, 1997 (in thousands):
BUSINESS. Woodlands Development's real estate activities are concentrated in The Woodlands, a planned community located north of Houston, Texas. Consequently, these operations and the associated credit risks may be affected, either positively or negatively, by changes in economic conditions in this geographical area. Activities associated with The Woodlands include residential and commercial land sales and the construction of commercial buildings.
REAL ESTATE. Costs associated with the acquisition and development of real estate, including holding costs consisting principally of interest and ad valorem taxes, are capitalized as incurred. Capitalization of such holding costs is limited to properties for which active development continues. Capitalization ceases upon completion of a property or cessation of development activities. Where practicable, capitalized costs are specifically assigned to individual assets; otherwise, costs are allocated based on estimated values of the affected assets.
LAND SALES. Earnings from sales of real estate are recognized when a third-party buyer has made an adequate cash down payment and has attained the attributes of ownership. Notes received in connection with land sales are discounted when the stated purchase prices are significantly different from those that would have resulted from similar cash transactions. The cost of land sold is generally determined as a specific percentage of the sales revenues recognized for each land development project. These percentages are based on total estimated development costs and sales revenues for each project.
DEPRECIATION. Depreciation of operating assets is provided on the straight-line method over the estimated useful lives of the assets, which range from three to fifty years.
INCOME TAXES. No liability for Federal income taxes is included in the accompanying financial statements since the Woodlands Development is not a tax-paying entity and all income and expenses are reported by the partners for tax reporting purposes.
The tax returns, the qualification of Woodlands Development for tax purposes and the amount of distributable partnership income or loss are subject to examination by Federal taxing authorities. If such examinations result in changes with respect to partnership qualification or in changes to distributable partnership income or loss, the tax liability of the partners could be changed accordingly.
STATEMENTS OF CASH FLOWS. Short-term investments with maturities of three months or less are considered to be cash equivalents. The reported amounts for proceeds from issuance of debt and debt repayments exclude the impact of borrowings with initial terms of three months or less. For the year ended December 31, 1998 and for the period from July 31, 1997 (inception) to December 31, 1997, Woodlands Development paid interest totaling $25,361,000 and $7,375,000 related to debt described in Note 5.
USE OF ESTIMATES. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.
2. NOTES AND CONTRACTS RECEIVABLE
Notes receivable are carried at cost, net of discounts. At December 31, 1998, Woodlands Development had one note receivable with an outstanding balance of $1,453,000 and utility district receivables totaling $28,587,000. The note receivable has an 8.0% rate. Utility district receivables, the collection of which is dependent on the ability of utility districts in The Woodlands to sell bonds, have a market interest rate of approximately 5.0% at December 31, 1998.
3. REAL ESTATE
The following is a summary of real estate at December 31, 1998 and 1997 (in thousands):
LAND. The principal land development is The Woodlands, a mixed-use, master-planned community located north of Houston, Texas. Residential land is divided into seven villages in various stages of development. Each village has or is planned to contain a variety of housing, neighborhood retail centers, schools, parks and other amenities. Woodlands Development controls the development of the residential communities and produces finished lots for sale to qualified builders. Housing is constructed in a wide choice of pricing and product styles.
Commercial land is divided into distinct centers that serve or are planned to serve as locations for office buildings, retail and entertainment facilities, industrial and warehouse facilities, research and technology facilities, and college and training facilities. Woodlands Development produces finished sites for third parties and uses land for its own building development activities.
COMMERCIAL PROPERTIES. A commercial property owned by Woodlands Development is leased to a third-party tenant. The lease term is five years. The lease is accounted for under the operating method. Minimum future lease revenues from the operating lease excludes contingent rentals that may be received. Tenant rents include rent for noncancelable operating leases. Contingent rents include pass-throughs of incremental operating costs. Other commercial properties are under development at December 31, 1998. Summarized financial information for commercial properties as of December 31, 1998 and for the year then ended follows (in thousands):
4. JOINT VENTURES AND PARTNERSHIPS
During 1998, Woodlands Development's principal partnership interests included the following:
Woodlands Development's net investment in each of these entities is included in the real estate caption on the balance sheets and their share of these entities' pretax earnings is included in revenues on the statements of earnings. A summary of their net investment as of December 31, 1998 and their share of pre-tax earnings for the year then ended follows (in thousands):
============= ============
Summarized financial statement information for partnerships in which Woodlands Development has an ownership interest at December 31, 1998 and for the year then ended follows (in thousands):
5. DEBT
A summary of Woodlands Development's outstanding debt at December 31, 1998 and 1997 follows (in thousands):
The bank credit agreement has a three year term expiring July 31, 2000 with two, one-year extension options. The interest rate is based on the London Interbank Offered Rate and averaged 8.1% for the year ended December 31, 1998. Interest is paid monthly. The credit agreement contains certain restrictions which, among other things, require the maintenance of specified financial ratios, restrict indebtedness and sale, lease or transfer of assets, and limit the right of Woodlands Development to merge with other companies and make distributions to its partners. Certain assets of Woodlands Development including cash and receivables secure the credit agreement. Mandatory debt maturities are $11,875,000 in 1999 and $326,875,000 in 2000. They may be made by Woodlands Development or Woodlands Commercial or both at their option. Additional principal payments may be required if sufficient cash is available, and additional prepayments can also be made at the discretion of Woodlands Development.
The mortgages payable have debt maturities for the five years subsequent to December 31, 1998 totaling $109,000; $140,000; $140,000; $151,000 and $2,723,000.
6. NOTES PAYABLE TO PARTNERS
Woodlands Development has notes payable to its partners totaling $25,000,000. The notes bear interest at 15%. Interest is payable beginning in October 1998 and quarterly thereafter. All outstanding balances are due in 2007. These notes are subordinate to the bank credit agreement and mortgages payable described above.
7. COMMITMENTS AND CONTINGENCIES
CONTINGENT LIABILITIES. At December 31, 1998, Woodlands Development had a contingent liability of $2,086,000, consisting of a letter of credit.
LEASES. Rental expense for operating leases for the year ended December 31, 1998 and the period from July 31, 1997 (inception) to December 31, 1997 totaled $14,000 and $4,000.
LEGAL ACTIONS. Legal actions have been brought or threatened against Woodlands Development and third parties by various homeowners in The Woodlands related to flooding in the North Houston area in October 1994. These claimants generally are seeking reimbursements for property damages, but some are making claims for deceptive trade practices or mental anguish. Woodlands Development contends that it was not responsible for these damages, which it believes resulted from a record, near 500-year flood and were not preventable with the exercise of ordinary care and generally accepted drainage design, development and maintenance.
Woodlands Development is also a party to other claims and legal actions arising in the ordinary course of their business and to recurring examinations by the Internal Revenue Service and other regulatory agencies.
Management believes, after consultation with outside counsel, that adequate financial statement accruals have been provided for all known litigation contingencies where losses are deemed probable. Since the ultimate cost will depend on the outcomes of the uncertainties discussed in this note, it is possible, however, that additional future charges might be required that would be significant to the operating results of a particular period. Based on the status of the cases, Woodlands Development is unable to determine a range of such possible additional losses, if any, that might be incurred in connection with this litigation. Woodlands Development believes it is not probable that the ultimate resolution of this litigation will have a material adverse effect on its financial position.
COUNTRY CLUB MEMBERSHIP. As of December 31, 1998, the Woodlands Development had collected $765,000 for memberships to a new country club, which began construction at the end of 1998. Because of certain conditions that had to be satisfied, these funds were being held by Woodlands Development at the end of the year. Subsequent to year-end, these conditions were satisfied and the funds were recorded.
8. RELATED PARTY TRANSACTIONS
Woodlands Operating provides services to Woodlands Development under management and advisory services agreements. These agreements have an initial term ending December 31, 1998 and are automatically renewable on an annual basis. Woodlands Development pays Woodlands Operating an advisory fee equal to cost plus 3%. In addition, Woodlands Development reimburses Woodlands Operating for all cost and expenses incurred on their behalf. For the year ended December 31, 1998 and the period from July 31, 1997 (inception) to December 31, 1997, Woodlands Development recorded expenses of $11,050,000 and $4,598,000 for services provided by Woodlands Operating.
9. PARTNERS' EQUITY
Crescent's entity in Woodlands Development is The Woodlands Land Company, Inc. Morgan Stanley's entities are MS/TWC Joint Venture and MS TWC, Inc. The partners' percentage interests are summarized below:
The partnership agreement provides, among other things, the following:
(i) Woodlands Development is governed by an Executive Committee composed of equal representation from their respective general partners.
(ii) Net income and losses from operations are currently allocated so that partners' capital accounts stand in the ratio of the percentage interest listed above.
(iii) Distributions are made to partners based on specified payout percentages and include cumulative preferred returns to Morgan Stanley's affiliates. The payout percentage to Morgan Stanley's affiliates is 57.5% until the affiliates receive distributions equal to their capital contributions and a 12% cumulative preferred return compounded quarterly. Then, the payout percentage to Morgan Stanley's affiliates is 50.5% until the affiliates receive distributions equal to their capital contributions and an 18% cumulative preferred return compounded quarterly. Thereafter the payout percentage to Morgan Stanley's affiliates is 47.5%.
(iv) Woodlands Development will continue to exist until December 31, 2040 unless terminated earlier due to specified events.
(v) No additional partners may be admitted to Woodlands Development unless specific conditions in the partnership agreements are met. Partnership interests may be transferred to affiliates of Crescent or Morgan Stanley. Crescent has the right of first refusal to buy the partnership interests of the Morgan Stanley affiliates at the same terms and conditions offered to a third party purchaser, or sell its affiliates' interests to the same third party purchaser.
(vi) Crescent and Morgan Stanley have the right to offer to purchase the other partner's affiliates' partnership interests in the event of failure to make specified capital contributions or a specified default by the other. Specified defaults include bankruptcy, breach of partnership covenants, transfer of partnership interests except as permitted by the partnership agreements, and fraud or gross negligence.
10. FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts and estimated fair values of Woodlands Development's financial instruments as of December 31, 1998 follows (in thousands):
Fair values of notes and contracts receivable were estimated by discounting future cash flows using interest rates at which similar loans currently could be made for similar maturities to borrowers with comparable credit ratings. Fair values of fixed-rate, long-term debt were based on current interest rates offered to Woodlands Development for debt with similar remaining maturities. For floating-rate debt obligations, carrying amounts and fair values were assumed to be equal because of the nature of these obligations. The carrying amounts of Woodlands Development's other financial instruments approximate their fair values.
11. YEAR 2000 COMPLIANCE (UNAUDITED)
Woodlands Development utilizes and is dependent on computer systems to conduct its business. These systems include hardware and software developed and maintained by third parties and purchased software run on in-house networks. A third party manages the in-house systems under a contractual arrangement. Woodlands Development is undertaking a project to determine whether their computer systems are year 2000 compliant. The project plan has been reviewed by Woodlands Development's senior management and involves an assessment of each software application and related hardware. Vendors will be contacted to assess year 2000 compliance and determine what corrective measures, if any, are needed. A plan has been developed to make the necessary corrections, or take some alternative action. The plan is being implemented and tested to ensure compliance. Systems that have the greatest impact will be given a higher priority.
Management has not determined the final cost of its year 2000 readiness efforts or the related potential impact on Woodlands Development's results of operations. There can be no assurance that there will not be an adverse impact on Woodlands Development's financial position or results of operations if Woodlands Development's systems or
the systems of other companies on which the Woodlands Development relies are not compliant in time. However, based on preliminary assessments management believes the risk of such adverse impact is low.
12. CHANGE IN ACCOUNTING PRINCIPLE
Effective January 1, 1998 Woodlands Development changed its method of accounting for organization costs to conform to Statement of Position 98-5 "Reporting on the Costs of Start-Up Activities." In 1998 Woodlands Development expensed previously capitalized costs that totaled $639,000.
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