Item 1. Business
General
Brandywine Realty Trust (collectively with its subsidiaries, the "Company") is a self-administered and self-managed real estate investment trust ("REIT") active in acquiring, developing, redeveloping, leasing and managing office and industrial properties. As of December 31, 1998, the Company owned a portfolio of 201 office properties, 70 industrial facilities and one mixed use property (the "Properties") that contained an aggregate of approximately 18.8 million net rentable square feet. As of December 31, 1998, the Properties (excluding two properties under development or redevelopment) were approximately 93.6% leased to 1,357 tenants and had an average age of approximately 14.6 years. As of December 31, 1998, 183 of the 272 Properties (approximately 62.8% of the Company's portfolio based on net rentable square feet) were located in the Suburban Philadelphia Office and Industrial Market. The term "Suburban Philadelphia Office and Industrial Market" or "Market" means the areas comprised of the following counties: Berks, Bucks, Chester, Delaware, Lehigh, Montgomery and Northampton in Pennsylvania and Burlington and Camden in New Jersey.
As of December 31, 1998, 11 tenants individually represented more than 1.0% of the Company's annualized minimum rent, none of which represent 10%. The Company's 11 largest tenants accounted for approximately 20.8% of annualized minimum rent for the year ended December 31, 1998.
As of December 31, 1998, the Company also owned or held options to purchase approximately 457.0 acres of land for future development.
As of December 31, 1998, the Company owned economic interests, ranging from 35% to 65%, in nine office development joint ventures (the "Real Estate Ventures"). Three of the Real Estate Ventures own three suburban office buildings that contain an aggregate of approximately 323,000 net rentable square feet. Two other Real Estate Ventures are currently redeveloping or developing two suburban office buildings that are expected to contain an aggregate of approximately 243,000 net rentable square feet upon completion in 1999. As of December 31, 1998, the Real Estate Ventures also owned or held options to purchase approximately 46.8 acres of land for future development. As of December 31, 1998, the Company had invested or committed to invest a total of approximately $27.9 million in the Real Estate Ventures.
The Company's business objectives are to:
o maximize cash flow through leasing strategies designed to capture potential rental growth as rental rates increase and as below-market leases are renewed;
o ensure a high tenant retention rate through an aggressive tenant services program responsive to the varying needs of the Company's diverse tenant base;
o broaden its geographic and economic diversification while maximizing economies of scale;
o acquire high-quality office and industrial properties and portfolios of such properties at attractive yields in selected submarkets within the Mid-Atlantic region (including Delaware, Maryland, New Jersey, New York, Pennsylvania, Virginia and the District of Columbia), which management expects will experience economic growth;
o capitalize on management's redevelopment expertise to selectively acquire, redevelop and reposition underperforming properties in desirable locations;
o acquire land in anticipation of developing office or industrial properties on a build-to-suit basis, under circumstances where significant pre-leasing can be arranged or as otherwise warranted by market conditions;
o enhance the Company's investment strategy through the pursuit of joint venture opportunities with high quality partners having attractive real estate holdings or significant financial resources; and
o execute an investment strategy that effectively balances creating long-term growth opportunities with the Company's public market valuation.
In pursuit of its business objectives, the Company has recently experienced rapid growth. Between January 1, 1997 and March 15, 1999, the Company acquired 168 office properties containing approximately 12.9 million net rentable square feet, 67 industrial facilities containing approximately 3.9 million net rentable square feet and one mixed use property containing approximately 167,760 net rentable square feet and, together with the Real Estate Ventures, acquired ownership of, or rights to acquire, approximately 503.8 acres of undeveloped land. The aggregate purchase price for the 236 Properties acquired by the Company between January 1, 1997 and March 15, 1999 was approximately $1.7 billion. During this period, the Company also sold one office property containing approximately 156,175 net rentable square feet for a net sales price of approximately $14.7 million. During such period, the Company also completed the development or redevelopment of three office properties and one industrial facility containing an aggregate of approximately 388,000 net rentable square feet for aggregate development costs, including the cost of acquiring land, of approximately $28.6 million.
The Company expects to continue to concentrate its real estate activities in submarkets within the Mid-Atlantic region where it believes that: (i) barriers to entry (such as zoning restrictions, utility availability, infrastructure limitations, development moratoriums and limited developable land) will create supply constraints on office and industrial space; (ii) current market rents and absorption statistics justify limited new construction activity; (iii) it can maximize market penetration by accumulating a critical mass of properties and thereby enhance operating efficiencies; and (iv) there is potential for economic growth.
The Company's executive offices are located at 14 Campus Boulevard, Suite 100, Newtown Square, Pennsylvania 19073 and its telephone number is (610) 325-5600.
Organization
The Company was organized and commenced its operations in 1986 as a Maryland real estate investment trust. The Company owns its assets and conducts its operations through Brandywine Operating Partnership, L.P. (the "Operating Partnership") and subsidiaries of the Operating Partnership. As of December 31, 1998, the Company's ownership interest in the Operating Partnership was approximately 88.5% and the Company was entitled to 94.6% of the Operating Partnership's income after distributions by the Operating Partnership to holders of its preferred units. The structure of the Company as an "UPREIT" is designed, in part, to permit persons contributing properties (or interests in properties) to the Company to defer some or all of the tax liability they might otherwise incur. The Company conducts its real estate management services through a management company (the "Management Company"). The Company, through its indirect ownership of preferred and common stock of the Management Company, is entitled to receive 95% of amounts paid as dividends by the Management Company. See "-- Management Company."
Equity Offerings
Since January 1, 1998, the Company has consummated four underwritten public offerings pursuant to which the Company issued an aggregate of 13,267,741 Common Shares and raised aggregate net proceeds of approximately $301.0 million. The Company contributed the net proceeds from these offerings to the Operating Partnership.
On February 4, 1998, the Company consummated an underwritten public offering of 10,000,000 Common Shares at a price to the public of $24.00 per share. On March 6, 1998, the Company issued an additional 1,000,000 Common Shares pursuant to exercise by the underwriters of their over-allotment option. Proceeds to the Company were used to repay indebtedness and for working capital purposes.
On February 18, 1998, the Company consummated an underwritten public offering of 1,012,820 Common Shares at a price to the public of $24.06 per share. Proceeds to the Company were used to repay indebtedness.
On February 27, 1998, the Company consummated an underwritten public offering of 629,921 Common Shares at a price to the public of $23.81 per share. Proceeds to the Company were used to repay indebtedness.
On April 21, 1998, the Company consummated an underwritten public offering of 625,000 Common Shares at a price to the public of $24.00 per share. Proceeds to the Company were used to repay indebtedness.
In addition, both the Company and the Operating Partnership have issued their securities as part of the acquisition consideration for certain properties.
On March 31, 1998, the Operating Partnership issued 153,036 Class A Units of limited partnership interest ("Class A Units"), which are redeemable for an equal number of Common Shares, to acquire a portfolio of six office and industrial properties.
On May 8, 1998, the Operating Partnership issued 390,364 Class A Units to acquire a portfolio of 11 office and industrial properties.
On September 29, 1998, the Operating Partnership issued 1,550,000 Series B Preferred Units of limited partnership interest ("Series B Preferred Units") and the Company issued 750,000 Series A Preferred Shares to acquire a portfolio of 67 office and industrial properties.
On October 6, 1998, the Operating Partnership issued 1,127,895 Class A Units to acquire a portfolio of 26 office and industrial properties.
On December 31, 1998, the Operating Partnership issued 83,468 Class A Units to acquire an office property.
Credit Facility
At December 31, 1997, the Company maintained a $150.0 million secured credit facility (the "1997 Credit Facility") which bore interest at LIBOR plus 175 basis points.
During the first quarter of 1998, the Company replaced the 1997 Credit Facility with a $330.0 million unsecured credit facility (the "1998 Credit Facility"). The 1998 Credit Facility bore interest at a reduced interest rate equal to the 30, 60, 90 or 180-day LIBOR plus, in each case, a range of 100 to 137.5 basis points based on the Company's leverage and debt rate. Alternatively, the Company could have borrowed funds at a base rate equal to the higher of the Prime Rate and Fed Funds Rate plus 50 basis points.
During the third quarter of 1998, the Company replaced the 1998 Credit Facility with a new $550.0 million credit facility (the "New 1998 Credit Facility") from NationsBank, N.A. The New 1998 Credit Facility is currently unsecured, but can convert to a secured borrowing if certain leverage requirements are not met by March 31, 1999. The interest rate borne by the New 1998 Credit Facility was LIBOR plus 150 basis points initially, with the spread over LIBOR subject to reductions between 12.5 to
35 basis points and a possible increase of 25 basis points based on the Company's leverage. The spread over LIBOR may also be reduced to either 115 or 100 basis points depending upon the Company's long-term debt rating. The New 1998 Credit Facility matures in September 2001 and requires the Company to maintain ongoing compliance with a number of customary financial and operational covenants including leverage ratios and debt service coverage ratios, limitations on liens and distributions and a minimum net worth requirement. On December 31, 1998, there was approximately $531.3 million of indebtedness outstanding under the New 1998 Credit Facility.
Additional Facility
During the second quarter of 1998, the Company entered into a $150.0 million unsecured credit facility (the "Additional Facility") to facilitate certain property acquisitions. The Additional Facility bore interest at LIBOR plus 150 basis points or, at the Company's option, the Prime Rate plus 25 basis points.
During the third quarter of 1998, the Company replaced the Additional Facility with a new $150.0 million unsecured credit facility (the "New Additional Facility") from NationsBanc Mortgage Capital Corp. The New Additional Facility bore interest at LIBOR plus 200 basis points and was scheduled to mature on March 31, 1999. On December 31, 1998, there was approximately $150.0 million of indebtedness outstanding under the New Additional Facility.
During the first quarter of 1999, the Company repaid all amounts outstanding under the New Additional Facility. The Company funded its repayment with a portion of the proceeds of a $119.0 million mortgage loan secured by four properties and a $75.0 million mortgage loan secured by five properties.
Mortgage and Certain Other Debt
Mortgage and Certain Other Indebtedness. The following table sets forth the Company's mortgage and certain other indebtedness outstanding at December 31, 1998.
Property -- Indebtedness
(a) "Annual Debt Service" is calculated by annualizing the normal principal and interest amortization. For loans that bear interest at a variable rate, the rates in effect at December 31, 1998 have been assumed to remain constant. Loans with zero Annual Debt Service represent construction loans having no principal or monthly interest payments.
(b) As of the date of this Form 10-K, this loan has been repaid in full.
(c) Construction loan with no monthly interest or principal payments, all of which becomes due at maturity.
(d) Two percent through December 31, 1998, which prepayment penalty is reduced by 1% in 1999.
(e) All of these properties secure a single loan.
(f) This loan may not be prepaid unless the 5910-6090 Six Forks loan is also prepaid. The prepayment penalty equals the greater of 1% of the principal amount prepaid or a yield maintenance premium.
(g) Subsequent to December 31, 1998, these loans have been extended until January 1, 2001 with a floating rate of prime or LIBOR plus 225 basis points.
(h) One percent of the amount of the loan prepaid.
(i) Pursuant to the terms of this loan, the Company has the right to borrow up to approximately $1.3 million to fund tenant improvements and leasing commissions.
(j) No payment is permitted until November, 1999, at which time this loan may be prepaid in full (but not in part) along with a penalty equal to the greater of 1% of the principal amount prepaid or a yield maintenance premium.
(k) No prepayment is permitted unit March 1999, at which time this loan may be prepaid in full (but not in part) along with a penalty equal to the greater of 1% of the principal amount prepaid or a yield maintenance premium.
(l) This loan may be prepaid without prepayment of the loan secured by One-Three Greentree Centre, provided certain loan-to-value ratios and coverage tests with regard to the One-Three Greentree Centre loan are satisfied and upon payment of a premium equal to the greater of 1% of the principal amount prepaid or a yield maintenance premium.
(m) No prepayment is permitted until September, 2000, at which time this loan may be prepaid in full together with a yield maintenance premium based upon treasury rates.
(n) Consists of 35 Properties, at various locations, acquired on September 28, 1998.
(o) No prepayment is permitted until July 11, 2007, at which time this loan may be prepaid in full without penalty.
(p) Two percent through July 1999, which prepayment penalty is reduced to 1% through July 2000. After July 2000, there is no prepayment penalty.
(q) Two percent through July 1999, which prepayment penalty is reduced to 1% through July 2000. After July 2000, there is no prepayment penalty.
(r) Consists of 25 Properties, at various locations, acquired on September 28, 1998.
(s) No prepayment is permitted until July 11, 2007, at which time this loan may be prepaid in full without penalty.
(t) The Company purchased these properties on September 28, 1998, and received the economic benefits and liabilities of such properties from September 29, 1998, although transfer of title did not occur until March 11, 1999.
(u) The Company incurred unsecured debt in the principal amount of $3.8 million on November 14, 1996 in connection with its acquisition of a property portfolio. The debt does not bear interest and is payable in two installments: the first installment of $2.5 million was paid on June 30, 1998; the second installment of $1.3 million is payable on December 31, 1999. The Company recorded a $548,000 adjustment to the purchase price and a corresponding reduction in debt to reflect the fair value of the note payable to the seller and will accrue interest expense to the date of maturity.
(v) The Company incurred unsecured debt in the principal amount of $1.3 million on May 8, 1998 in connection with its acquisition of a property portfolio. The debt is payable in full on June 30, 2001. The Company recorded a $255,000 adjustment to the purchase price and a corresponding reduction in debt to reflect the fair value of the note payable to the seller and will accrue interest expense to the date of maturity.
Guaranty. As of March 15, 1999, the Company had guaranteed repayment of an $18.7 million construction loan made to a Real Estate Venture (a portion of which guaranty was in the form of a commitment by the Company to contribute approximately $6.4 million in equity to the Real Estate Venture).
Management Company
The Company conducts its real estate management services business through the Management Company. The Company manages, through the Management Company, certain of the Properties and additional properties on behalf of unaffiliated third parties. As of December 31, 1998, the Management Company was managing properties containing an aggregate of approximately 17.1 million net rentable square feet, of which approximately 16.9 million net rentable square feet related to Properties then owned by the Company or subject to purchase options held by the Company, and approximately 258,695 net rentable square feet related to properties owned by unaffiliated third parties. Through its indirect ownership of 100% of the preferred stock and 5% of the common stock of the Management Company, the Operating Partnership is entitled to receive 95% of amounts paid as dividends by the Management Company. Because certain executive officers of the Company indirectly own 95% of the voting common stock of the Management Company, the Company does not control the timing or amount of distributions by, or the management and operations of, the Management Company. The Management Company has made no distributions to any executive officers of the Company since its inception.
Industry Segments
The Company operates in one industry segment. The Company does not have any foreign operations and its business is not seasonal.
Competition
The leasing of real estate is highly competitive. The Properties compete for tenants with similar properties located in its markets primarily on the basis of location, rent charged, services provided, and the design and condition of the improvements. The Company also faces competition when attempting to acquire real estate, including competition from domestic and foreign financial institutions, other REIT's, life insurance companies, pension trusts, trust funds, partnerships and individual investors.
Employees
As of December 31, 1998, the Company employed 198 persons, including executive officers.
Risk Factors
An investment in the Company involves various risks. Our actual results may differ significantly from those expressed or implied by forward-looking statements made by us or on our behalf. These statements are identified by words such as "expect," "anticipate," "should," "pro forma" and words of similar import. Factors that might cause such a difference include the various risks stated below that we believe are material to investors who purchase or own our securities. Prospective investors should carefully consider the following risk factors together with the other reports and documents we file with the Securities and Exchange Commission, which may include additional or more current relevant information.
o There can be no assurance that we will effectively manage our rapid growth
We have been growing rapidly. Since August 1, 1996, we have acquired or developed 268 of the 272 Properties owned by us on December 31, 1998. We have managed this growth by applying our experience to newly acquired properties and we expect continued success in that effort. No assurances can be given, however, that we will succeed in our integration efforts or that newly acquired properties will perform as we expect.
o We depend on the performance of our primary markets, and changes in such markets may adversely affect our financial condition
Most of our Properties are currently located in suburban markets in Pennsylvania, New Jersey, New York, Virginia and Delaware. Like other real estate markets, these commercial real estate markets have experienced economic downturns in the past, and future declines in any of these real estate markets could adversely affect our operations or cash flow and ability to make distributions to shareholders. Our financial performance will be particularly sensitive to the economic conditions in these markets. Our revenues and the value of our Properties may be adversely affected by a number of factors, including the economic climate in these markets (which may be adversely impacted by business layoffs, industry slowdowns, changing demographics and other factors) and real estate conditions in these markets (such as oversupply of or reduced demand for office and industrial properties). These factors, when and if they occur in the area in which our Properties are located, would adversely affect our cash flow and ability to make distributions to shareholders.
o Our ability to make distributions is subject to various risks
We pay regular distributions to our shareholders. Our ability to make distributions in the future will depend upon:
o the performance of our Properties;
o expenditures with respect to existing and newly acquired properties;
o the amount of, and the interest rates on, our debt;
o the absence of significant expenditures relating to environmental and other regulatory matters; and
o future sales of securities.
Certain of these matters are beyond our control and any significant difference between our expectations and actual results could have a material adverse effect on our cash flow and our ability to make or sustain distributions to shareholders.
o We may be unable to renew leases or relet space as leases expire
If our tenants fail to renew their leases upon expiration, we may be unable to relet the subject space. Even if the tenants do renew their leases or we can relet the space, the terms of renewal or reletting (including the cost of required renovations) may be less favorable than current lease terms. Certain leases grant the tenants an early termination right upon payment of a termination penalty. While we have estimated the necessary expenditures for new and renewal leases for 1999 and 2000, no assurances can be given as to the accuracy of such estimates.
o Financially distressed tenants may limit our ability to realize the value of our investments
Following a tenant's lease default, we may experience delays in enforcing our rights as a landlord and may incur substantial costs in protecting our investment. In addition, a tenant may seek bankruptcy law protection which could relieve the tenant from its obligation to make lease payments.
o We face significant competition from other real estate developers
We compete with a number of real estate developers, operators and institutions for tenants and acquisition opportunities. Some of these competitors have significantly greater resources than we do. No assurances can be given that this competition will not adversely affect our cash flow and ability to make distributions to shareholders.
o Because real estate is illiquid, we may not be able to sell properties when appropriate
Real estate investments generally cannot be sold quickly. We may not be able to vary our portfolio promptly in response to economic or other conditions. In addition, the Internal Revenue Code of 1986 (the "Code") limits our ability to sell properties held for fewer than four years. Purchase options and rights of first refusal held by certain tenants may also limit our ability to sell certain properties. Any of these factors could adversely affect our cash flow and ability to make distributions to shareholders as well as the ability of someone to purchase us, even if a purchase were in our shareholders' best interests.
o We have agreed not to sell certain of our properties
We have agreed with the sellers of certain of our properties not to sell certain properties for varying periods of time in any transaction that would trigger taxable income, subject to certain exceptions. Some of these agreements are with current trustees of our company. In addition, we may enter into similar agreements with future sellers of properties. These agreements generally provide that we may dispose of the applicable properties in transactions that qualify as tax-free exchanges under Section 1031 of the Code. Therefore, without suffering adverse tax consequences, we may be precluded from selling certain properties other than in transactions that would qualify as tax-free exchanges for federal income tax purposes.
o Changes in the law may adversely affect our cash flow
Because increases in income and service taxes are generally not passed through to tenants under leases, such increases may adversely affect our cash flow and ability to make expected distributions to shareholders. The Properties are also subject to various regulatory requirements, such as those relating to fire and safety. Our failure to comply with these requirements could result in the imposition of fines and damage awards. While we believe that the Properties are currently in material compliance with all such requirements, there can be no assurance that these requirements will not change or that newly imposed requirements will not require significant unanticipated expenditures.
o By holding properties through the Operating Partnership and various joint ventures, we are exposed to certain additional risks
We own our Properties and our interests in our real estate ventures through the Operating Partnership. In the future, we expect to continue to participate with other entities in property ownership through joint ventures or partnerships. Partnership or joint venture investments may, under certain circumstances, involve risks not otherwise present in direct investments. Such risks include:
o the potential bankruptcy of our partners or co-venturers;
o a conflict between our business goals and those of our partners or co-venturers; and
o actions taken by our partners or co-venturers contrary to our instructions or objectives, including our policy of maintaining the Company's REIT qualification.
We will, however, seek to maintain sufficient control of such partnerships and joint ventures to enable us to achieve our business objectives. Investors should be aware that there is no limitation under our organizational documents as to the amount of funds which we may invest in partnerships or joint ventures.
o Future acquisitions may fail to perform in accordance with our expectations and may require development and renovation costs exceeding our estimates
We intend to continue operating as a full service, integrated real estate company. These efforts may, under appropriate circumstances, result in the Company acquiring office and industrial properties. Changing market conditions, however, including competition from others, may diminish our opportunities for making attractive acquisitions. Once made, our investments may fail to perform in accordance with our expectations. The estimated renovation and improvement costs incurred in bringing an acquired property up to market standards may exceed our estimates. We anticipate financing future acquisitions and renovations through a combination of advances under lines of credit and other forms of secured or unsecured financing. If new developments are financed through construction loans, there is a risk that, upon completion of construction, permanent financing for newly developed properties may not be available or may be available only on disadvantageous terms.
In addition, we periodically develop, redevelop and construct office buildings and other commercial properties. Risks associated with these development, redevelopment and construction activities include:
o the unavailability of favorable financing;
o the abandonment of such activities prior to completion;
o construction costs exceeding original estimates;
o construction and lease-up delays resulting in increased debt service and construction costs; and
o insufficient occupancy rates and rents at a newly completed property causing a property to be unprofitable.
o Our indebtedness subjects us to additional risks
Debt Financing and Existing Debt Maturities. We are subject to risks normally associated with debt financing, such as the insufficiency of cash flow to meet required payment obligations and the inability to refinance existing indebtedness. If our debt cannot be paid, refinanced or extended at maturity, in addition to our failure to repay our debt, we may not be able to make distributions to shareholders at expected levels or at all. Furthermore, if any refinancing is done at higher interest rates, the increased interest expense could adversely affect our cash flow and ability to make distributions to shareholders. If we do not meet our mortgage financing obligations, any properties securing such indebtedness could be foreclosed on, which would have a material adverse effect on our cash flow and ability to make distributions and, depending on the number of properties foreclosed on, could threaten our continued viability.
Risk of Rising Interest Rates and Variable Rate Debt. Increases in interest rates on variable rate indebtedness would increase our interest expense, which could adversely affect our cash flow and ability to make distributions to shareholders.
No Limitation on Debt. Our organizational documents do not contain any limitation on the Company's debt-to-total market capitalization ratio. Accordingly, we could increase our leverage without restriction. The increased debt service could adversely affect our cash flow and ability to make distributions and could increase the risk of default on our indebtedness.
o Our status as a REIT is dependent on compliance with federal income tax requirements
Our failure to qualify as a REIT would have serious adverse consequences to our shareholders. We believe that since 1986, we have qualified for taxation as a REIT for federal income tax purposes. We plan to continue to meet the requirements for taxation as a REIT. Many of these requirements, however, are highly technical and complex. The determination that we are a REIT requires an analysis of various factual matters and circumstances that may not be totally within our control. For example, to qualify as a REIT, at least 95% of our gross income must come from certain sources that are itemized in the REIT tax laws. We are also required to distribute to shareholders at least 95% of our REIT taxable income (excluding capital gains). The fact that we hold our assets through the Operating Partnership and its subsidiaries further complicates the application of the REIT requirements. Even a technical or inadvertent mistake could jeopardize our REIT status. Furthermore, Congress and the IRS might change the tax laws and regulations, and the courts might issue new rulings that make it more difficult, or impossible, for the Company to remain qualified as a REIT. We do not believe, however, that any pending or proposed tax law changes would jeopardize our REIT status.
To maintain REIT status, a REIT may not own more than 10% of the voting stock of any corporation, except for a qualified REIT subsidiary (which must be wholly-owned by the REIT) or another REIT. In order to comply with this rule, the Operating Partnership owns 5% of the voting common stock and all of the non-voting preferred stock of the Management Company. The Internal Revenue Service ("IRS"), however, could contend that the Operating Partnership's ownership of all of the non-voting preferred stock of the Management Company should be viewed as voting stock because of the Operating Partnership's substantial economic position in the Management Company. If successful in such a contention, the Company's status as a REIT would be lost and the Company would be subject to the consequences summarized below.
Arthur Andersen LLP, special tax advisor to the Company, has given us an opinion to the effect that, beginning with our taxable year ended December 31, 1986, we have been organized and have operated in conformity with the requirements for qualification and taxation as a REIT under the Code for each of our taxable years and that our current method of organization and operation will enable us to continue to so qualify. The opinion of Arthur Andersen LLP is based on assumptions and factual representations made by us regarding our ability to meet the requirements for qualification as a REIT. Such opinion is not binding on the IRS or any court. Moreover, Arthur Andersen LLP does not review or monitor our compliance with the requirements for REIT qualification on an ongoing basis. We cannot guarantee that we will be qualified and taxed as a REIT, because our qualification and taxation as a REIT will depend upon our ability to meet, on an ongoing basis, the requirements imposed under the Code.
If we fail to qualify as a REIT, we would be subject to federal income tax at regular corporate rates. Also, unless the IRS granted us relief under certain statutory provisions, we would remain disqualified as a REIT for four years following the year we first failed to qualify. If we failed to qualify as a REIT, we would have to pay significant income taxes and would therefore have less money available for investments or for distributions to shareholders. This would likely have a significant adverse affect of the value of our securities. In addition, we would no longer be required to make any distributions to shareholders.
In order to make the distributions required to maintain our REIT status, we may need to borrow funds. To obtain the favorable tax treatment associated with REIT qualification, we generally will be required to distribute to shareholders at least 95% of our annual REIT taxable income (excluding net capital gain). In addition, we will be subject to tax on our undistributed net taxable income and net capital gain and a 4% nondeductible excise tax on the amount, if any, by which certain distributions paid by us with respect to any calendar year are less than the sum of 85% of our ordinary income plus 95% of our capital gain net income for the calendar year, plus certain undistributed amounts from prior years.
We intend to make distributions to shareholders to comply with the distribution provisions of the Code and to avoid income and other taxes. Our income will consist primarily of our share of the income of the Operating Partnership and our cash flow will consist primarily of our share of distributions from the Operating Partnership. Differences in timing between the receipt of income and the payment of expenses in arriving at taxable income (of the Company or the Operating Partnership) and the effect of required debt amortization payments could require us to borrow funds on a short-term basis or liquidate funds on adverse terms to meet the REIT qualification distribution requirements.
The failure of the Operating Partnership (or a subsidiary partnership) to be treated as a partnership would have serious adverse consequences to our shareholders. If the IRS were to successfully challenge the tax status of the Operating Partnership or any of its subsidiary partnerships for federal income tax purposes, the Operating Partnership or the affected subsidiary partnership would be taxable as a corporation. In such event, we would cease to qualify as a REIT and the imposition of a corporate tax on the Operating Partnership or a subsidiary partnership would reduce the amount of cash available for distribution from such partnership to us and our shareholders.
We do pay some taxes. Even if we qualify as a REIT, we are required to pay certain federal, state and local taxes on our income and property. In addition, the Management Company is subject to federal, state and local income tax at regular corporate rates on its net taxable income derived from its management, leasing and related service business. If we have net income from a prohibited transaction, such income will be subject to a 100% tax.
We own a subsidiary REIT. One of our subsidiaries, Atlantic American Properties Trust ("AAPT"), that indirectly holds approximately 35 of the Properties, elected to be taxed as a REIT for the year ended December 31, 1997. So long as we seek to maintain AAPT's REIT status, AAPT will be subject to all the requirements and risks associated with maintaining REIT status summarized above, including the limitation on the ownership of more than 10% of the voting securities of any corporation (other than a qualified REIT subsidiary or another REIT). AAPT indirectly owns non-voting common stock issued by a corporation which is neither a qualified REIT subsidiary nor a REIT.
o Environmental problems are possible and may be costly
Federal, state and local laws, ordinances and regulations may require a current or previous owner or operator of real estate to investigate and clean up hazardous or toxic substances or releases at such property. The owner or operator may be forced to pay for property damage and for investigation and clean-up costs incurred by others in connection with environmental contamination. Such laws typically impose clean-up responsibility and liability without regard to whether the owner or operator knew of or caused the presence of the contaminants. Even if more than one person may have been responsible for the contamination, each person covered by the environmental laws may be held responsible for all of the clean-up costs incurred. In addition, third parties may sue the owner or operator of a site for damages and costs resulting from environmental contamination emanating from that site. These costs may be substantial and the presence of such substances may adversely affect the owner's ability to sell or rent such property or to borrow using such property as collateral.
Independent environmental consultants have conducted a standard Phase I or similar general environmental site assessment ("ESA") of each of our Properties to identify potential sources of environmental contamination and assess environmental regulatory compliance. For a number of the Properties, the Phase I ESA either referenced a prior Phase II ESA obtained on such Property or prompted us to have a Phase II ESA of such Property conducted. A Phase II ESA generally involves invasive procedures, such as soil sampling and testing or the installation and monitoring of groundwater wells. While the ESAs conducted have identified environmental contamination on a few of the Properties, they have not revealed any environmental contamination, liability or compliance concern that we believe would have a material adverse effect on our cash flow or ability to make distributions to shareholders.
It is possible that the existing ESAs relating to the Properties do not reveal all environmental contaminations, liabilities or compliance concerns which currently exist. In addition, future properties which we acquire may be subject to environmental conditions.
o Some potential losses are not covered by insurance
We carry comprehensive liability, fire, extended coverage and rental loss insurance on all of our Properties. We believe the policy specifications and insured limits of these policies are adequate and appropriate. There are, however, certain types of losses, such as lease and other contract claims that generally are not insured. Should an uninsured loss or a loss in excess of insured limits occur, we could lose all or a portion of the capital we have invested in a property, as well as the anticipated future revenue from the property. In such an event, we might nevertheless remain obligated for any mortgage debt or other financial obligations related to the property.
o We do not control the Management Company
While we own substantially all (95%) of the economic interest in the Management Company, to maintain our REIT qualification, certain of the executive officers of the Company indirectly hold 95% of the voting common stock of the Management Company. Therefore, we do not control the timing or amount of distributions by, or the management and operation of, the Management Company. As a result, decisions relating to the payment of distributions by, and the business policies and operations of, the Management Company could be adverse to our interests.
o We are dependent upon our key personnel
We are dependent upon the efforts of our executive officers, particularly Anthony A. Nichols, Sr. and Gerard H. Sweeney. The loss of their services could have an adverse affect on our operations. Although we have employment agreements with Messrs. Nichols and Sweeney, such agreements do not restrict their ability to become employed by a competitor following the termination of their employment with us.
o Certain limitations exist with respect to a third party's ability to acquire us or effectuate a change in control
Limitations imposed to protect our REIT status. In order to protect us against loss of our REIT status, our Declaration of Trust limits any shareholder from owning more than 9.8% in value of our outstanding shares, subject to certain exceptions. If you or anyone else acquires shares in excess of the ownership limit, we may:
o consider the transfer to be null and void;
o not reflect the transaction on our books;
o institute legal action to stop the transaction;
o not pay dividends or other distributions with respect to those shares;
o not recognize any voting rights for those shares; and
o consider the shares held in trust for the benefit of a person to whom such shares may be transferred.
Limitation due to our ability to issue preferred shares. Our Declaration of Trust authorizes the Board of Trustees to issue preferred shares. The Board of Trustees may establish the preferences and rights
of any preferred shares issued which could have the effect of delaying or preventing someone from taking control of us, even if a change in control were in our shareholders' best interests.
Limitations imposed by the Business Combination Law. The Maryland General Corporation Law (the "MGCL"), as applicable to Maryland real estate investment trusts, establishes special restrictions against "business combinations" between a Maryland real estate investment trust and "interested shareholders" or their affiliates unless an exemption is applicable. An interested shareholder includes a person who beneficially owns, and an affiliate or associate of the trust who, at any time within the two-year period prior to the date in question, was the beneficial owner of, ten percent or more of the voting power of our then-outstanding voting shares. Among other things, the law prohibits (for a period of five years) a merger and certain other transactions between the trust and an interested shareholder unless the board of trustees approved the transaction before the party became an interested shareholder. The five-year period runs from the most recent date on which the interested shareholder became an interested shareholder. Thereafter, any such business combination must be recommended by the board of trustees and approved by two super-majority shareholder votes unless, among other conditions, the trust's common shareholders receive a minimum price for their shares and the consideration is received in cash or in the same form as previously paid by the interested shareholder for its shares or unless the board of trustees approved the transaction before the party in question became an interested shareholder. The business combination statute could have the effect of discouraging offers to acquire us and of increasing the difficulty of consummating any such offers, even if our acquisition would be in our shareholders' best interests.
We have exempted any business combination involving Safeguard Scientific, Inc. ("SSI"), The Nichols Company ("TNC"), the Commonwealth of Pennsylvania State Employees' Retirement System ("SERS") and a voting trust established for its benefit (the "SERS Voting Trust"), Morgan Stanley Asset Management Inc. and two funds (the "Morgan Stanley Funds") managed by it, Lazard Freres Real Estate Investors, L.L.C. ("Lazard"), Gerard H. Sweeney (the Company's President and Chief Executive Officer) and any of their respective affiliates or associates.
Limitations imposed by the Maryland Control Share Statute. The Maryland General Corporation Law provides that "control shares" of a Maryland real estate investment trust acquired in a "control share acquisition" have no voting rights except to the extent approved by a vote of two-thirds of the votes entitled to be cast on the matter, excluding shares of beneficial interest owned by the acquiror, by officers or by trustees who are employees of the trust. If voting rights are not approved at a meeting of shareholders or if the acquiring person does not deliver an acquiring person statement as required by the statute, then, subject to certain conditions and limitations, the trust may redeem any or all of the control shares (except those for which voting rights have previously been approved) for fair value. If voting rights for control shares are approved at a shareholders meeting and the acquiror becomes entitled to vote a majority of the shares entitled to vote, all other shareholders may exercise appraisal rights. The control share statute could have the effect of discouraging offers to acquire us and of increasing the difficulty of consummating any such offers, even if our acquisition would be in our shareholders' best interests.
We have exempted acquisitions by SSI, TNC, SERS, the SERS Voting Trust, Morgan Stanley Asset Management Inc., the Morgan Stanley Funds and any current or future affiliates or associates of theirs from the control shares statute. As a result, these entities will be able to possess voting power not generally available to other persons.
o The issuance of preferred shares may adversely affect the rights of holders of Common Shares
Because the Board of Trustees has the power to establish the preferences and rights of each class or series of preferred shares, it may afford the holders in any series or class of preferred shares preferences, distributions, powers and rights, voting or otherwise, senior to the rights of holders of Common Shares.
Item 2.
Item 2. Properties
Properties
As of December 31, 1998, the Company owned a portfolio of 201 office properties, 70 industrial facilities and one mixed-use property that contained an aggregate of approximately 18.8 million net rentable square feet. As of December 31, 1998, 183 of the Properties (approximately 62.8% of the Company's portfolio based on net rentable square feet) were located in the Suburban Philadelphia Office and Industrial Market. As of December 31, 1998, the Properties (excluding two Properties under development or redevelopment) were approximately 93.6% leased to 1,357 tenants. The office Properties are primarily one to three story suburban office buildings containing an average of approximately 72,000 net rentable square feet. The industrial Properties accommodate a variety of tenant uses including light manufacturing, assembly, distribution and warehousing. The Company carries comprehensive liability, fire, extended coverage and rental loss insurance covering all of the Properties, with policy specifications and insured limits which the Company believes are adequate.
The following table sets forth certain information with respect to the Properties at December 31, 1998:
(RESTUBBED TABLE)
(RESTUBBED TABLE)
(RESTUBBED TABLE)
(RESTUBBED TABLE)
(a) Calculated by dividing net rentable square feet included in leases signed on or before December 31, 1998 at the property by the aggregate net rentable square feet of the Property.
(b) "Total Base Rent" for the twelve months ended December 31, 1998 represents base rents received during such period, excluding tenant reimbursements, calculated in accordance with generally accepted accounting principles (GAAP) determined on a straight-line basis. Tenant reimbursements generally include payment of real estate taxes, operating expenses and common area maintenance and utility charges.
(c) "Average Annualized Rental Rate" is calculated as follows: (i) for office leases written on a triple net basis, the sum of the annualized contracted base rental rates payable for all space leased as of December 31, 1998 (without giving effect to free rent or scheduled rent increases that would be taken into account under GAAP) plus the 1998 budgeted operating expenses excluding tenant electricity; and (ii) for office leases written on a full service basis, the annualized contracted base rent payable for all space leased as of December 31, 1998. In both cases the annualized rental rate is divided by the total square footage leased as of December 31, 1998 without giving effect to free rent or scheduled rent increases that would be taken into account under GAAP.
(d) The data reflected for these properties are presented on a consolidated basis.
(e) The net rentable square feet for these properties is presented on a consolidated basis.
(f) These properties are under redevelopment and are excluded from the percentages for Weighted Average Percentage Leased and Average Annualized Rental Rate information.
(g) This property is subject to a ground lease.
The table set forth below shows certain information regarding rental rates and lease expirations for the Properties at December 31, 1998, assuming none of the tenants exercises renewal options or termination rights, if any, at or prior to scheduled expirations:
(a) "Final Annualized Base Rent" for each lease scheduled to expire represents the cash rental rate of base rents, excluding tenant reimbursements, in the final month prior to expiration multiplied by 12. Tenant reimbursements generally include payment of real estate taxes, operating expenses and common area maintenance and utility charges.
At December 31, 1998, the Properties were leased to 1,357 tenants that are engaged in a variety of businesses. The following table sets forth information regarding leases at the Properties with the 20 largest tenants based upon Annualized Escalated Rent from the Properties as of December 31, 1998:
(a) The identified tenant includes affiliates in certain circumstances.
(b) Annualized Escalated Rent represents the monthly Escalated Rent for each lease in effect at December 31, 1998 multiplied by 12. Escalated Rent represents fixed base rental amounts plus pass-throughs of operating expenses, including electricity costs. The Company estimates operating expenses pass-throughs based on historical amounts and comparable market data.
(c) Consists of three leases: a lease representing 222,987 net rentable square feet that expires in September 2009, a lease representing 117,428 net rentable square feet that expires in August 2008 and a lease representing 43,201 net rentable square feet that expires in September 2002.
(d) Consists of twenty six leases: twenty three leases representing 274,531 net rentable square feet that expire in January 2012, two leases representing 53,894 net rentable square feet that expire in June 2010 and a lease representing 19,708 net rentable square feet that expires in September 2002.
(e) Consists of nine leases: three leases representing 49,593 net rentable square feet that expire in July 2000, a lease representing 172,448 net rentable square feet that expires in April 2001, a lease representing 74,728 net rentable square feet that expires in July 2006, a lease representing 17,179 net rentable square feet that expires in October 1999, two leases representing 80,000 net rentable square feet that expire in November 2003 and a roof lease that expires in February 2001.
(f) Consists of four leases: a lease representing 132,000 net rentable square feet that expires in September 2001, a lease representing 61,102 net rentable square feet that expires in September 2003, a lease representing 208,774 net rentable square feet that expires in December 2007 and a lease representing 991 net rentable square feet that expires in June 1999.
(g) Consists of eight leases: a lease representing 158,000 net rentable square feet that expires in September 2002, a lease representing 112,905 net rentable square feet that expired in January 1999, a lease representing 30,280 net rentable square feet that expires in May 1999, a lease representing 14,750 net rentable square feet that expires in January 2001, a lease representing 13,956 net rentable square feet that expires in October 2004, a lease representing 12,498 net rentable square feet that expires in June 2002, a lease representing 16,041 net rentable square feet that expires in May 2000 and a lease representing 31,078 net rentable square feet that expires in April 2002.
(h) Consists of eight leases: a lease representing 47,067 net rentable square feet that expires in February 2002, a lease representing 59,844 net rentable square feet that expired in January 1999, three leases that represent 47,988 net rentable square feet that expire in December 2001, a lease representing 71,312 net rentable square feet that expires in January 2004 and two leases representing 47,799 net rentable square feet that expired in February 1999.
(i) Consists of twenty two leases: twenty one leases that represent 238,028 net rentable square feet in the aggregate that expire in January 2010 and a lease representing 6,052 net rentable square feet that expired in January 1999.
(j) Consists of five leases: a lease representing 17,110 net rentable square feet that expires in March 2001, two leases representing 5,692 net rentable square feet in the aggregate that expire in October 1999, and two leases representing 145,009 net rentable square feet in the aggregate that expire in August 1999.
(k) Consists of four leases: a lease that represents 67,481 net rentable square feet that expires in December 2004, two leases that represent 76,480 net rentable square feet that expire in December 2007 and a lease that represents 15,000 net rentable square feet that expires in May 1999.
(l) Consists of two leases: a lease representing 109,800 net rentable square feet that expires in December 2005 and a lease representing 35,968 net rentable square feet that expires in June 2003.
(m) Consists of four leases: a lease representing 47,176 net rentable square feet that expires in May 2002, a lease representing 36,830 net rentable square feet that expires in November 2001, a lease representing 15,000 net rentable square feet that expires in October 2000 and a lease representing 12,727 net rentable square feet that expires in August 2003.
(n) Consists of three leases: two leases that represent 95,361 net rentable square feet that expire in October 2002 and a lease that represents 15,375 net rentable square feet that expires in December 2003.
(o) Consists of two leases: a lease representing 69,511 net rentable square feet that expires in June 2000 and a lease representing 8,699 net rentable square feet that expires in September 2001.
(p) Consists of six leases: two leases representing 68,841 net rentable square feet that expire in October 2002, two leases representing 4,907 net rentable square feet that expire in January 2003, a lease that represents 3,848 net rentable square feet that expires in June 2002, and a lease that represents 6,383 net rentable square feet that expires in February 2000.
Real Estate Ventures
Since January 1, 1997, the Company, through the Operating Partnership and subsidiaries wholly-owned by the Operating Partnership, has entered into nine Real Estate Ventures.
On September 19, 1997, the Company acquired a 50% interest in a newly-formed limited liability company that developed a three-story office property in Newark, Delaware containing approximately 150,000 net rentable square feet. Development of this property was completed in May 1998 and Computer Sciences, Corporation has leased the entire facility through May 31, 2007. The Company's equity contribution to this company was approximately $2.0 million. Total project costs were approximately $17.0 million. Project costs have been financed primarily through a $13.1 million institutional loan.
On September 19, 1997, the Company also acquired a 50% membership interest in a newly-formed limited liability company that acquired two parcels of undeveloped land containing an aggregate of approximately 11 acres in Newark, Delaware for a purchase price of approximately $1.0 million in anticipation of the construction on such land of two office buildings. The Company's initial equity contribution to this company was $1.0 million. Architectural plans for the development of the land have not been completed and development of the land is subject to receipt of a construction loan as well as certain land development and other necessary approvals.
On November 4, 1997, the Company acquired a 65% general partner interest in a newly-formed limited partnership that completed development of an approximately 86,000 net rentable square foot, four-story office building in West Conshohocken, Pennsylvania during the fourth quarter of 1998. Total project costs were approximately $17.0 million. The Company's equity contribution to this partnership was approximately of $5.8 million. Project costs have been financed primarily through an $11.0 million institutional loan.
On November 4, 1997, the Company also acquired a 65% general partner interest in a newly-formed limited partnership that holds an option to purchase approximately 9.3 acres of undeveloped land in West Conshohocken, Pennsylvania for approximately $3.2 million. The Company believes this land can accommodate an office building containing approximately 210,000 net rentable square feet. The term of
the option expires on November 2, 1999. The Company's equity contributions to this partnership through December 31, 1998 were approximately $1.3 million, $348,000 of which was used by the limited partnership to acquire the above referenced option.
As part of the November 4, 1997 transactions, the Company also acquired the right to become a 35% general partner in an existing limited partnership that owns a four-story office property containing approximately 83,000 net rentable square feet in Conshohocken, Pennsylvania. On May 11, 1998, the Company acquired such 35% interest for approximately $2.7 million. As of December 31, 1998, this property was fully leased to five tenants.
On December 31, 1997, the Company acquired a 50% general partner interest in a newly-formed general partnership that was established to own and operate a project involving the redevelopment of a building situated on approximately five acres in Delaware County, Pennsylvania. Redevelopment of the office building was completed in the first quarter of 1999 for a total cost of approximately $4.8 million. The Company's equity contribution to this partnership was approximately $2.6 million. Project costs have been financed primarily through a $6.0 million institutional loan.
On February 3, 1998, the Company acquired an approximately 60% economic interest in a partnership that owns approximately 12.5 acres of land in Plymouth Meeting, Pennsylvania. The Company believes the land (on which an inn is currently situated) can accommodate an office building containing approximately 210,000 net rentable square feet. The Company acquired its interest through a loan and equity contribution aggregating approximately $4.2 million. Architectural plans for the development of the land have been substantially completed and development of the land is subject to receipt of a construction loan, as well as certain land development and other necessary approvals.
On February 25, 1998, the Company acquired a 50% general partner interest in a newly-formed general partnership that was established to develop a three-story office property containing approximately 180,000 net rentable square feet in Chester County, Pennsylvania. Total project costs are estimated to be approximately $37.0 million. The Company has agreed to contribute approximately $5.4 million to the partnership upon receipt of a construction loan. Architectural plans for the development of the land have been substantially completed and final land development approval has been received. Development of the land is subject to receipt of a construction loan.
On November 30, 1998, the Company acquired a 65% general partnership interest in a newly-formed limited partnership that intends to develop a four-story office property in Conshohocken, Pennsylvania. The Company expects this property to contain approximately 112,000 net rentable square feet upon completion. The Company has committed to make an equity investment of $6.4 million to the partnership. Total project costs, which the partnership is financing through a construction loan, are estimated to be approximately $18.7 million, with construction scheduled to be completed during the first quarter of 2000. The Company has guaranteed repayment of that portion of the construction loan in excess of its equity commitment.
Item 3.
Item 3. Legal Proceedings
The Company is involved from time to time in litigation on various matters, which include disputes with tenants and disputes arising out of agreements to purchase properties. Given the nature of the Company's business activities, these lawsuits are considered routine to the conduct of its business. The result of any particular lawsuit cannot be predicted, because of the very nature of litigation, the litigation process and its adversarial nature, and the jury system.
As of the date of this filing, the Company is a defendant in case in which the plaintiffs allege that the Company breached its obligation to purchase a portfolio of properties for approximately $83.0 million. The plaintiffs' allegations assert claims for reformation, breach of contract, breach of duty of good faith
and fair dealing, fraud, violation of the New Jersey Consumer Fraud Statute and unjust enrichment. The Company intends to oppose the litigation vigorously. The Company believes that plaintiff failed to satisfy the conditions precedent to the Company's obligation to close under the agreement and has moved to dismiss all of the plaintiff's claims. As of the date of this filing, the court has not ruled on the Company's motion to dismiss plaintiffs' claims, and discovery has not commenced.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
The Company did not submit any matters to a vote of security holders in the fourth quarter of the fiscal year ended December 31, 1998.
PART II
Item 5.
Item 5. Market for Registrant's Common Equity and Related Shareholder Matters
The Common Shares commenced trading on the NYSE under the symbol "BDN" on October 21, 1997. Prior to October 21, 1997, the Common Shares were traded on the American Stock Exchange ("AMEX"). On March 23, 1999, there were approximately 317 holders of record of the Common Shares. On March 23, 1999, the last reported sale price of the Common Shares on the NYSE was $16 5/8. The following table sets forth the quarterly high and low closing sale price per share reported on the AMEX for the indicated periods through October 20, 1997 and on the NYSE for the indicated periods subsequent to October 20, 1997 and the distributions paid by the Company with respect to each such period.
Share Price Share Price Distributions High Low Declared For Quarter ---- --- --------------------
First Quarter 1997 $22 $19 3/8 $0.35 Second Quarter 1997 $20 3/4 $18 3/8 $0.36 Third Quarter 1997 $23 15/16 $20 1/4 $0.36 Fourth Quarter 1997 $25 1/8 $22 7/8 $0.37
First Quarter 1998 $26 3/8 $23 1/16 $0.37 Second Quarter 1998 $24 5/16 $21 1/16 $0.38 Third Quarter 1998 $23 1/8 $16 1/4 $0.38 Fourth Quarter 1998 $19 $16 1/4 $0.39
Future distributions by the Company will be at the discretion of the Board of Trustees and will depend on the actual cash flow of the Company, its financial condition, capital requirements, the annual distribution requirements under the REIT provisions of the Internal Revenue Code of 1986 and such other factors as the Board of Trustees deems relevant.
Summarized below is information regarding the sale by the Company of securities during 1998 and through the date of this Annual Report on Form 10-K that were not registered under the Securities Act of 1933.
During 1998, the Company issued an aggregate of 303,821 Common Shares upon the redemption of 303,821 Class A Units: January 1, 1998 (252,387 Common Shares); June 22, 1998 (50,000 Common Shares); and June 30, 1998 (1,434 Common Shares). The redemptions were effected by the Company in accordance with the Amended and Restated Agreement of Limited Partnership of the Operating Partnership, as amended (the "Partnership Agreement"), and no cash proceeds were received by the Company in connection with such redemptions.
On May 20, 1998, the Company issued an aggregate of 1,248 Common Shares to three members of the Company's Board of Trustees in payment of one-half of the annual trustee fee payable to non-employee Trustees of the Company.
On September 28, 1998, the Company issued 750,000 shares of the Company's 7.25% Series A Cumulative Convertible Preferred Shares of Beneficial Interest ("Series A Preferred Shares"), which are currently convertible into 1,339,285 Common Shares, as part of the acquisition price for the Lazard Portfolio.
As partial consideration for the purchase price of certain property acquisitions on the following dates during 1998, the Operating Partnership issued an aggregate of 1,754,763 Class A Units which are exchangeable for an equal number of Common Shares: March 31, 1998 (153,036 Class A Units); May 8, 1998 (390,364 Class A Units); October 6, 1998 (1,127,895 Class A Units); and December 31, 1998 (83,468 Class A Units).
On September 28, 1998, the Operating Partnership issued an aggregate of 1,550,000 Series B Preferred Units which after September 27, 1999 will be convertible into 2,767,857 Common Shares as part of the acquisition for the Lazard Portfolio.
If the market price of the Common Shares does not exceed $23.00 during the 60-day trading day period ending on December 31, 2002, then the Series A Preferred Shares and Series B Preferred Units, if not previously converted, will become convertible into an aggregate of 1,415,094 and 2,924,528 Common Shares, respectively.
No underwriter was involved in connection with the foregoing securities issuances, which were exempt from registration pursuant to Section 4(2) of the Securities Act of 1933, as transactions not involving public offerings.
Item 6.
Item 6. Selected Financial Data
(in thousands, except per Common Share data and number of properties)
Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
The following discussion should be read in conjunction with the financial statements appearing elsewhere herein. The results of operations, liquidity and capital resources and cash flows of the Company include the historical results of operations of the Properties held by the Company during the years ended December 31, 1998, 1997 and 1996. This Annual Report on Form 10-K contains forward-looking statements for purposes of the Securities Act of 1933 and the Securities Exchange Act of 1934 and as such may involve known and unknown risks, uncertainties and other factors that may cause the actual results, performance or achievements of the Company to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements. Although the Company believes that the expectations reflected in such forward-looking statements are based upon reasonable assumptions, there can be no assurance that these expectations will be realized.
OVERVIEW
The Company believes it has established an effective platform in the Suburban Philadelphia, Pennsylvania market that provides a foundation for achieving the Company's goal of maximizing market penetration and operating economies of scale. The Company believes this platform provides a basis to continue its penetration into additional targeted markets in the Mid-Atlantic United States through strategic transactions structured to increase cash available for distribution and maximize shareholder value.
The Company continued its growth in 1998 by purchasing 153 office, industrial and mixed-use properties containing approximately 11.6 million net rentable square feet for an aggregate purchase price of approximately $1.3 billion. The 1998 acquisitions expanded the Company's market share in the Suburban Philadelphia Office and Industrial Market and expanded the Company's market presence into several other markets within the Mid-Atlantic Region. The acquisitions occurred throughout the year through 12 separate transactions. Three of the 12 transactions aggregated approximately $966.0 million of the $1.3 billion aggregate purchase price of all the 1998 acquisitions. The first of the three transactions, which closed on January 5, 1998, was a $229.1 million portfolio purchase of 23 properties containing approximately 2.0 million net rentable square feet. The portfolio strengthened the Company's market share in the Philadelphia suburbs and established operating platforms in Northern New Jersey, Delaware and Maryland. The second major portfolio acquisition closed on March 31, 1998. This portfolio, which was acquired for $137.8 million, contained six properties containing approximately 933,000 net rentable square feet and established the Company's market presence in Central New Jersey. The third major portfolio acquisition closed on September 28, 1998 and significantly broadened the Company's holdings by adding 66 properties, containing approximately 5.5 million square feet, located in the Philadelphia suburbs; southern New Jersey; Allentown, Pennsylvania; Richmond, Virginia; and Northern Virginia. The aggregate purchase price was approximately $599.1 million. The remainder of the 1998 acquisitions increased the Company's market share in suburban Philadelphia and expanded the Company's presence in the Wilmington, Delaware; Harrisburg, Pennsylvania; Northern New Jersey; and Long Island, New York markets.
The Company completed the development of three properties in 1998 containing approximately 288,177 net rentable square feet. The Company also sold an office property located in Ohio containing approximately 156,175 net rentable square feet for a net sales price of approximately $14.7 million. As of December 31, 1998, the Company's portfolio consisted of 201 office properties, 70 industrial properties and one mixed use property totaling approximately 18.8 million net rentable square feet.
The 1998 acquisitions were financed through a combination of: proceeds received from four public offerings of an aggregate of approximately 13.3 million Common Shares which raised net proceeds of approximately $301.0 million; borrowings under the Company's credit facilities; the issuance of approximately 1.8 million Class A Units in the Operating Partnership valued at approximately $41.0 million; the issuance of 1,550,000 Series B Preferred Units with an aggregate stated value of $77.5 million; and the issuance of 750,000 Series A Preferred Shares with an aggregate stated value of $37.5 million.
The Company receives income primarily from rental revenue (including tenant reimbursements) from the Properties and, to a lesser extent, from the management of certain properties owned by third parties. The Company expects that revenue growth in the next two years will result primarily from rent increases in its current portfolio, as well as from additional acquisitions.
RESULTS OF OPERATIONS
Comparison of the Year Ended December 31, 1998 to the Year Ended December 31, 1997
Net income before extraordinary item for the year ended December 31, 1998 was $35.0 million compared with net income before extraordinary item of $15.0 million for the corresponding period in 1997. The increase in net income was primarily attributable to the operating results contributed by the 235 properties acquired from January 1, 1997 through December 31, 1998.
Revenues, which include rental income, recoveries from tenants and other income, increased from $61.1 million for the year ended December 31, 1997 to $192.9 million for the corresponding period in 1998. The increase was primarily a result of property acquisitions and, to a lesser extent, increased occupancy. The impact of straight-line rent adjustments increased revenues by $6.3 million for the year ended December 31, 1998 and $1.7 million for the year ended December 31, 1997.
Property operating expenses, depreciation and amortization and management fees increased from $38.0 million for the year ended December 31, 1997 to $117.2 million for the corresponding period in 1998. The increase was primarily a result of property acquisitions.
Property level operating income for the 117 properties owned as of December 31, 1997 increased from $38.6 million for the year ended December 31, 1997 to $40.6 million for the corresponding period in 1998, an increase of 5.2%. Occupancy for these 117 properties increased from 91% to 95% driving revenue growth of 5.0% and causing expenses to increase by 4.7%.
During the year ended December 31, 1998, 91 leases representing 516,652 square feet of office and industrial space commenced at an average rate per square foot of $15.47, which was 13.8% higher than the average rate per square foot on the expired leases.
Interest expense increased from $7.1 million for the year ended December 31, 1997 to $36.9 million for the corresponding period in 1998. The increase in interest expense was primarily a result of additional indebtedness incurred to finance certain of the Company's acquisitions.
Administrative expenses increased from $0.7 million for the year ended December 31, 1997 to $1.7 million for the corresponding period in 1998. This increase was primarily a result of management and staffing additions to support the Company's growth.
Minority interest primarily represents the portion of the Operating Partnership which is not owned by the Company.
Comparison of the Year Ended December 31, 1997 to the Year Ended December 31, 1996
Net income for the year ended December 31, 1997 was $15.0 million compared with a net loss of $162,000 for the corresponding period in 1996. The increase in net income was primarily attributable to the operating results contributed by the 112 properties acquired from August 22, 1996 through December 31, 1997, and to a lesser extent attributable to a 1.9% increase in occupancy from 1996 to 1997 at properties owned on December 31, 1996.
Revenues increased by $51.0 million for the year ended December 31, 1997 as compared to the corresponding prior year period primarily as a result of property acquisitions and, to a lesser extent, increased occupancy.
Property operating expenses, depreciation and amortization and management fees increased in the aggregate by $31.5 million for the year ended December 31, 1997 as compared with the prior year period primarily as a result of property acquisitions. Interest expense increased by $4.3 million as a result of additional indebtedness incurred to finance certain of the Company's acquisitions.
LIQUIDITY AND CAPITAL RESOURCES
Cash Flows
During the year ended December 31, 1998, the Company generated $69.2 million in cash flow from operating activities. Other sources of cash flow consisted of (i) $566.0 million in net additional borrowings under the Company's credit facilities, (ii) $301.0 million in net proceeds from share issuances, (iii) $14.7 million from a property sale and (iv) $19.3 million in additional mortgage notes payable. During the year ended December 31, 1998, the Company used its cash to (i) finance the cash portion ($878.5 million) of the acquisition cost of 153 properties, (ii) repay borrowings under its credit facilities of $808.4 million, (iii) invest $5.0 million in unconsolidated real estate ventures, (iv) fund capital expenditures and leasing commissions of $26.3 million, (v) pay distributions to shareholders and minority
partners in the Operating Partnership totaling $52.4 million, (vi) repay mortgage notes payable of $14.7 million, (vii) pay other debt costs of $4.9 million and (viii) repurchase Common Shares for $1.7 million.
Capitalization
During the first quarter of 1998, the Company refinanced its $150.0 million secured credit facility ("1997 Credit Facility") with a $330.0 million unsecured credit facility (the "1998 Credit Facility"). The interest rate was reduced by 37.5 to 60 basis points depending on the Company's degree of leverage. Approximately $858,000 of unamortized deferred financing costs related to the 1997 Credit Facility were expensed in the first quarter of 1998 and were classified as an extraordinary item on the statement of operations.
During the second quarter of 1998, the Company entered into an additional $150.0 million unsecured credit facility (the "Additional Facility") to facilitate certain of the Company's property acquisitions. The interest rate on the Additional Facility was equal to LIBOR plus 150 basis points or, at the Company's option, the Prime Rate plus 25 basis points. Amounts repaid under the Company's Additional Facility were not subject to reborrowing.
During the third quarter of 1998, the Company replaced the 1998 Credit Facility with a $550.0 million unsecured credit facility (the "New 1998 Credit Facility"). The interest rate borne on the New 1998 Credit Facility was LIBOR plus 150 basis points initially, subject to certain adjustments based on the Company's leverage. The New 1998 Credit Facility matures in September 2001. Approximately $1.1 million of unamortized deferred financing costs related to the 1998 Credit Facility were expensed in the third quarter of 1998 and were classified as an extraordinary item on the statement of operations.
Also during the third quarter of 1998, the Company replaced the Additional Facility with the New Additional Facility with a borrowing capacity of $150.0 million. The New Additional Facility bears interest at LIBOR plus 200 basis points and is payable in full on March 31, 1999.
As of December 31, 1998, the Company had approximately $1.0 billion of debt outstanding, consisting of mortgage loans totaling $319.2 million and borrowings under the New 1998 Credit Facility and the New Additional Facility totaling $681.3 million. The mortgage loans mature between January 1999 and July 2027. As of December 31, 1998, the Company had $18.7 million of availability remaining under the New 1998 Credit Facility and had no remaining availability under the New Additional Facility. For the year ended December 31, 1998, the weighted average interest rate under the Company's credit facilities was 7.05%, and the weighted average interest rate for borrowings under mortgage notes payable was 7.63%.
In January 1999, the Company obtained a $119.0 million, five year loan from two financial institutions. The loans have a fixed interest rate of 7.18% and are secured by four properties. The proceeds were used to reduce the New Additional Facility by $80.0 million and to fund working capital.
In March 1999, the Company obtained a $75.0 million, three year loan. The loan has a floating interest rate of LIBOR plus 250 basis points and is secured by five properties. The net proceeds were primarily used to repay the remaining $70.0 million borrowed under the New Additional Facility.
As of December 31, 1998, the Company's debt to market capitalization ratio was 54.8%. As a general policy, the Company intends, but is not obligated, to adhere to a policy of maintaining a long-term average debt to market capitalization ratio of no more than 50%. The Company expects to reduce its current leverage through a combination of asset sales, formation of joint venture transactions and the issuance of preferred securities in the next six to twelve months.
During the year ended December 31, 1998, the Company sold an aggregate 13.3 million Common Shares for net proceeds of approximately $301.0 million pursuant to four public offerings. The proceeds were contributed to the Operating Partnership in exchange for 13.3 million units of general partnership interest in the Operating Partnership.
During the third quarter of 1998, the Company's Board of Trustees authorized a share repurchase program allowing the Company to repurchase up to 2,000,000 of its outstanding Common Shares. No time limit has been placed on the duration of the share repurchase program. During the third quarter of 1998, the Company repurchased 86,744 of its Common Shares from the public at share prices ranging from $17.75 per share to $20.125 per share for a total purchase price of approximately $1.7 million. The repurchased shares remain authorized, but are no longer issued and outstanding.
During the year ended December 31, 1998, as consideration for certain of the Company's property acquisitions, (i) the Operating Partnership issued 1,550,000 Series B Preferred Units with a stated value of $77.5 million, (ii) the Operating Partnership issued 1,754,763 Class A Units with an aggregate value of approximately $41.0 million and (iii) the Company issued 750,000 Series A Preferred Shares with a stated value of $37.5 million, the proceeds of which were contributed by the Company to the Operating Partnership in exchange for 750,000 Series A Preferred Mirror Units.
Short and Long Term Liquidity
The Company believes that its cash flow from operations and current financing alternatives are adequate to fund its short-term liquidity requirements for 1999. Cash flow from operations is generated primarily from rental revenues and operating expense reimbursements from tenants and management services income from the provision of services to third parties. The Company intends to use these funds to meet its principal short-term liquidity needs, which are to fund operating expenses, debt service requirements, recurring capital expenditures, tenant allowances, leasing commissions and the minimum distribution required to maintain the Company's REIT qualifications under the Internal Revenue Code. During the first quarter of 1999, the Company used the net proceeds from two secured financings to repay the balance of the New Additional Facility and for other working capital requirements.
On December 18, 1998, the Board of Trustees declared a quarterly dividend distribution of $0.39 per share, paid on January 15, 1999 to shareholders of record as of December 28, 1998. The increase from $0.38 to $0.39 in the fourth quarter was the seventh increase during the past ten quarters. Total distributions for 1998 were $1.52 per share compared to $1.44 in 1997, representing an increase of over 5.6%.
As of December 31, 1998, the Company had entered into guaranties, and agreements contemplating the provision of guaranties, for the benefit of unconsolidated real estate ventures, aggregating approximately $16.8 million. Payment under these guaranties would constitute loan obligations of, or preferred equity positions in, the applicable unconsolidated real estate venture.
The Company expects to meet its long-term liquidity requirements, such as for property acquisition, development, investments in unconsolidated real estate ventures, scheduled debt maturities, renovations, expansions and other non-recurring capital improvements, through borrowings under the New 1998 Credit Facility and other long-term secured and unsecured indebtedness and the issuance of additional Class A Units and other equity securities.
Funds from Operations
Management generally considers Funds from Operations ("FFO") as one measure of REIT performance. FFO is calculated as net income (loss) adjusted for depreciation expense attributable to real property, amortization expense attributable to
capitalized leasing costs, gains on sales of real estate investments and extraordinary and nonrecurring items and comparable adjustments for real estate ventures accounted for using the equity method. Management believes that FFO is a useful disclosure in the real estate industry, however, the Company's disclosure may not be comparable to other REIT's. FFO should not be considered an alternative to net income as an indication of the Company's operating performance or to operating cash flows as a measure of liquidity.
FFO for the years ended December 31, 1998 and 1997 is summarized in the following table (in thousands, except share data).
Year 2000 Compliance
The Year 2000 compliance issue concerns the inability of computerized information systems to accurately calculate, store or use a date after 1999. This could result in a system failure or miscalculations causing disruptions of operations. The Year 2000 issue affects virtually all companies and all organizations. The Company recognizes the importance of ensuring that its business operations are not disrupted as a result of Year 2000 related computer system and software issues.
The Company is currently upgrading its internal computer information systems as a normal part of its business. During this conversion, the Company will assess the new hardware and software systems for Year 2000 compliance. The Company expects to complete its conversion by June 30, 1999 at an estimated cost of $250,000. The planned conversion was not accelerated, nor were incremental costs incurred as a result of the Year 2000 issue.
The Company is currently evaluating and assessing those computer systems that do not relate to information technology (such as systems designed to operate a building, which typically include embedded technology), including, without limitation, its telecommunication systems, security systems (such as card-access door lock systems), energy management systems, sprinkler systems and elevator systems. The Company's Year 2000 compliance program is being centrally coordinated, but involves all property management personnel. For each of the Company's properties, compliance letters have been sent to the manufacturers of key operational systems, third-party service providers and vendors. In the event a satisfactory response is not received, the Company intends to consider changing service providers, testing systems for compliance, replacing systems, or pursuing alternative measures to ensure Year 2000 compliance. This assessment is approximately 50% complete for properties owned by the Company as of December 31, 1998. The total cost of bringing these internal systems and equipment into Year 2000 compliance has not been quantified. The Company is unable to determine, based on available information, whether these costs will have a material adverse effect on its business, financial condition or results of operations.
The Company expects to be Year 2000 compliant by June 30, 1999. The Company is currently evaluating the consequences of a potential failure to remediate these matters on time and is in the process of developing contingency plans regarding these matters. The Company expects to have such contingency
plans in place by June 30, 1999. Under a most reasonably likely worst case scenario, until systems became operational, the Company would resort to a combination of temporary hiring, operational system repair or replacement and alternative software to process normal accounts and financial information.
Further, no estimates have been made as to any potential adverse impact resulting from the failure of third-party service providers (including, without limitation, its banks, its payroll processor and its telecommunications providers) vendors and tenants to prepare for the Year 2000. The Company is attempting to identify those risks that could have a material impact on the Company's operations by June 30, 1999 and is also attempting to receive compliance certificates from all third-parties that could have a material impact on the Company's operations by June 30, 1999. Although the Company is in the process of working with such third-parties in order to attempt to eliminate its Year 2000 concerns the cost to the Company of the third-party Year 2000 compliance has not been quantified. The Company would consider changing to third-party service providers and vendors who are Year 2000 compliant before incurring any significant additional costs.
To date, the Company has not expended significant funds to assess its Year 2000 issues, as the Company's evaluation of its Year 2000 concerns has been conducted by its own personnel at routine staffing levels and without any out-of-pocket expenses for consultants. The Company's evaluation has not been subject to any independent verification or review process.
Inflation
A majority of the Company's leases provide for separate escalations of real estate taxes and operating expenses either on a triple net basis or over a base amount. In addition, many of the office leases provide for fixed base rent increases or indexed escalations (based on the CPI or other measure). The Company believes that inflationary increases in expenses will be significantly offset by the expense reimbursement and contractual rent increases.
Interest Rate Risk and Sensitivity Analysis
The analysis below presents the sensitivity of the market value of the Company's financial instruments to selected changes in market rates. The range of changes chosen reflects the Company's view of changes which are reasonably possible over a one-year period. Market values are the present value of projected future cash flows based on the market rates chosen.
The Company's financial instruments consist of both fixed and variable rate debt. As of December 31, 1998, the Company's consolidated debt portfolio consists of $241.7 million fixed rate mortgages with maturities through 2027, $77.5 million in floating rate mortgage notes, and $681.3 million borrowed under its credit facilities. All financial instruments entered into for other than trading purposes and the net market value of these financial instruments is referred to as the net financial position. Changes in interest rates have different impacts on the fixed and variable rate portions of the Company's debt portfolio. A change in interest rates on the fixed portion of the debt portfolio impacts the net financial instrument position but has no impact on interest incurred or cash flows. A change in interest rates on the variable portion of the debt portfolio impacts the interest incurred and cash flows but does not impact the net financial instrument position.
The sensitivity analysis related to the fixed portion of the Company's debt portfolio assumes an instantaneous 100 basis point move in interest rates from their actual levels at December 31, 1998 with all other variables held constant. As of December 31, 1998, a 100 basis point increase in market interest rates would result in a decrease in the net financial instrument position of $22.3 million and a 100 basis point decrease in market interest rates would result in an increase in the net financial instrument position of $11.7 million.
Based on the variable-rate debt included in the Company's debt portfolio on December 31, 1998, a 100 basis point increase in interest rates would result in an additional $7.6 million in interest incurred per year and a 100 basis point decline would reduce interest incurred by $7.6 million per year.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosure About Market Risk
See discussion in Management's Discussion and Analysis included in Item 7 herein.
Item 8.
Item 8. Financial Statements and Supplementary Data
The financial statements and supplementary financial data are listed under Item 14(a) and filed as part of this Annual Report on Form 10-K. See Item 14.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
PART III
Item 10.
Item 10. Trustees and Executive Officers of the Registrant
The following table sets forth certain information with respect to the officers, significant employees and Trustees of the Company:
The following are biographical summaries of the officers, significant employees and Trustees of the Company:
Anthony A. Nichols, Sr., Chairman of the Board and Trustee. Mr. Nichols was elected Chairman of the Board on August 22, 1996. Mr. Nichols founded The Nichols Company, a private real estate development company ("TNC"), through a corporate joint venture with Safeguard Scientifics, Inc. ("SSI") and was President and Chief Executive Officer of TNC from 1982 through August 22, 1996. From 1968 to
1982, Mr. Nichols was Senior Vice President of Colonial Mortgage Service Company (now GMAC Mortgage Corporation), a subsidiary of CoreStates Bank, N.A. Mr. Nichols has been a member of the National Association of Real Estate Investment Trusts ("NAREIT"), a member of the Board of Governors of the Mortgage Banking Association and Chairman of the Income Loan Committee of the regional Mortgage Bankers Association. Mr. Nichols also serves on the Board of Directors of CenterCore Inc. and is a member of the National Association of Industrial and Office Parks ("NAIOP"), the Philadelphia Board of Realtors and the Urban Land Institute ("ULI").
Gerard H. Sweeney, President, Chief Executive Officer and Trustee. Mr. Sweeney was elected a Trustee on February 9, 1996. Mr. Sweeney has served as President and Chief Executive Officer of the Company since August 8, 1994 and as President since November 9, 1989. In addition to his role with the Company, prior to August 8, 1994, Mr. Sweeney served as Vice President of LCOR, Incorporated ("LCOR"), a real estate development firm. Mr. Sweeney was employed by The Linpro Company (a predecessor of LCOR) from 1983 to 1994 and served in several capacities, including Financial Vice President and General Partner. Mr. Sweeney is a member of NAREIT, the ULI, the American Institute of Certified Public Accountants ("AICPA") and the Pennsylvania Institute of Certified Public Accountants ("PICPA").
Jeffrey F. Rogatz, Senior Vice President and Chief Financial Officer. Mr. Rogatz became Senior Vice President and Chief Financial Officer of the Company on January 19, 1999. Prior to joining the Company, Mr. Rogatz was employed for over 11 years as an investment banker with Legg Mason Wood Walker, Inc. ("Legg Mason") and most recently served as a managing director in the corporate finance group. Mr. Rogatz served as the lead investment banker from Legg Mason in advising Brandywine on capital markets transactions including seven public offerings which raised in excess of $650 million. Mr. Rogatz is a member of NAREIT, the International Council of Shopping Centers and the Urban Land Institute, and currently serves on the Board of Governors at Goodwill Industries of the Chesapeake.
Anthony S. Rimikis, Senior Vice President--Development and Construction. Mr. Rimikis became an executive of the Company on October 13, 1997. From January 1994 until October 1997, Mr. Rimikis served as Vice President of Emmes Realty Services, Inc., a New York based real estate services company where he managed the company's construction and development activities in New Jersey and Maryland. Prior to joining Emmes, he served as Vice President of Development for DKM Properties Corp. from 1988 to 1994.
John M. Adderly, Jr., Senior Vice President--Operations. Mr. Adderly has served as an officer of the Company since January 1995. Mr. Adderly was employed by the Rodin Group, a Philadelphia-based real estate development, management and brokerage firm from 1982 until 1995, where he served as Vice President and Chief Financial Officer from 1986 until 1995, and as Corporate Controller from 1982 until 1986. Mr. Adderly serves on the Jefferson Bank Advisory Council and is a member of the Board of Directors of Businesses Committed to Burlington County.
Brad A. Molotsky, General Counsel and Corporate Secretary. Mr. Molotsky became General Counsel of the Company on October 27, 1997 and Secretary of the Company on November 18, 1997. Prior to joining the Company he was an associate at Pepper Hamilton LLP, Philadelphia, Pennsylvania where he practiced law since September 1989. Mr. Molotsky is a member of NAIOP, NAREIT, the American Society of Corporate Secretaries, the American Bar Association, the New Jersey Bar Association and the Pennsylvania Bar Association. He also serves on the Board of Directors of Philadelphia Volunteer Lawyers for the Arts, Triple Threat Productions, Inc. and Businesses Committed to Burlington County.
Barbara L. Yamarick, Vice President--Tenant Services and Property Management. Ms. Yamarick joined the Company on October 20, 1997. Prior to joining the Company she was a Regional Vice President of Premisys Real Estate Services, Inc., a subsidiary of Prudential Insurance Company engaged in the management and leasing of real estate, which she joined in 1991.
H. Jeffrey DeVuono, Vice President--Operations. Mr. DeVuono became an officer of the Company on January 15, 1997. From January 1993 until that time he was employed in several capacities by LCOR, Incorporated, a real estate development firm. During Mr. DeVuono's employment at LCOR, he was responsible for asset management and marketing for LCOR's western Philadelphia suburban properties.
Mark W. Hamer, Vice President--Operations. Mr. Hamer became an officer of the Company on October 6, 1998. Prior to joining the Company, he was President and Chief Operating Officer of Donald E. Axinn Companies, a Long Island-based real estate company. Previously from 1991 to 1996, Mr. Hamer served as Vice President for the North Fork Bank in Melville, N.Y. At North Fork Bank, he assisted in forming and managing the special asset department. From 1989 to 1991, Mr. Hamer was employed at Nations Bank, N.A. Mr. Hamer also serves as a trustee of the Nature Conservancy - Long Island Chapter.
Anthony A. Nichols, Jr., Vice President--Operations. Mr. Nichols became an officer of the Company on August 22, 1996. Previously Mr. Nichols was employed at TNC, which he joined in 1989 as a marketing representative. In 1992 Mr. Nichols became an Assistant Vice President--Property Management of TNC and in 1995 he became Vice President--Marketing. Mr. Nichols is a member of the Board of Directors for the Eastern Pennsylvania Region of the NAIOP. Mr. Nichols is the son of Anthony A. Nichols, Sr., the Company's Chairman of the Board.
George D. Sowa, Vice President--Operations. Mr. Sowa became an officer of the Company on April 13, 1998. Mr. Sowa was employed by Keating Development Company from 1997 to 1998 as a Development Manager where he was responsible for the development and financing of a $51 million redevelopment project in Central New Jersey. Mr. Sowa was employed by LCOR, Incorporated as Director of Development / Operations from 1989 to 1997. At LCOR, Mr. Sowa was responsible for development, leasing and operations of LCOR's Central New Jersey office retail portfolio. Mr. Sowa is a member of the Society of College and University Planners, NAIOP and the Middlesex Somerset Mercer (MSM) Regional Council.
Donald E. Axinn, Trustee. Mr. Axinn was elected a Trustee on October 6, 1998. Mr. Axinn was the founder and chairman of the Donald E. Axinn Companies, developers of office and industrial parks throughout the New York metropolitan area.
Walter D'Alessio, Trustee. Mr. D'Alessio was elected a Trustee on August 22, 1996. He has served as President and Chief Executive Officer of Legg Mason Real Estate Services, Inc., a mortgage banking firm headquartered in Philadelphia, Pennsylvania since 1982. Previously, Mr. D'Alessio served as Executive Vice President of the Philadelphia Industrial Development Corporation and Executive Director of the Philadelphia Redevelopment Authority. He also serves on the Board of Directors of PECO Energy Company, Pennsylvania Blue Shield and Independence Blue Cross, Philadelphia Beltline Railroad, the Philadelphia Private Industry Council and the Greater Philadelphia Chamber of Commerce.
Murry N. Gunty, Trustee. Mr. Gunty was elected a Trustee on September 28, 1998. Mr. Gunty serves as principal and member of the senior investment team of Lazard Freres Real Estate Investors, L.L.C. ("LFREI) and a manager of realty investment funds. Mr. Gunty also serves on the Board of Directors of ARV Assisted Living, Atria Senior Quarters, Cliveden plc, the Fortress Group, Inc., Konover Property Trust, Intown Suites, Inc., and the Rubenstein Company.
Warren V. Musser, Trustee. Mr. Musser was elected a Trustee on August 22, 1996. He has served as Chairman and Chief Executive Officer of SSI since 1953. Mr. Musser also serves as the Chairman of the Board of Directors of Cambridge Technology Partners, Inc., and is a director of Coherent Communications Systems Corporation, CompuCom Systems, Inc. and National Media Corp. Mr. Musser also serves on a variety of civic, educational, and charitable Boards of Directors, including the Franklin Institute and the Board of Overseers of the Wharton School of the University of Pennsylvania. He also
serves as Vice President/Development, Cradle of Liberty Council, Boy Scouts of America and as Vice Chairman of the Technology Council of the Philadelphia metropolitan area.
Charles P. Pizzi, Trustee. Mr. Pizzi was elected a Trustee on August 22, 1996. Mr. Pizzi has served as President of the Greater Philadelphia Chamber of Commerce since 1989. Mr. Pizzi is a director of Vestaur Securities, Inc. and also serves on a variety of civic, educational and charitable Boards of Directors, including the American Chamber of Commerce Executives, Boy Scouts of America (Philadelphia Council), Drexel University, Greater Philadelphia Chamber of Commerce, Independence Blue Cross, Pennsylvania Academy of the Fine Arts, Philadelphia Convention & Visitors Bureau, Temple University School of Business Management, United Way of Southeastern Pennsylvania, University of Pennsylvania Graduate School of Education Board of Overseers and the Urban League of Philadelphia.
Each Trustee has been elected to serve for a one-year term expiring at the 1999 annual meeting of shareholders and until the election and qualification of his successor. Messrs. Nichols, Musser and D'Alessio were initially elected to the Board of Trustees as nominees of SSI and TNC in connection with the Company's acquisition of properties from SSI and TNC in August 1996, and Mr. Pizzi was initially elected to the Board of Trustees as the joint nominee of SSI, TNC and the Company in connection with such transaction.
Mr. Gunty was initially elected to the Board of Trustees as a nominee of LFREI in connection with the Company's acquisition of the Lazard Portfolio in September 1998. LFREI has a right to maintain a designee on the Board until the earlier of a change of control of the Company and the date when LFREI ceases to own at least 60% in value of the securities that it acquired in the September 1998 transaction. Mr. Axinn was initially elected to the Board of Trustees in connection with the Company's acquisition of the Axinn Portfolio in October 1998.
Committees of the Board of Trustees
Audit Committee. The audit committee of the Board of Trustees (the "Audit Committee") currently consists of Messrs. D'Alessio, Pizzi and Axinn. The Audit Committee makes recommendations concerning the engagement of independent public accountants, reviews with the independent public accountants the plans and results of the audit engagement, approves professional services provided by the independent public accountants, reviews the independence of the independent public accountants, considers the range of audit and non-audit fees and reviews the adequacy of the Company's internal accounting controls.
Compensation Committee. The compensation committee of the Board of Trustees (the "Compensation Committee") currently consists of Messrs. D'Alessio, Pizzi and Gunty. The Compensation Committee is authorized to determine compensation for the Company's executive officers, although formal action on compensation matters during 1998 was taken by the full Board (with interested members of the Board abstaining).
Executive Committee. The executive committee of the Board of Trustees (the "Executive Committee") currently consists of Messrs. Nichols, Sr., Sweeney and D'Alessio. The Executive Committee has been delegated all powers of the Board of Trustees except the power to: (i) declare dividends on Common Shares; (ii) issue Common Shares (other than as permitted by the By-Laws as in effect from time to time); (iii) recommend to shareholders any action that requires shareholder approval; (iv) amend the Bylaws of the Company; or (v) approve any merger or share exchange which does not require shareholder approval.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Securities Exchange Act of 1934 requires the Company's officers, Trustees and persons who own more than 10% of the Common Shares to file reports of ownership and changes in ownership with the Securities and Exchange Commission. Officers, Trustees and greater than 10% shareholders are required by regulation to furnish the Company with copies of all Section 16(a) forms they file. Based solely on review of the copies of such forms furnished to the Company, or written representations that no Annual Statements of Beneficial Ownership of Securities on Form 5 were required to be filed, the Company believes that during the fiscal year ended December 31, 1998, all Section 16(a) filing requirements applicable to its officers, Trustees and greater than 10% shareholders were complied with.
Item 11.
Item 11. Executive Compensation
Cash and Non-Cash Compensation Paid to Executive Officers
The following table sets forth certain information concerning the compensation paid for the years ended December 31, 1998, 1997 and 1996: (i) to the Company's President and Chief Executive Officer and (ii) to each of the other four most highly compensated executive officers (the "Named Executive Officers") of the Company, having a combined salary and bonus during the year ended December 31, 1998 exceeding $100,000.
(1) Mr. Nichols, Sr. became an employee of the Company on August 22, 1996. See "Employment Agreements" below.
(2) Mr. Rimikis became an employee of the Company on October 13, 1997.
(3) Mr. Kripke became an employee of the Company on April 7, 1997. Mr. Kripke resigned from his position with the Company effective December 31, 1998.
(4) 1998 bonus amounts, which were approved by the Board of Trustees in accordance with the Company's executive compensation guidelines, were paid as follows: (i) 25% in Common Shares valued at $17.88 per share (the closing price of a Common Share on December 31, 1998) and (ii) 75%, at the election of the applicable executive officer, in any combination of cash and Common Shares valued at $15.19 per share (85% of the closing price of a Common Share on December 31, 1998). Of the Common Shares elected to be received in satisfaction of the 75% portion of the bonus ("Bonus Shares"), the portion of such Common Shares received as a result of the discounted purchase price is subject to certain transfer restrictions until December 31, 2000. Common Shares issued to the recipients were acquired by the Company through open market purchases.
(5) Paid as follows: (a) 25% portion, 2,332 Common Shares and (b) 75% portion $144,928 in cash and 2,745 Bonus Shares. The bonus amount shown above excludes an additional $50,000 bonus awarded in March 1999 on account of 1998 performance.
(6) Paid as follows: (a) 25% portion, 2,799 Common Shares and (b) 75% portion, $173,901 in cash and 3,294 Bonus Shares. The bonus amount shown above excludes an additional $80,000 bonus awarded in March 1999 on account of 1998 performance.
(7) Paid as follows: (a) 25% portion, 909 Common Shares and (b) 75% portion, $32,500 in cash and 1,070 Bonus Shares.
(8) Paid as follows: (a) 25% portion, 699 Common Shares and (b) 75% portion, 2,469 Bonus Shares.
(9) The number of restricted shares awarded to each of the executives was equal to the dollar value specified above divided by the closing price of the Common Shares on January 2, 1998 ($25.25).
(10) The options awarded in 1996 are evidenced by certificates denominated as "warrants" and were vested and exercisable on the date of grant. The options awarded in 1998 vest ratably over five years.
Stock Options Granted to Executive Officers During Last Fiscal Year
Summarized in the following table is information concerning options awarded to the President and Chief Executive Officer and each of the other Named Executive Officers of the Company for the year ended December 31, 1998.
(a) Options vest ratably over five years, subject to acceleration of vesting under certain circumstances, such as upon a change in control of the Company. Upon a change of control, unexercised options convert to 79,208, 118,812 and 10,575 Common Shares for Mr. Nichols, Mr. Sweeney and Mr. Adderly, respectively. The number of Common Shares issuable upon a change of control is subject to a proportional reduction in the event of any prior option exercise.
(b) The grant date present values for the options are determined using the Black-Scholes option pricing model. The assumptions used in calculating the Black-Scholes present values for the option grants were as follows: (a) a risk-free interest rate of 5.81% (based on the yield on a U.S. Treasury security with a maturity of 10 years (the life of the option)); (b) a dividend yield of 6.785%; (c) volatility of the Common Shares of 18.7% (based on the daily Common Share price for one year prior to the option grant); and (d) an option term of ten years.
The Black-Scholes option pricing model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. The amount realized from an employee stock option ultimately depends on the market value of the Common Shares on the date of exercise.
(c) Mr. Kripke's options terminate by their terms on March 31, 1999, the ninetieth day following termination of his employment.
With respect to the options granted to John M. Adderly, Jr., 72,933 of such options will qualify as performance-based compensation under Section 162(m) of the Code since the shares subject to these options have previously been approved for awards by the Company's shareholders. The balance of the options granted to Mr. Adderly will not qualify as performance-based compensation under Section 162(m).
With respect to the options granted to Anthony A. Nichols, Sr. and Gerard H. Sweeney, none of such options will qualify as performance-based compensation under Section 162(m) of the Code, and the taxable income recognized in any year with respect to these awards will count toward the $1.0 million limit on compensation deductible by the Company for compensation to each of Mr. Nichols, Sr. and Sweeney for such year.
Stock Options Held by Executive Officers at December 31, 1998
The following table sets forth certain information regarding options for the purchase of Common Shares that were held by: (a) the Company's President and Chief Executive Officer and (b) each of the other Named Executive Officers of the Company at December 31, 1998. No options for the purchase of Common Shares were exercised by such persons during the fiscal year ended December 31, 1998.
Aggregated Option/SAR Exercises in Last Fiscal Year and Fiscal Year End Option/SAR Values
Employment Agreements
On January 2, 1998, each of Messrs. Nichols, Sr. and Sweeney entered into a five-year employment agreement with the Company. In December 1998, the Company extended the term of each such agreement for an additional one year. The employment agreements established annual base salaries for each of Messrs. Nichols, Sr. and Sweeney of $250,000 and $300,000, respectively, which compensation may be increased by the Board of Trustees in its discretion. The employment agreements include a provision entitling the applicable executive to a payment equal to three times the sum of his annual salary and bonus: (i) upon termination of the executive's employment without cause, (ii) upon resignation by the executive "for good reason" or (iii) upon his death. Resignation by the executive within six months following a reduction in the executive's salary, an adverse change in his status or responsibilities, certain changes in the location of the Company's headquarters or a change in control of the Company would each constitute a resignation "for good reason."
Severance Agreements
On December 17, 1998, each of John M. Adderly, Jr. and Anthony S. Rimikis entered into severance agreements with the Company. These agreements provide that, if such executive's employment is terminated (or constructively terminated) within one year following the effective date of a change of control of the Company, such executive will be entitled to salary continuation for a period of one and a half years, with respect to Mr. Adderly, and one year, with respect to Mr. Rimikis, from the effective date of such executive's termination. The Company has entered into a similar agreement with Jeffrey F. Rogatz, who became a Senior Vice President and Chief Financial Officer of the Company in January 1999, and has entered into similar agreements with five other non-executive officers of the Company.
401(k) Plan
The Company maintains a Section 401(k) and Profit Sharing Plan (the "401(k) Plan") covering its eligible employees and other designated affiliates.
The 401(k) Plan permits eligible employees of the adopting employers (the "Participating Companies") to defer up to a designated percentage of their annual compensation, subject to certain limitations imposed by the Code. The employees' elective deferrals are immediately vested and non-forfeitable upon contribution to the 401(k) Plan. Each Participating Company reserves the right to make matching contributions or discretionary profit sharing contributions in the future.
The 401(k) Plan is designed to qualify under Section 401 of the Code so that contributions by employees or by the Participating Companies to the 401(k) Plan, and income earned on plan contributions, are not taxable to employees until withdrawn from the 401(k) Plan, and so that contributions by the Participating Companies, if any, will be deductible by them when made.
Compensation Committee Interlocks and Insider Participation
The Compensation Committee of the Board of Trustees is currently comprised of Charles P. Pizzi, Walter D'Alessio and Murry N. Gunty. No executive officer of the Company serves on the Compensation Committee.
Walter D'Alessio, a member of the Company's Board of Trustees and Compensation Committee, is President of Legg Mason Real Estate Services, Inc., a mortgage banking firm and a subsidiary of Legg Mason, Inc. Legg Mason, Inc. is the parent of Legg Mason Wood Walker, Incorporated, which was an underwriter in three of the four public offerings of Common Shares consummated by the Company between January 1, 1998 and the date of this Annual Report.
On December 31, 1997, the Company acquired an office property in Valley Forge, Montgomery County, Pennsylvania (the "PECO Building") from PECO Energy Company for a purchase price of $9.5 million. Mr. D'Alessio, a member of the Company's Board of Trustees, is a director of PECO Energy Company. A committee of the Board of Trustees, of which Mr. D'Alessio was not a participant, made the decision to purchase the PECO building and negotiated the terms of the transaction.
On September 28, 1998, the Company consummated a transaction (the "Lazard Transaction") in which it acquired a portfolio of 67 office, industrial and mixed use properties from LREI and its affiliates. Murry N. Gunty, one of the principals of LFREI, became a member of the Board of Trustees on September 28, 1998. In connection with the Lazard Transaction, the Company agreed to acquire an additional office property known as 8260 Greensboro Drive, McLean, Virginia for $20.0 million payable through the issuance of Series B Preferred Units of the Operating Partnership. In connection with the Lazard Transaction, the Company also obtained an option to acquire an office property known as 1676 International Drive, McLean, Virginia and currently under construction for $68 million in cash. In the Lazard Transaction, an LFREI affiliate acquired Series B Preferred Units having a stated value of $3.0 million in exchange for a $3.0 million promissory note that bears interest at 7.25% and matures on September 30, 1999. The Company may elect to use this note to pay a portion of the exercise price for 1676 International Drive, should the Company exercise its purchase option.
Compensation of Trustees
During 1998, the Company paid its Trustees who are not employees of the Company fees for their services as Trustees. These non-employee Trustees received annual compensation of $20,000 (of which one-half was paid in Common Shares and one-half was paid in cash) and a fee of $1,000 for attendance at each meeting of the Board of Trustees and $500 for participation at each meeting of a committee of the Board of Trustees. Trustees who are employees of the Company receive no separate compensation for service as a trustee or committee member.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The following table sets forth certain information as of March 15, 1999 (except as indicated in Note 3) regarding the beneficial ownership of Common Shares (and Common Shares for which Class A Units may be exchanged) by each Trustee, by each executive officer, by all Trustees and executive officers as a group, and by each person known to the Company to be the beneficial owner of 5% or more of the outstanding Common Shares. Except as indicted below, to the Company's knowledge, all of such Common Shares are owned directly, and the indicated person has sole voting and investment power.
*Less than one percent.
(a) Unless indicated otherwise, the business address of each person listed is 14 Campus Boulevard, Suite 100, Newtown Square, Pennsylvania 19073.
(b) Assumes that all Class A Units eligible for redemption held by each named person or entity are redeemed for Common Shares. The total number of Common Shares outstanding used in calculating the percentage of Common Shares assumes that none of the Class A Units eligible for redemption held by other named persons or entities are redeemed for Common Shares.
(c) Based on a Schedule 13G dated February 9, 1999, and filed for the year ended December 31, 1998. Morgan Stanley Dean Witter & Co. has a business address at 1585 Broadway, New York, New York 10036. Of this amount, 1,488,329 (or 60%) of the Common Shares are owned by investment advisory clients of Morgan Stanley Dean Witter Asset Management Inc., a wholly-owned subsidiary of Morgan Stanley Dean Witter & Co.
(d) Represents Common Shares issuable upon conversion, at $28.00 per Common Share, of 750,000 issued and outstanding Series A Preferred Shares having an aggregate stated value of $37.5 million which are held by Prometheus AAPT Holdings, L.L.C ("Prometheus"). Excludes an aggregate of 3,482,142 Common Shares issuable upon redemption of Class A Units (issuable upon redemption or conversion of Series B Preferred Units held by entities controlled by LFREI) which are generally not subject to redemption until September 28, 1999. Mr. Gunty is a principal of LFREI, which is a general partner of LR Strategic Investors L.P., which is the sole member of Prometheus. Mr. Gunty disclaims beneficial ownership of all such Common Shares, except to the extent of his pro rata interests in such Common Shares. Mr. Gunty has a business address at 30 Rockefeller Plaza, 63rd Floor, New York, New York 10020.
(e) Includes (a) 283,477 Common Shares and (b) 350,363 Common Shares issuable upon the exercise of options and warrants that are currently exercisable or that become exercisable within 60 days of March 15, 1999.
(f) Includes (a) 269,596 Common Shares, (b) 192,564 Common Shares issuable upon exercise of warrants that are currently exercisable or that become exercisable within 60 days of March 15, 1999, and (c) 43,818 Common Shares issuable upon conversion of Class A Units beneficially owned by TNC or issuable to TNC on or before September 1, 1999. Mr. Nichols shares investment and voting power over the Common Shares beneficially owned by TNC. The foregoing includes 16,773 Common Shares and warrants to purchase an additional 21,696 Common Shares which Mr. Nichols owns jointly with his wife.
(g) Includes (a) 1,000 Common Shares and (b) 100,000 Common shares issuable upon the exercise of options that are currently exercisable. Excludes an aggregate of 928,651 Common Shares issuable upon redemption of Class A Units which are generally not subject to redemption until October 6, 1999. Mr. Axinn has a business address at 131 Jericho Turnpike, Jericho, NY 11743.
(h) Includes (a) 38,490 Common Shares and (b) 28,128 Common Shares issuable upon the exercise of options and warrants that are currently exercisable or that become exercisable within 60 days of March 15, 1999.
(i) Excludes 4,521 Common Shares issuable upon the exercise of options which terminated on March 31, 1999. Mr. Kripke resigned from his position within the Company effective December 31, 1998.
(j) Includes (a) 6,507 Common Shares and (b) 5,000 Common Shares issuable upon the exercise of options that become exercisable within 60 days of March 15, 1999.
(k) Mr. Musser has a business address at 800 The Safeguard Building, 435 Devon Park Drive, Wayne, Pennsylvania 19087.
(l) Mr. D'Alessio has a business address at 1735 Market Street, Philadelphia, Pennsylvania 19103.
(m) Mr. Pizzi has a business address at 200 South Broad, Philadelphia, Pennsylvania 19103
(n) Includes 1,339,285 Common Shares beneficially owned by Prometheus. Mr. Gunty disclaims beneficial ownership of all such Common Shares, except to the extent of his pro rata interest in such Common Shares.
Item 13.
Item 13. Certain Relationships and Related Transactions
August 22, 1996 Transaction
On August 22, 1996, the Company consummated a transaction (the "SSI/TNC Transaction") in which the Company acquired, through the Operating Partnership, substantially all of the real estate holdings of Safeguard Scientifics, Inc. ("SSI") and SSI's real estate affiliate, The Nichols Company ("TNC"), then a private real estate development and management services company. The then President of TNC, Anthony A. Nichols, Sr. and the Chairman and Chief Executive Officer of SSI, Warren V. Musser, became members of the Board of Trustees on August 22, 1996. In addition to the 495,837 Units issued by the Operating Partnership to SSI, TNC and the other persons that became limited partners in the Operating Partnership as part of the SSI/TNC Transaction (collectively, the "Original Limited Partners") on August 22, 1996, the Operating Partnership will be required to issue to certain of the Original Limited Partners 44,322 Units by September 1, 1999 to acquire residual interests retained by them in certain of the Properties contributed to the Operating Partnership on August 22, 1996. The Partnership Agreement of the Operating Partnership gives the Original Limited Partners the right to cause the Company to redeem their Class A Units for cash, at a per Class A Unit price based on the average closing price of the Common Shares for the five consecutive trading days prior to such determination (or, at the option of the Company, Common Shares on a one Common Share per Unit basis, subject to customary antidilution adjustments).
Option Properties
At the closing of the SSI/TNC Transaction, the Operating Partnership acquired an option from an affiliate of TNC entitling it to acquire, in the Operating Partnership's discretion, four properties containing an aggregate of approximately 159,000 net rentable square feet (collectively, the "Option Properties") at any time during the two-year period ending August 22, 1998 (subject to two extensions of one year each). The Operating Partnership exercised the first of the two extensions resulting in a one year extension to August 22, 1999. The parties have agreed that the purchase price payable by the Operating Partnership upon exercise of its option will consist of $10.00 in excess of the mortgage debt encumbering the Option Properties at the time of exercise (which as of December 31, 1998 aggregated $21.2 million. Exercise of the option is subject to a right of first refusal in favor of, and the consent of, the holder of the mortgage encumbering the Option Properties. There can be no assurance that the Company will exercise its option or that the holder of such mortgage will consent to the exercise of the option.
Environmental Indemnity
SSI has agreed to indemnify the Operating Partnership against the cost of remediation that may be required to be undertaken on account of certain environmental conditions at one of the Properties acquired in the SSI/TNC Transaction subject to an aggregate maximum liability of approximately $2.0 million. The term of the SSI indemnity agreement expires on August 22, 2001.
Repayment of Certain Obligations
On August 21, 1997, the Company paid an aggregate of approximately $594,384 (the "Payment Amount") to satisfy obligations of TNC (a company controlled by Mr. Nichols, Sr.) on account of brokerage commissions and tenant improvements. In exchange, TNC transferred to the Company 28,994 Units. The number of Class A Units transferred to the Company equaled the Payment Amount divided by the then market value of the number of Common Shares into which such transferred Class A Units were then redeemable.
Involvement of Legg Mason
Walter D'Alessio, a member of the Company's Board of Trustees and Compensation Committee, is President of Legg Mason Real Estate Services, Inc., a mortgage banking firm and a subsidiary of Legg Mason, Inc. Legg Mason, Inc. is the parent of Legg Mason Wood Walker, Incorporated, which was an underwriter in three of the four public offerings of Common Shares consummated by the Company between January 1, 1998 and the date of this Annual Report.
Interests in Sellers
On March 7, 1997, the Company acquired a 6.763 acre parcel of undeveloped land located in Horsham Township, Montgomery County, Pennsylvania for approximately $1.0 million. The seller was Horsham Valley, Inc. The purchase price was paid through a combination of approximately $645,000 in cash and a non-interest bearing promissory note for $369,166 that was paid on February 27, 1998. The purchase price for the property was determined by negotiation between the Company and the seller. Mr. Nichols, Sr., the Company's Chairman, holds an approximately 25% interest in the seller.
On December 17, 1997, the Company acquired an office property in Valley Forge, Montgomery County, Pennsylvania (the "PECO Building") from PECO Energy Company for a purchase price of $9.5 million. Mr. D'Alessio, a member of the Company's Board of Trustees, is a director of PECO Energy Company. A committee of the Board of Trustees, of which Mr. D'Alessio was not a participant, made the decision to purchase the PECO Building and negotiated the terms of the transaction.
On July 29, 1998, the Company acquired approximately 23 acres of undeveloped land in Horsham Township, Montgomery County, Pennsylvania for approximately $3.5 million. The seller was LC/N Keith Valley Partnership II. The purchase price was paid in cash. The purchase price for the property was determined by negotiation between the Company and the seller. Mr. Nichols, Sr., the Company's Chairman, holds an approximately 25% indirect interest in the seller.
Lazard Transaction
On September 28, 1998, the Company consummated a transaction (the "Lazard Transaction") in which it acquired a portfolio of 67 office, industrial and mixed use properties from LREI and its affiliates. Murry N. Gunty, one of the principals of LFREI, became a member of the Board of Trustees on September 28, 1998. In connection with the Lazard Transaction, the Company agreed to acquire an additional office property known as 8260 Greensboro Drive, McLean, Virginia for $20.0 million payable through the issuance of Series B Preferred Units of the Operating Partnership. In connection with the Lazard Transaction, the Company also obtained an option to acquire an office property known as 1676 International Drive, McLean, Virginia and currently under construction for $68.0 million in cash. In the Lazard Transaction, an LFREI affiliate acquired Series B Preferred Units having a stated value of $3.0 million in exchange for a $3.0 million promissory note that bears interest at 7.25% and matures on September 30, 1999. The Company may elect to use this note to pay a portion of the exercise price for 1676 International Drive, should the Company exercise its purchase option.
Axinn Transaction
On October 6, 1998, the Company consummated a transaction (the "Axinn Transaction") in which it acquired a portfolio of 22 office and industrial properties from the Donald E. Axinn Companies and affiliates. Mr. Axinn became a member of the Board of Trustees on October 6, 1998. In connection with the Axinn Transaction, the Company agreed to acquire an additional six office properties containing an aggregate of approximately 983,053 net rentable square feet for an aggregate purchase price of $63.1 million, upon satisfaction of certain conditions. On December 28, 1998, the Company acquired one of these properties, known as 3 Paragon Drive, Montvale, New Jersey, for $11.0 million in cash.
Share Purchase Loans
On October 20, 1998, following Board authorization of Company loans aggregating up to $5.0 million to enable employees of the Company to purchase Common Shares on the open market, the Operating Partnership loaned executive officers of Brandywine an aggregate of $1,399,792, as follows: Mr. Nichols, Sr. ($499,995), Mr. Sweeney ($599,786), Mr. Adderly ($250,006), and Mr. Rimikis ($50,005). Proceeds of these loans were used solely to enable these executive officers to purchase Common Shares. The loans have a five-year term, are full recourse and are secured by the Common Shares purchased. Interest accrues on the loans at the lower of the interest rate borne on borrowings under Brandywine's New 1998 Credit Facility (6.49% as of February 16, 1999) and a rate based on the dividend payments on the Common Shares (8.6 % based on the $0.39 fourth quarter 1998 dividend) and is payable quarterly. The principal of the loans is payable at the earlier of October 20, 2001 and 90 days following termination of the applicable executive's employment with Brandywine. In connection with the hiring by the Company of Mr. Rogatz as Senior Vice President and Chief Financial Officer of the Company, the Company agreed to loan Mr. Rogatz up to $200,000 to acquire Common Shares on the same terms as the foregoing loan. In January 1999, the Operating Partnership agreed to loan executive officers of Brandywine an aggregate of $81,107, as follows: Mr. Nichols, Sr. ($26,897), Mr. Sweeney ($32,276), Mr. Adderly ($11,521) and Mr. Rimikis ($10,413). Proceeds of these loans funded tax withholding payments due in connection with certain year-end bonuses. These loans mature on December 31, 1999, are full recourse and accrue interest at the short-term applicable federal rate as of January 1, 1999 (4.5%).
PART IV
Item 14.
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) 1. and 2. Financial Statements and Schedules
The financial statements and schedules listed below are filed as part of this annual report on the pages indicated.
Index to Financial Statements and Schedules
3. Exhibits
(1) Previously filed as an exhibit to the Company's Form 8-K dated June 9, 1997 and incorporated herein by reference.
(2) Previously filed as an exhibit to the Company's Form 8-K dated September 10, 1997 and incorporated herein by reference.
(3) Previously filed as an exhibit to the Company's Form 8-K dated June 3, 1998 and incorporated herein by reference.
(4) Previously filed as an exhibit to the Company's Form 8-K dated October 13, 1998 and incorporated herein by reference.
(5) Previously filed as an exhibit to the Company's Form 8-K dated December 31, 1996 and incorporated herein by reference.
(6) Previously filed as an exhibit to the Company's Registration statement of Form S-11 (File No. 33-4175) and incorporated herein by reference.
(7) Previously filed as an exhibit to the Company's Form 10-K for the fiscal year ended December 31, 1993 and incorporated herein by reference.
(8) Previously filed as an exhibit to the Company's Form 8-K dated August 22, 1996 and incorporated herein by reference.
(9) Previously filed as an exhibit to the Company's Form 8-K dated December 17, 1997 and incorporated herein by reference.
(10) Previously filed as an exhibit to the Company's Form 8-K dated April 13, 1998 and incorporated herein by reference.
(11) Previously filed as an exhibit to the Company's Form 8-K dated May 14, 1998 and incorporated herein by reference.
(12) Previously filed as an exhibit to the Company's Form 8-K dated July 30, 1998 and incorporated herein by reference.
(13) Previously filed as an exhibit to the Company's Form 8-K dated August 13, 1998 and incorporated herein by reference.
(14) Previously filed as an exhibit to the Company's Form 10-K for the fiscal year ended December 31, 1997 and incorporated herein by reference.
** Management contract or compensatory plan or arrangement.
(b) Reports on Form 8-K
During the fourth quarter of the year ended December 31, 1998, the Company filed two Current Reports on Form 8-K. On October 13, 1998, the Company filed a Current Report on Form 8-K (reporting under Items 2, 5 and 7). On October 21, 1998, the Company filed a Current Report on Form 8-K (reporting under Item 7). This Current Report included an audited statement of revenues and certain operating expenses of the Lazard Properties for the year ended December 31, 1997 and the unaudited statement of revenue and certain operating expenses for the six months ended June 30, 1998. This Current Report also included an audited statement of revenues and certain operating expense of the Axinn Properties for the year ended December 31, 1997 and the unaudited statement of revenue and certain operating expenses for the six months ended June 30, 1998. This Current Report also included an audited statement of revenues and certain operating expenses of the Axinn Properties for the year ended December 31, 1997 and the unaudited statement of revenue and certain operating expenses for the six months ended June 30, 1998. This Current Report also included pro forma financial information for the six months ended June 30, 1998 and for the year ended December 31, 1997.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
BRANDYWINE REALTY TRUST
By: /s/ Gerard H. Sweeney ------------------------------------- Gerard H. Sweeney President and Chief Executive Officer
Pursuant to the requirements of the Securities and Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant in the capacities and on the dates indicated.
Exhibit Index
- - -----------------
*Indicates management contract or compensatory plan or arrangement.
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Beneficiaries of Brandywine Realty Trust:
We have audited the consolidated balance sheets of Brandywine Realty Trust (a Maryland real estate investment trust) and subsidiaries as of December 31, 1998 and 1997, and the related consolidated statements of operations, beneficiaries' equity and cash flows for each of the three years in the period ended December 31, 1998. These consolidated financial statements and the schedules referred to below are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and schedules based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Brandywine Realty Trust and subsidiaries as of December 31, 1998 and 1997, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles.
Our audit was made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedules listed on the index of financial statement schedules on Item 14 are presented for purposes of complying with the Securities and Exchange Commission's rules and are not a required part of the basic financial statements. These schedules have been subjected to the auditing procedures applied in the audit of the basic financial statements and in our opinion fairly state in all material respects the financial data required to be set forth therein to the basic financial statements taken as a whole.
ARTHUR ANDERSEN LLP
Philadelphia, Pennsylvania March 2, 1999 (except with respect to the matter discussed in Note 15, as to which the date is March 26, 1999)
BRANDYWINE REALTY TRUST CONSOLIDATED BALANCE SHEETS (in thousands)
The accompanying notes are an integral part of these statements.
BRANDYWINE REALTY TRUST CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except per share information)
The accompanying notes are an integral part of these statements.
BRANDYWINE REALTY TRUST CONSOLIDATED STATEMENTS OF BENEFICIARIES' EQUITY FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996 (in thousands, except number of shares)
The accompanying notes are an integral part of these statements.
BRANDYWINE REALTY TRUST CONSOLIDATED STATEMENTS OF CASH FLOW (in thousands)
The accompanying notes are an integral part of these statements.
1. ORGANIZATION AND NATURE OF OPERATIONS: --------------------------------------
Brandywine Realty Trust (collectively with its subsidiaries, the "Company") is a self-administered and self-managed real estate investment trust (a "REIT"). The Company currently owns a portfolio of real estate assets located primarily in the Mid-Atlantic Region. As of December 31, 1998, the Company's portfolio included 201 office properties, 70 industrial facilities and one mixed use property (collectively, the "Properties") that contain an aggregate of approximately 18.8 million net rentable square feet. As of December 31, 1998, the Company also held economic interests in nine office real estate ventures (the "Real Estate Ventures").
The Company's interest in the Properties and the Real Estate Ventures is held through Brandywine Operating Partnership, L.P. (the "Operating Partnership"). The Company is the sole general partner of the Operating Partnership and, as of December 31, 1998, the Company held approximately 88.5% interest in the Operating Partnership and was entitled to 94.6% of the Operating Partnership's income after distributions to holders of Series B Preferred Units. The Operating Partnership holds a 95% economic interest in Brandywine Realty Services Corporation (the "Management Company") through its ownership of 100% of the Management Company's non-voting preferred stock and 5% of its voting common stock. As of December 31, 1998, the Management Company was managing and leasing properties containing an aggregate of approximately 17.1 million net rentable square feet, of which 16.9 million net rentable square feet related to properties owned by the Company or subject to purchase options held by the Company, and approximately 259,000 net rentable square feet related to properties owned by unaffiliated third parties.
A majority of the Properties are located within the suburban Philadelphia office and industrial market. As such, a downturn in business activity in this market could negatively impact the Company. Management believes the Philadelphia office and industrial market provides a well-diversified economic base which helps to mitigate the types of market risks that can adversely affect a single-sector economy.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: -------------------------------------------
Principles of Consolidation - - ---------------------------
The Company consolidates its accounts and the accounts of the Operating Partnership and reflects the remaining interest in the Operating Partnership as minority interest. All significant intercompany transactions have been eliminated in consolidation. The Company internally evaluates all properties as one segment and accordingly does not report segment information.
Management's 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 revenues and expenses during the reporting period. Actual results could differ from those estimates.
Capitalization of Costs - - -----------------------
The Company has capitalized as deferred costs certain expenditures related to the financing and leasing of the Properties. Capitalized loan fees are being amortized over the terms of the related loans and leasing commissions are being amortized over the term of the related leases. Deferred costs are presented net of accumulated amortization totaling $3.7 million, $2.0 million and $729,000 as of December 31, 1998, 1997, and 1996, respectively. The Company has capitalized interest expense related to the development of certain Properties and land holdings. During the years ended December 31, 1998, 1997 and 1996, capitalized interest totaled $1.2 million, $62,000 and none, respectively.
Real estate investments - - -----------------------
Real estate investments are carried at cost, less accumulated depreciation. It is the Company's policy to review the carrying amounts of long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying value of such assets may not be recoverable. Measurement of the impairment loss is based on the fair value of the asset. Generally, fair value will be determined using valuation techniques such as the present value of expected future cash flows. No impairment adjustments have been made as a result of this review process during 1998, 1997 or 1996.
Depreciation and Amortization - - -----------------------------
Depreciation is computed using the straight-line method. Estimated useful lives range from 25 to 35 years for buildings and improvements and five years for personal property. Amortization of tenant improvements is provided over the shorter of the lease term or the life of the assets.
Accounts Receivable - - -------------------
Accounts receivable is presented net of allowance for doubtful accounts of $3.2 million and $582,000 as of December 31, 1998 and 1997, respectively, and includes straight-line rents receivable of $8.5 million and $2.2 million as of December 31, 1998 and 1997, respectively.
Income Taxes - - ------------
The Company intends to maintain its election to be taxed as a real estate investment trust under Sections 856-860 of the Internal Revenue Code. In management's opinion, the requirements to maintain this election are being met. Accordingly, no provision for Federal income taxes has been reflected in the financial statements.
Earnings and profits, which will determine the taxability of distributions to shareholders, will differ from net income reported for financial reporting purposes due to differences in cost basis, differences in the estimated useful lives used to compute depreciation and differences between the allocation of the Company's net income and loss for financial reporting purposes and for tax reporting purposes.
The Company is subject to a 4% Federal excise tax if it does not distribute a sufficient amount of its taxable income within the prescribed time limits. The excise tax equals 4% of the annual amount, if any, by which the sum of (a) 85% of the Company's ordinary income and (b) 95% of the Company's capital gain net income exceeds cash distributions and certain taxes paid by the Company. No excise tax was incurred in 1998, 1997 or 1996.
The Management Company is subject to Federal and state income taxes. The operating results of the Management Company include a provision for income taxes of approximately $83,000 and $21,000 for 1998 and 1997, respectively.
Revenue Recognition - - -------------------
Rental revenue from tenants is recognized on a straight-line basis over the term of the lease agreements regardless of when payments are due. The impact of the straight-line rent adjustment increased revenues by approximately $6.3 million, $1.7 million and $337,000 during the years ended December 31, 1998, 1997 and 1996, respectively. Certain lease agreements contain provisions which provide for reimbursement of the tenants' share of real estate taxes and certain common area maintenance costs. These reimbursements are reflected on the accrual basis.
No tenant represented 10% or more of the Company's rental revenue in 1998, 1997 or 1996.
Fair Value of Financial Instruments - - -----------------------------------
The carrying amounts reported in the balance sheet for cash, accrued liabilities, and short-term borrowings approximate their fair values due to the short-term nature of these instruments. Accordingly, these items have been excluded from the fair value disclosures included elsewhere in these notes.
Statements of Cash Flows - - ------------------------
For purposes of reporting cash flows, cash and cash equivalents include cash on hand and short-term investments with original maturities of 90 days or less.
Reclassifications - - -----------------
Certain amounts have been reclassified to conform to the current year presentation.
Newly Issued Accounting Standards - - ---------------------------------
Comprehensive Income
In June 1997, the Financial Accounting Standards Board ("FASB") issued SFAS No. 130, "Reporting Comprehensive Income". The standard establishes additional disclosure for the elements of comprehensive income and a total comprehensive income calculation. Net income as reported by the Company reflects total comprehensive income for the years ended December 31, 1998, 1997 and 1996.
Accounting for Derivative Instruments and Hedging Activities
Statement of Financial Accounting Standards No. 133 ("SFAS 133") "Accounting for Derivative Instruments and Hedging Activities" is effective for all fiscal years beginning after June 15, 1999, although earlier application is encouraged. SFAS 133 established accounting and reporting standards related to financial activities with respect to derivative instruments and hedging. The Company has not engaged in the practice of using financial derivative instruments and hedging activities. The Company does not believe that the implementation of SFAS 133 will have a material impact on the Company's financial position or results of operations.
3. MINORITY INTEREST: ------------------
Minority interest relates to interests in the Operating Partnership that are not owned by the Company. Income allocated to the Minority Interest is based on the percentage ownership of the Operating Partnership held by third parties throughout the year. Minority interest is comprised of Class A Units of limited partnership interest ("Class A Units") and Series B Preferred Units of limited partnership ("Series B Preferred Units"). The Operating Partnership issued these interests to persons that contributed assets to the Operating Partnership. The Operating Partnership will, at the request of a holder, be obligated to redeem each Class A Unit held by such holder, at the option of the Company, for cash or one Common Share. Each Series B Preferred Unit has a stated value of $50.00 and is convertible, at the option of the holder, into Class A Units at a conversion price of $28.00. The conversion price is subject to a reduction to $26.50 if the average trading price of the Common Shares during the 60-day period ending December 31, 2003 is $23.00 or lower. The Series B Preferred Units bear a preferred distribution of 7.25% per annum, subject to an increase in the event quarterly distributions paid to holders of Common Shares exceed $0.51 per share. The distributions for the Series B Preferred Units during 1998 were approximately $1.5 million. As of December 31, 1998, there were 2,158,368 outstanding Class A Units held by holders other than the Company and 1,550,000 outstanding Series B Preferred Units, all held by third party investors.
4. ACQUISITIONS AND DISPOSITIONS OF REAL ESTATE INVESTMENTS: ---------------------------------------------------------
The Company continued its growth in 1998 by purchasing 153 office, industrial and mixed-use properties containing approximately 11.6 million net rentable square feet for an aggregate purchase price of approximately $1.3 billion. The 1998 acquisitions expanded the Company's market share in the
suburban Philadelphia office and industrial market and expanded the Company's market presence into several other markets within the Mid-Atlantic Region. The acquisitions occurred throughout the year through 12 separate transactions. Three of the 12 transactions aggregated approximately $966.0 million of the $1.3 billion aggregate purchase price of all the 1998 acquisitions. The first of the three transactions, which closed on January 5, 1998, was a $229.1 million portfolio purchase of 23 properties containing approximately 2.0 million feet. The portfolio strengthened the Company's market share in the Philadelphia suburbs and established operating platforms in Northern New Jersey, Delaware and Maryland. The second major portfolio acquisition closed on March 31, 1998. This portfolio contained six properties containing approximately 933,000 square feet for a purchase price of $137.8 million, and established a market presence in Central New Jersey. The third major portfolio acquisition closed on September 28, 1998 and significantly broadened the Company's holdings by adding 66 properties, containing approximately 5.5 million square feet, located in the Philadelphia suburbs; southern New Jersey; Allentown, Pennsylvania; Richmond, Virginia; and Northern Virginia. The aggregate purchase price was approximately $599.1 million. The remainder of the 1998 acquisitions combined to increase market share in suburban Philadelphia and to expand into Wilmington, Delaware; Harrisburg, Pennsylvania; Northern New Jersey; and Long Island, New York.
The 1998 acquisitions were financed through a combination of: proceeds received from four public offerings of an aggregate of approximately 13.3 million Common Shares which raised net proceeds of approximately $301.0 million; borrowings under the Company's credit facilities; the issuance of approximately 1.8 million Class A Units in the Operating Partnership valued at approximately $41.0 million; the issuance of 1,550,000 Series B Preferred Units with a stated value of $77.5 million; and the issuance of 750,000 Series A Preferred Shares with a stated value of $37.5 million.
The Company completed the development of three properties in 1998 containing approximately 288,177 net rentable square feet. The Company also sold an office property located in Ohio containing approximately 156,175 net rentable square feet for a net sales price of approximately $14.7 million.
The Company's acquisitions were accounted for by the purchase method. The results of operations for each of the acquired properties have been included from the respective purchase dates. All pro forma financial information presented herein is unaudited and is not necessarily indicative of the results which actually would have occurred if acquisitions had been consummated on the respective dates indicated, nor does the pro forma information purport to represent the results of operations for future periods.
The following unaudited pro forma financial information of the Company for the years ended December 31, 1998 and 1997 gives effect to the properties acquired and the Common Share, Class A Unit, Series B Preferred Unit and Preferred Share issuances during 1998 as if the purchases and issuances had occurred on January 1, 1997.
- - ----
During 1997, the Company acquired 80 properties (61 office properties and 19 industrial facilities) containing an aggregate of approximately 5.1 million net rentable square feet. The aggregate purchase price for the 1997 property acquisitions was $403.7 million, consisting of $378.3 million of cash, debt assumption of $15.9 million and $9.5 million in Class A Units.
The following unaudited pro forma financial information of the Company for the years ended December 31, 1997 and 1996 gives effect to the properties acquired during 1997 and 1996 as if the purchases and Common Share issuances had occurred on January 1, 1996.
- - ----
The Company acquired 33 properties in 1996 (30 office properties and three industrial facilities) containing an aggregate of approximately 1.7 million net rentable square feet. The aggregate purchase price for the 1996 property acquisitions was $139.7 million, consisting of $36.6 million of cash, debt assumption of $63.6 million and $39.5 million in Class A Units, Common Shares and warrants.
The following unaudited pro forma financial information of the Company for the years ended December 31, 1996 and 1995 gives effect to the properties acquired during 1996 as if the purchases had occurred on January 1, 1995.
5. MANAGEMENT COMPANY ------------------
On August 22, 1996, the Management Company commenced operations and is responsible for various activities including: management, leasing, construction, redevelopment and development of the Company's Properties and properties on behalf of third parties as well as providing other real estate related services for third parties. Investment in the Management Company is accounted for using the equity method. Total management fees paid by the Company's Properties to the Management Company are included in management fee expense in the accompanying statements of operations and amounted to $6.7 million during 1998, $2.3 million during 1997 and $263,000 for the period from August 22, 1996 to December 31, 1996. The Management Company also receives payments of certain costs attributable to the operation of the Properties. Such reimbursements are included in property operating expenses in the accompanying statements of operations and amounted to $5.3 million during 1998, $1.9 million during 1997 and $147,000 for the period from August 22, 1996 to December 31, 1996.
Summarized unaudited financial information for the Management Company as of December 31, 1998, 1997 and 1996, for the years ended December 31, 1998 and December 31, 1997 and for the period from August 22, 1996 to December 31, 1996 is as follows:
6. INVESTMENT IN UNCONSOLIDATED REAL ESTATE VENTURES -------------------------------------------------
The Company accounts for its non-controlling interests in Real Estate Ventures using the equity method of accounting. Non-controlling ownership interests range from 35% to 65%. These investments are recorded initially at the Company's cost and subsequently adjusted for the Company's net equity in income or loss and cash contributions and distributions.
As of December 31, 1998, the Company intends on making equity contributions to Real Estate Ventures under development totaling approximately $13.9 million of which $4.2 million was contributed as of December 31, 1998. The Company had guaranteed repayment of an aggregate of approximaely $17.3 million of consruction loans made to two Real Estate Ventures (a portion of which guaranty was in the form of a commitment to contribute approximately $6.8 million in equity to the borrower). Payment under these guaranties would constitute loan obligations of, or preferred equity positions in, the applicable Real Estate Venture.
The Company has advanced approximately $4.3 million to a Real Estate Venture. The loan bears interest at 10%. The Company has an option to convert this loan into a capital contribution after certain conditions have been met.
7. INDEBTEDNESS ------------
Borrowings under Credit Facilities --
The Company utilizes credit facility borrowings for general business purposes, including the acquisition of office and industrial properties and the repayment of certain outstanding debt. At December 31, 1997, the Company had a $150.0 million secured credit facility (the "1997 Credit Facility"). The 1997 Credit Facility was secured by 39 of the Properties and bore interest at a per annum floating rate equal to the Company's choice of 30, 60 or 90-day LIBOR plus 175 basis points.
During the first quarter of 1998, the Company replaced the 1997 Credit Facility with a $330.0 million unsecured revolving credit facility (the "1998 Credit Facility"). The Company wrote off $858,000 of unamortized deferred financing costs relating to the 1997 Credit Facility which has been accounted for as an extraordinary item in the statement of operations. The 1998 Credit Facility enabled the Company to borrow funds at a reduced interest rate equal to the 30, 60, 90 or 180-day LIBOR, plus, in each case, a range of 100 to 137.5 basis points, depending on the Company's then existing leverage and debt rating. Alternatively, the Company could have borrowed funds at a base rate equal to the higher of the Prime Rate or the Fed Funds Rate plus 50 basis points.
During the second quarter of 1998, the Company entered into a $150.0 million unsecured credit facility (the "Additional Facility") to finance certain of the Company's property acquisitions. Amounts repaid by the Company under the Additional Facility were not subject to reborrowing.
During the third quarter of 1998, the Company replaced the 1998 Credit Facility with a new revolving credit facility of $550.0 million (the "New 1998 Credit Facility"). The New 1998 Credit Facility is currently unsecured, but will convert to a secured facility if certain leverage requirements are not met by March 31, 1999. The Company wrote off approximately $1.1 million of unamortized deferred financing costs related to the 1998 Credit Facility which has been accounted for as an extraordinary item in the statement of operations. The interest rate borne by the New 1998 Credit Facility was LIBOR plus 150 basis points initially, with the spread over LIBOR subject to reductions of from 12.5 to 35 basis points and a possible increase of 25 basis points based on the Company's leverage. The spread over LIBOR may also be reduced to either 115 or 100 basis points depending on the Company's long term debt rating. The New 1998 Credit Facility matures in September 2001 and requires the Company to maintain ongoing compliance with a number of customary financial and other covenants, including leverage ratios and debt service coverage ratios, limitations on liens and distributions and a minimum net worth requirement. At December 31, 1998, the Company had approximately $531.3 million of indebtedness outstanding under the New 1998 Credit Facility.
During the third quarter of 1998, the Company also replaced the Additional Facility with a new $150.0 million unsecured credit facility (the "New Additional Facility") which bears interest at LIBOR plus 200 basis points and is payable in full on March 31, 1999. Amounts repaid under the New Additional Facility are not subject to reborrowing. The New Additional Facility contains financial and other covenants that are identical to those applicable to the New 1998 Credit Facility. At December 31, 1998, the Company had approximately $150.0 million of indebtedness outstanding under the New Additional Facility.
Borrowings under the New 1998 Credit Facility and the New Additional Facility were primarily used to fund the costs of acquiring properties. For the year ended December 31, 1998, the weighted average interest rate for borrowings under the Company's credit facilities was 7.05%.
In January 1999, the Company obtained a $119.0 million, five year loan from two financial institutions. The loans have a fixed interest rate of 7.18% and are secured by four properties. The proceeds were used to reduce the New Additional Facility by $80.0 million and to fund working capital.
Mortgage Notes Payable --
Mortgage loans encumbered 84, 20 and 18 of the Properties as of December 31, 1998, 1997 and 1996, respectively. Additionally, as of December 31, 1998, mortgage loans encumbered certain of the Company's land holdings. Interest rates on the mortgage loans ranged from 5.0% to 9.9% and had weighted average interest rates of 7.6%, 8.3% and 8.4% during 1998, 1997 and 1996 respectively.
Included in mortgage notes payable are non-interest bearing loans which have an imputed 8% interest rate. On December 31, 1998, 1997 and 1996, these loans totaled $2.3 million, $3.8 million and $4.8 million, respectively, with unamortized discounts of $280,000, $254,000 and $587,000, respectively. Amortization of the discounts aggregated $234,000, $333,000 and $63,000 during 1998, 1997 and 1996, respectively.
Aggregate principal payments on mortgage notes payable and credit facilities at December 31, 1998 are due as follows:
As of December 31, 1998, the Company was in compliance with all debt covenants. During the years ended December 31, 1998, 1997, and 1996, interest paid totaled $35.0 million, $6.1 million and $2.8 million respectively. The carrying values of the Company's debt at December 31, 1998 exceeded their respective fair values by approximately $6.5 million, as determined by using year end interest rates and market conditions.
8. SHARES, WARRANTS AND OPTIONS: -----------------------------
The following table summarizes the Company's activity relative to Common Shares, warrants and options:
(a) During 1996, the Company effected a one-for-three reverse share split of its Common Shares. All share and per share amounts have been presented on a post-split basis.
(b) Proceeds are net of underwriter's discounts and before deducting other expenses, if any.
(c) In November 1998, 133,333 options granted to SERS expired.
(d) Pursuant to the share repurchase plan approved by the Board during 1998, permitting the Company to purchase up to 2,000,000 Common Shares, the Company repurchased 86,744 of its Common Shares on the open market between August 11, 1998 and September 2, 1998 for prices ranging from $17.75 per share and $20.125 per share.
(e) These offerings were pursuant to the exercise of underwriters' over-allotment options.
(f) The Company issued Common Shares as partial payment of annual fees to non-employee Trustees.
(g) SERS represents the Commonwealth of Pennsylvania State Employees' Retirement System.
(h) On November 14, 1996, the Company issued 481,818 Series A Preferred Shares of beneficial interest. During 1997, the preferred shares were converted into 1,606,060 Common Shares.
(i) Unit Redemptions represent Common Shares issued upon redemption of Units.
(j) RMO represents an investment fund controlled by Richard M. Osborne, a former Trustee of the Company.
(k) Indicated price represents the aggregate per share value of the Common Shares and warrants issued.
As of December 31, 1998, 750,000 Preferred Shares of the Company were outstanding. Each Preferred Share has a stated value of $50.00 and is convertible at the option of the holder into Common Shares at a conversion price of $28.00. The conversion price is subject to reduction to $26.50 if the trading price of the Common Shares during the 60-day period ending December 31, 2003 is $23.00 or lower. The Preferred Shares bear a preferred distribution of 7.25% per annum, subject to an increase in the event quarterly distributions paid to holders of Common Shares exceeds $0.51 per share.
At December 31, 1998, the Company had "restricted" Common Shares in aggregate of 438,274 to five of the Company's executives. These restricted shares vest over five to eight year periods and were valued at approximately $11.1 million at the date of issuance (based on the closing price of Common Shares on January 2, 1998).
The Company has reserved, as of December 31, 1998, 2,672,476 Common Shares for issuance upon the exercise of share options and warrants described above. At December 31, 1998, 1,056,287 options and warrants were exercisable. With the exception of options issued to Company executives in 1998, all options and warrants were granted with an exercise price equal to the fair market value on the date of grant. The 1998 options to Company executives were issued with exercise prices ranging from fair market value on the date of grant to 115% of fair market value on the date of grant. At December 31, 1998, outstanding options and warrants had a weighted average remaining contractual life of 7.8 years, an average exercise price of $25.53 per share and an aggregate purchase price of $68.2 million.
During 1996, the Company adopted a new stock-based compensation accounting standard, "Accounting for Stock-Based Compensation" ("SFAS No. 123"). SFAS No. 123 encourages a fair value method of accounting for employee stock options and similar equity instruments. The statement also allows an entity to continue to account for stock-based compensation using the intrinsic value based method in APB Opinion No. 25. As provided for in the statement, the Company elected to continue the intrinsic value method of expense recognition. If compensation cost for the warrants and options granted to executive officers and other employees during 1996 and 1998 had been determined using the fair value method prescribed by SFAS No. 123, the Company's net earnings and earnings per share would have been the pro forma amounts indicated below:
The pro forma effect on results may not be representative of the impact in future years because the fair value method was not applied to options granted before 1995.
The weighted average fair value of each option issued in 1998 and the assumptions used in estimating the fair value on the grant date using the Black-Scholes option pricing model are as follows:
The weighted average fair value of each option issued in 1996 and the assumptions used in estimating the fair value on the grant date using the Black-Scholes option pricing model are as follows:
Executive Other officers employees --------- --------- Exercise Price $ 19.50 $ 19.50 Fair Value of the Options $ 1.38 $ 1.13 Expected life in years 5 3 Risk-free interest rate 6.0% 6.0% Volatility 17.5% 17.5% Dividend yield 7.0% 7.0%
9. NET INCOME (LOSS) PER COMMON SHARE: -----------------------------------
In February 1997, the Financial Accounting Standards Board issued Statement No. 128, "Earnings per Share" ("SFAS 128"). SFAS 128 establishes standards for computing and presenting earnings per share ("EPS"). Basic earnings per share are based on the weighted average number of Common Shares outstanding during the year. Diluted earnings per share are based on the weighted average number of Common Shares outstanding during the year adjusted to give effect to common share equivalents. All per share amounts for all periods presented have been restated to conform to SFAS 128. A reconciliation between basic and diluted EPS is shown below (in thousands, except common share and per common share data).
10. DISTRIBUTIONS: --------------
11. RELATED-PARTY TRANSACTIONS: ---------------------------
During 1996, the Company consummated a transaction (the "SSI/TNC Transaction") in which the Company acquired substantially all of the real estate holdings of Safeguard Scientifics, Inc. ("SSI") and SSI's real estate affiliate, The Nichols Company ("TNC"), then a private real estate development and management services company. The then President of TNC, Anthony A. Nichols, Sr. and the Chairman and Chief Executive Officer of SSI, Warren V. Musser, became members of the Company's Board of Trustees.
In March 1997, the Company acquired a parcel of undeveloped land from Horsham Valley, Inc., an entity in which Mr. Nichols, Sr. holds an approximate 25% interest. The purchase price of approximately $1.0 million was determined through arm's-length negotiation between the Company and the seller.
At the closing of the SSI/TNC Transaction, the Operating Partnership acquired an option from an affiliate of TNC entitling it to acquire, in the Operating Partnership's discretion, four properties containing an aggregate of approximately 159,000 net rentable square feet (collectively, the "Option Properties") at any time during the two-year period ending August 22, 1998 (subject to two extensions of one year each). The Operating Partnership exercised the first of the two extensions resulting in a one year extension to August 22, 1999. The parties have agreed that the purchase price payable by the Operating Partnership upon exercise of its option will consist of $10.00 in excess of the mortgage debt encumbering the Option Properties at the time of exercise (which as of December 31, 1998 aggregated $21.2 million). Exercise of the option is subject to a right of first refusal in favor of, and the consent of, the holder of the mortgage encumbering the Option Properties. There can be no assurance that the Company will exercise its option or that the holder of such mortgage will consent to the exercise of the option.
In August 1997, the Company satisfied obligations of TNC (a company controlled by Mr. Nichols, Sr.) on account of brokerage commissions and tenant improvements. In exchange, TNC transferred to the Company 28,944 Units.
Walter D'Alessio, a member of the Company's Board of Trustees, is President of Legg Mason Real Estate Services, Inc., a mortgage banking firm and a subsidiary of Legg Mason, Inc. Legg Mason, Inc. is the parent of Legg Mason Wood Walker, Incorporated, which was an underwriter in three of the four public offerings of Common Shares consummated by the Company between January 1, 1998 and the date of this Annual Report.
Mr. D'Alessio is a director of PECO Energy Company. In December 1997, the Company acquired an office property from PECO Energy Company for a purchase price of $9.5 million. The Company's Trustee was not a participant in the committee which made the decision to purchase the property and negotiated the related terms of the transaction.
On July 29, 1998, the Company acquired approximately 23 acres of undeveloped land in Horsham Township, Montgomery County, Pennsylvania for approximately $3.5 million. The seller was LC/N Keith Valley Partnership II. The purchase price was paid in cash. The purchase price for the property was determined by negotiation between the Company and the seller. Mr. Nichols, Sr., the Company's chairman, holds approximately a 25% indirect interest in the seller.
On September 28, 1998, the Company consummated a transaction (the "Lazard Transaction") in which it acquired a portfolio of 67 office, industrial and mixed use properties from LFREI and its affiliates. The Company had effective control over four of the properties acquired, and actual title is expected to be transferred by the end of the first quarter. Murry N. Gunty, one of the principals of LFREI, became a member of the Board of Trustees on September 28, 1998. In connection with the Lazard Transaction, the Company agreed to acquire an additional office property for $20.0 million payable through the issuance of Series B Preferred Units of the Operating Partnership. In connection with the Lazard Transaction, the Company also obtained an option to acquire an office property currently under construction for $68.0 million in cash. In the Lazard Transaction, an LFREI affiliate acquired Series B Preferred Units having a stated value of $3.0 million in exchange for a $3.0 million promissory note that bears interest at 7.25% and matures on September 30, 1999. The Company may elect to use this note to pay a portion of the exercise price for a property in which the Company holds a purchase option.
On October 6, 1998, the Company consummated a transaction (the "Axinn Transaction") in which it acquired a portfolio of 22 office and industrial properties from the Donald E. Axinn Companies and affiliates. Mr. Axinn became a member of the Board of Trustees on October 6, 1998. In connection with the Axinn Transaction, the Company agreed to acquire an additional six office properties containing an aggregate of approximately 983,053 net rentable square feet for an aggregate purchase price of $63.1 million, upon satisfaction of certain conditions. On December 28, 1998, the Company acquired one of these properties for $11.0 million in cash.
On October 20, 1998, the Operating Partnership loaned employees an aggregate of approximately $2.4 million to fund the purchase of 130,428 Common Shares in the open market. The loans are full recourse and mature in five years. The interest on the loans is due quarterly and the rate is based on the lower of the Company's existing interest rate on credit facility borrowings or the Company's dividend yield.
In January 1999, the Operating Partnership agreed to loan executive officers of the Company an aggregate of approximately $81,107 to fund tax withholding payments due in connection with certain year-end bonuses. These loans are full recourse, bear interest at approximately 5% and mature on December 31, 1999.
12. OPERATING LEASES: -----------------
The Company leases its properties to tenants under operating leases with various expiration dates extending to the year 2017. At December 31, 1998, leases covering approximately 2.1 million square feet or 11% of the net leasable space were scheduled to expire during 1999. Gross minimum future rentals and accrued rental income on noncancelable leases at December 31, 1998 are as follows (in thousands):
The total minimum future rentals presented above do not include amounts that may be received as tenant reimbursements for charges to cover increases in certain operating costs.
13. SUMMARY OF INTERIM RESULTS (UNAUDITED): ---------------------------------------
The following summary interim financial information is unaudited and presented in thousands, except per share data:
(a) Earnings before interest, depreciation and amortization excludes gains on sale of interests in real estate, minority interest and extraodinary items.
The summation of quarterly earnings per share amounts do not necessarily equal year to date amounts.
14. SUMMARY OF COMMITMENTS AND CONTINGENCIES: -----------------------------------------
Legal Proceedings
The Company is involved from time to time in litigation on various matters, which include disputes with tenants and disputes arising out of agreements to purchase properties. Given the nature of the Company's business activities, these lawsuits are considered routine to the conduct of its business. The result of any particular lawsuit cannot be predicted, because of the very nature of litigation, the litigation process and its adversarial nature, and the jury system.
As of the date of this filing, the Company is a defendant in case in which the plaintiffs allege that the Company breached its obligation to purchase a portfolio of properties for approximately $83.0 million. The plaintiffs' allegations assert claims for reformation, breach of contract, breach of duty of good faith and fair dealing, fraud, violation of the New Jersey Consumer Fraud Statute and unjust enrichment. The Company believes that the plaintiff failed to satisfy the conditions precedent to the Company's obligation to close under the agreement and has moved to dismiss all of the plaintiff's claims. As of the date of this filing, the court has not ruled on the Company's motion to dismiss plaintiffs' claims, and discovery has not commenced.
As of December 31, 1998, the Company also owned or held options to purchase approximately 457.0 acres of land for future development.
Letters of Credit and Other Commitments
In connection with certain mortgages, the Company is required to maintain leasing and capital reserve accounts with the mortgage lender through letters of credit which totaled $12.1 million at December 31, 1998. The Company is also required to maintain escrow accounts for taxes, insurance and tenant security deposits which amounted to $3.5 million at December 31, 1998. The related tenant rents are deposited into the loan servicer's depository accounts, which are used to fund debt service, operating expenses, capital expenditures and the escrow and reserve accounts as necessary. The excess cash is included in cash and cash equivalents on the accompanying balance sheet at December 31, 1998.
As of December 31, 1998, the Company also owned or held options to purchase approximately 457.0 acres of land for future development.
15. SUBSEQUENT EVENT: ----------------
On March 26, 1999, the Company obtained a $75.0 million, three year loan. The loan has a floating interest rate of LIBOR plus 250 basis points and is secured by five properties. The net proceeds were primarily used to repay the remaining $70.0 million borrowed under the New Additional Facility.
Brandywine Realty Trust
Schedule II
Valuation and Qualifying Accounts
(in thousands)
BRANDYWINE REALTY TRUST Real Estate and Accumulated Depreciation - December 31, 1998 (in thousands)
(RESTUBBED TABLE)
(RESTUBBED TABLE)
(RESTUBBED TABLE)
(RESTUBBED TABLE0
(RESTUBBED TABLE)
(a) Reconciliation of Real Estate: The following table reconciles the real estate investments from January 1, 1998 to December 31, 1998(in thousands): Balance at beginning of year $ 586,414 Additions during year: Acquisitions 1,295,615 Capital expenditures 26,301 Deletions during year: Retirements (235) =========== Balance at end of year $ 1,908,095 ===========
(b) Reconciliation of Accumulated Depreciation: The following table reconciles the accumulated depreciation on real estate investments from January 1, 1998 to December 31, 1998 (in thousands) Balance at beginning of year $ 22,857 Additions during year: Depreciation expense 45,040 Deletions during year: Retirements (420) =========== Balance at end of year $ 67,477 ===========
(c) At December 31, 1998, the two mortgage loans total $7.0 million and $2.6 million receptively. The loans are cross-collateralized and are secured by first mortgages on each property.
(d) Unsecured debt in connection with the Company's acquisition of a property portfolio containing eight properties.
(e) The loan is cross-collateralized and is secured by mortgages on 36 properties.
(f) The loan is cross-collateralized and is secured by mortgages on 4 properties.
(g) The loan is cross-collateralized and is secured by mortgages on 26 properties.