ITEM 1. BUSINESS
CenterTrust Retail Properties, Inc., a Maryland corporation, dba Center Trust (the "Company"), is a self-administered and self-managed real estate investment trust. The Company engages in the ownership, management, leasing, acquisition, development and redevelopment of retail shopping centers in the western United States.
As of December 31, 1998, the Company owned a portfolio comprised of interests in 63 retail shopping centers (the "Properties"). See "Item 2
ITEM 2. PROPERTIES
As of December 31, 1998, the Properties consisted of 49 community shopping centers, 2 regional malls and 12 single tenant facilities, containing in the aggregate approximately 12.4 million square feet of total gross leasable area ("GLA"). Approximately 10.2 million square feet of GLA is owned by the Company, and the balance is owned by certain anchor retailers. The majority of the Properties are located throughout Southern California, including 14 in Los Angeles County, 7 in San Diego County, 2 in Orange County, 4 in San Bernardino County, 2 in Riverside County, 2 in Imperial County and 1 in Ventura County. Based on published industry sources, the Company believes that the geographic concentration of the Properties establishes it as one of the leading fully integrated owners, managers and developers of retail shopping centers in the western United States. In addition to its Southern California Properties the Company has 11 Properties in Northern and Central California, 7 Properties in Arizona, 3 Properties in Oregon, 9 Properties in Washington and 1 Property in Nevada.
The Company's single tenant facilities range in size from approximately 36,800 square feet of total GLA to approximately 119,000 square feet of total GLA. The Company's community shopping centers range in size from approximately 66,000 square feet of total GLA to approximately 626,000 square feet of total GLA. The Company's regional malls range in size from approximately 820,000 square feet of GLA to approximately 1,248,000 square feet of GLA.
The Properties are designed to attract local and regional area customers and are typically anchored by one or more nationally or regionally known retailers. Depending on the market focus of a specific Property, major retailers at a Property may include value-oriented discount stores, supermarkets, membership warehouses, traditional department stores, fashion- oriented department stores, shops or well-known specialty retailers. Several of the Properties contain an entertainment component such as a theater multiplex. Anchor leases are typically for initial terms of 10 to 35 years, with one or more renewal options available to the lessee upon expiration of the initial term. By contrast, smaller shop leases are typically for 5 to 10 year terms. The longer term of the anchor leases helps to protect the Company against significant vacancies and to insure the presence of anchor retailers who draw consumers to the Company's retail centers. The shorter term of the smaller shop leases allows the Company to adjust rental rates for non-anchor store space on a regular basis and upgrade the overall tenant mix. Anchor leases are generally for lower base rents than leases for smaller shop tenants. The lower base rents paid by anchor retailers may be offset, in part, through periodic escalations and/or the payment of percentage rents. Certain anchor retailers at some of the Properties occupy space not owned by the Company and therefore do not pay base rent to the Company.
During 1998, the Company continued the acquisition program it commenced in 1997 and significantly expanded its portfolio of community shopping centers in the western United States. As a result of its acquisition strategy, the Company acquired 19 properties in 1998, aggregating approximately 2.9 million square feet of Company owned GLA, with an aggregate purchase price of $309.9 million. The 1998 acquisitions consisted of the following:
During 1997, the Company acquired 8 properties, aggregating approximately 844,000 square feet of GLA, with an aggregate purchase price of $91 million. The acquisitions consisted of the following:
The acquisitions were principally funded through proceeds from the sale of common stock to LFREI, the issuance of OP Units and borrowings on the Company's Credit Facility.
Fifty-four of the Properties are owned by the Company in fee and nine are held by the Company under long-term ground leases. Included in the long-term ground leases are two partially-owned properties (the "Partially-Owned Properties"), in which the Company, through the Operating Partnership, owns, directly or indirectly, partnership interests, as described below.
The Operating Partnership owns a 75% managing general partnership interest in the partnership that owns Kenneth Hahn Plaza and a 85% managing general partnership interest in Haagen-Central Partnership, the general
partnership which is the managing general partner of, and holds a 40% interest in, the partnership that owns Vermont-Slauson Shopping Center. Therefore, the Operating Partnership holds the equivalent of a 34% interest in Vermont- Slauson Shopping Center.
The Operating Partnership is the managing general partner of each such partnership, with control over day-to-day operations of the Partially-Owned Properties. The Company may have certain fiduciary responsibilities to its outside partners which it will need to consider when making decisions relating to the Partially-Owned Properties. The consent of the Company's outside partners may be required for any sale, transfer or encumbrance of the Partially-Owned Properties. In addition, the sale, transfer, assignment or pledge of partnership interests in the partnerships which own the Partially- Owned Properties require the prior written consent of the other partners or are subject to certain rights of first refusal.
During 1998, the Company sold its single tenant Sears Hollywood facility to a related party for gross proceeds of $5.4 million, resulting in a net gain of $1.1 million. In addition, the Company also purchased from a related party, the Manhattan Beach, California building in which its corporate headquarters are located for $3.2 million.
In early 1999, the Company began to market Empire Center, a community shopping center, located in Fontana, California, and comprised of 262,000 square feet of Company owned GLA. Management expects that the property will be sold within one year. As such, the property has been written down to its estimated fair value, less estimated closing costs, resulting in a charge of $21.7 million which has been recorded in the 1998 financial statements.
Subsequent to December 31, 1998, the Company sold two of its Properties, the 194,000 square foot City Center in San Francisco, California, and the 119,000 square feet Sam's Club in Fountain Valley, California, one of the Company's single tenant facilities for gross proceeds of $47 million which resulted in a combined book gain of approximately $21.1 million. In addition, the Company purchased Randolph Plaza, a 179,000 square foot community center located in Tucson, Arizona, for approximately $9.5 million. The acquisition was funded with proceeds from the Company's Credit Facility. Randolph Plaza is anchored by Fry's, Walgreen's and MacFrugal's.
The tables on the following pages provide information regarding the physical descriptions of the Properties, the tenants and the debt secured by the Properties.
Description of Properties
The following table sets forth the physical description and anchor tenant information with respect to the Properties as of December 31, 1998.
- ------ (1) The date indicated is the expiration date of any ground lease after giving effect to all renewal periods.
(2) Indicates Anchor Not Owned.
Property Performance Summary
The following table sets forth, on a property-by-property basis, the GLA leased to anchor tenants, pad tenants and shop tenants, as of December 31, 1998:
- ---- (1) Anchor tenants are defined as those retail tenants occupying more than 25,000 square feet of GLA, 10% of a Property's aggregate GLA, or which represent a significant drawing power for the Property. (2) "Pad" tenants means freestanding single tenants. (3) Includes certain office space. (4) Based upon Total GLA, excluding GLA to be built. (5) Total annualized base rents of the Company for leases signed as of December 31, 1998, excluding (i) percentage rents, (ii) additional amounts payable by tenants such as common area maintenance, real estate taxes and other expense reimbursements and (iii) future contractual rent escalations or cost of living increases. (6) Calculated as total annualized base rent divided by GLA actually leased as of December 31, 1998. (7) Annual percentage rent reported during 1998.
The following table sets forth, as of December 31, 1998, square footage of GLA leased to national, regional and local retail tenants and the annualized base rent generated from such:
- -------- (1) National tenant refers to a business operating in three or more metropolitan areas located in at least three separate states. (2) Regional tenant refers to a business operating in more than one metropolitan area in one or two states. Includes financial institutions. (3) Local tenant refers to a business operating in only one metropolitan area.
The following table sets forth, as of December 31, 1998 the annualized base rent of all of the Properties, the percentage of annualized base rent, the average rent per square foot and the percentage leased, broken down by type of tenant:
Tenant Concentration
The following table sets forth, as of December 31, 1998, information as to anchor and/or national retail tenants which individually accounted for at least 1.0% of total annualized base rent of the Properties:
- -------- (1) Excludes non-owned Anchors.
Tenant Lease Expirations and Renewals
The following table sets forth, as of December 31, 1998, tenant lease expirations for the next ten years at the Properties, assuming that no tenants exercise renewal options:
Debt Secured by Properties
The following table summarizes the outstanding indebtedness secured by the Company's Properties as of December 31, 1998 (in thousands):
- -------- (1) Secured by KMart--Rocklin, KMart--El Centro, KMart--Banning, KMart--Los Banos, KMart--Madera, KMart--Phoenix, Advantage, Huntington Beach, Oracle Road and Simi Valley. Crosscollateralized with AEW Loan 2.
(2) Secured by Lakewood, Sam's Club--Downey, and Parkway Place, Crosscollateralized with AEW Loan 1.
(3) Secured by San Fernando Mission, Rosedale, Country Fair, Fullerton, La Verne, and Sam's Club--Fountain Valley.
(4) Secured by Media City Center, Montebello Town Square, The City Center, Medford Shopping Center, Empire Center, Ross Center, Pacific Linen, Vancouver Park Place, Sunrise Place, Marshalls Plaza, Ross Plaza-- Silverdale, Covington, Vineyards Marketplace, Frontier Village, Rheem Valley, Sixth Avenue, Madera Market Place, SouthPointe Plaza, Kyrene VIllage and Torrance Promenade.
(5) Excludes $6.1 million in Community Facility District Bonds at Empire Center.
(6) Weighted average interest rate on mortgage debt.
Aggregate future principal payments by year on the balance of mortgage indebtedness as of December 31, 1998 is as follows (in thousands):
- -------- (1) Amount represents balance outstanding on the secured line of credit which is due on December 31, 2000.
Other Assets of the Company
The Company's interest in Media City Center (Burbank, California) includes an interest in two promissory notes issued by the Redevelopment Burbank Agency of the City of Burbank (the "Burbank Agency") which mature on February 1, 2016. The first note, which is nonrecourse to the Burbank Agency, is unsecured and was issued by the Burbank Agency on November 15, 1989 with an $18.5 million principal amount and bears interest at 9.25% per annum. On each semi- annual payment date the Burbank Agency is required to make payments on the note to the extent of 70% of the real property tax increment generated by Media City Center, with certain exceptions. The second note is secured by certain tax revenues and was issued by the Burbank Agency on December 6, 1990 with a $33 million initial principal amount and bears interest at 9.25% per annum. The note is nonrecourse to the Burbank Agency but is secured by certain real property tax increments generated by the property as well as certain sales and use taxes generated by the property. On each semi-annual payment date the Burbank Agency is required to make payments on the note only to the extent of such tax items, less rent paid by Macy's (formerly Bullock's). Any amount which accrues under the notes that is not required to be paid is added to the principal amount of such notes. Any principal or interest due on either of the notes which has not been paid (due to the permitted reductions and limitation on payments described above) as of their respective maturity dates will be forgiven, and it is not likely that the full face amount of the notes and the interest thereon will be paid by such maturity dates. During the years ended December 31, 1998, 1997 and 1996, the Company recognized income of approximately $2,633,000, $2,656,000 and $2,797,000, respectively, pursuant to the terms of such agency note agreements.
Under similar commitments from the Community Redevelopment Agencies of the Cities of Fullerton and Chino, other income was recognized for the years ended December 31, 1998, 1997 and 1996 from Fullerton Town Center of $52,000, $48,000, and $57,000 respectively, and Country Fair Shopping Center of $146,000, $147,000 and $146,000 respectively. Such commitments expire in 2013 and 2001 for Fullerton and Chino, respectively, and any balance owing to the Company at expiration will be forgiven and discharged.
Such commitments have not been recorded as assets in the Company's financial statements as they are contingent in nature.
Environmental And Other Regulatory Requirements
Under various federal, state and local laws, ordinances and regulations, an owner or operator of real property may become liable for the costs of removal or remediation of certain hazardous or toxic substances on or in its properties. Such laws may impose such liability without regard to whether the Company knew of, or was responsible for, the presence of such hazardous or toxic substances. The costs of investigation, removal, or remediation of such substances may be substantial and the presence of such substances, or the failure to properly remediate such substances, may adversely affect the owner's ability to sell such real estate or to borrow using such real estate as collateral. In connection with its ownership and operation of properties, the Company may be potentially liable under such laws and may incur costs in responding to such liabilities. No assurance can be given that any existing environmental studies with respect to any of the Properties will reveal all environmental liabilities, that any prior owner or tenant of a Property did not create any material environmental condition not known to the Company, that future laws, ordinances or regulations will not impose any material environmental liability, or that a material environmental condition does not otherwise exist as to any one or more Properties.
Pursuant to an Environmental Indemnity Agreement, as modified by the Separation Agreement, the transferors of eight of the 36 properties acquired at the time of the Company's formation in December 1993 (the "Original Properties") have agreed to provide certain indemnities to the Company for environmental liabilities that may arise with respect to any contamination on or affecting the condition of the Original Properties which was known as of December 27, 1993 or which becomes known after December 27, 1993 as a result of additional environmental testing commenced prior to December 27, 1993. Pursuant to the transfer documents with respect to Rosedale Village, Gresham Town Fair, Medford Center and LaVerne Towne Center (the "1994 Acquisition Properties"), the transferors of such properties provided certain indemnities with respect to environmental liabilities to the Company. Because responsibility for such matters is being retained by the transferors no liabilities have been recorded in the financial statements of the Company with respect to such matters. For the Properties acquired during 1998 and 1997 where the Company's due diligence identified existing or potential environmental contamination, the Company either obtained indemnifications from the sellers or had remediation work paid for by the seller. For all other Properties acquired, based on the Company's due diligence, the Company does not believe that it has exposure to material environmental clean up cost.
The Properties are subject to the Americans with Disabilities Act of 1990 (the "ADA"). The ADA has separate compliance requirements for "public accommodations" and "commercial facilities" but generally requires that all public facilities be made accessible to people with disabilities. These requirements became effective in 1992. Although the Company believes that the Properties are substantially in compliance with the present requirements of the ADA, the Company may incur additional costs of complying with the ADA in the future. However, the Company does not believe that such costs of compliance will have a material effect on the Company.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
The Company is subject to various legal proceedings and claims that arise in the ordinary course of business. These matters are generally covered by insurance. While the resolution of these matters cannot be predicted with certainty, management believes, based on currently available information, that the final outcome of such matters will not have a material adverse effect on the financial position or results of operations of the Company.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the fourth quarter of 1998, no matters were submitted for a vote of stockholders of the Company.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock is listed on the New York Stock Exchange under the symbol "CTA." At February 28, 1999, the Company had approximately 177 stockholders of record and approximately 6,000 beneficial owners. The following table sets forth quarterly high and low sales prices of the Common Stock and the dividends paid by the Company with respect to each period.
Distributions included a return of capital component of approximately 82.5%, 72% and 76%, for the years ended December 31, 1998, 1997 and 1996, respectively. In addition, 1998 distributions included a 5.3% capital gain return. All distributions will be made by the Company at the discretion of the Board of Directors and will depend on the earnings of the Company, its financial condition and such other factors as the Board of Directors deems relevant. The historical return of capital component of the Company's distributions is not indicative of the return of capital component of future distributions, which may be lower than previous years. In order to qualify for the beneficial tax treatment accorded to real estate investment trusts under the Internal Revenue Code, the Company is required to make distributions to holders of its shares which will be at least 95% of the Company's "real estate investment trust taxable income," as defined in Section 857 of the Code.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth selected financial data for the Company. The following data should be read in conjunction with management's discussion and analysis of financial condition and results of operations and all of the financial statements and notes thereto included elsewhere in this Form 10-K.
- -------- (1) The Company computes funds from operations ("FFO") on both a basic and a diluted basis and considers Operating Partnership Units as the equivalent of shares for the purpose of these computations. The diluted basis assumes the conversion of the convertible and exchangeable debentures into shares of common stock as well as other common stock equivalents. For further discussion of FFO, see Item 7
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the "Selected Financial Data" and the Company's Consolidated Financial Statements and Notes thereto appearing elsewhere in this Form 10-K.
The following discussion of Financial Condition and Results of Operations contains certain forward-looking statements that are subject to risk and uncertainty. Investors and potential investors in the Company's securities are cautioned that a number of factors could adversely affect the Company's ability to obtain these results, including (a) the inability to lease currently vacant space in the Company's properties; (b) the inability of tenants to pay contractual rent and other expenses; (c) bankruptcies of tenants; (d) decisions by tenants, and anchor retailers who own their own space, to close stores at the Company's properties; (e) increases in certain operating costs at the Company's properties; (f) decreases in rental rates available from tenants leasing space at the Company's properties; (g) unavailability of financing for acquisition, development and redevelopment of properties by the Company; (h) increases in interest rates; (i) ability to dispose of properties; (j) environmental issues; (k) governmental compliance issues and (l) a general economic downturn resulting in lower retail sales and, in turn, store closures, rent delinquencies, reduced percentage rents and other downward pressure on occupancies and rents at retail properties.
Results of Operations
Comparison of the year ended December 31, 1998 to the year ended December 31, 1997.
Total revenues increased by $41.5 million to $130.5 million for the year ended December 31, 1998 from $89.0 million for the year ended December 31, 1997. The increase was primarily a result of the acquisition of 19 properties during 1998 and 8 properties in the latter part of 1997. The acquired properties account for $36.9 million of the increase. Covina Town Square and Medford Center, properties where the Company opened new theaters in early 1998 and late 1997, respectively, accounted for $3.8 million of the remaining difference. The balance of the increase came from growth from the existing portfolio.
Interest expense increased by $12.3 million to $48.4 million for the year ended December 31, 1998 from $36.1 million for the year ended December 31, 1997. The increase is principally a function of borrowings on the Company's line of credit which increased $92.2 million and the assumption of $96.0 million in mortgage debt. The principal purpose of such debt was to finance acquisitions.
Property operating costs increased $12.8 million from $27.7 million for the year ended December 31, 1997 to $40.5 million for the year ended December 31, 1998. The acquired properties referred to above accounted for $8.7 million of the increase over the prior year. $2.5 million of the increase relates to increases at Medford Center and Covina Town Center as well as increased operating costs at the Company's two regional malls.
Depreciation and amortization expense increased by $6.0 million to $24.3 million for the year ended December 31, 1998 from $18.3 million for the year ended December 31, 1997. This increase was a result of an overall increase in rental properties.
General and administrative costs increased $2.9 million from $2.9 million for the year ended December 31, 1997 to $5.8 million for the year ended December 31, 1998. During 1998, the Emerging Issues Task Force issued EITF 97- 11, "Accounting for Internal Costs Related to Real Estate Property Acquisitions," which prohibits the capitalization of internal costs associated with the acquisition of properties. This ruling, along with costs related to abandoned acquisitions, accounted for $1.5 million of the increase. The balance of the increase was principally a result of the additional staffing required to accommodate the growth within the Company.
As of December 31, 1998, the Company recorded a writedown of an asset held for sale of $21.7 million. The write down resulted from the Company's decision to sell Empire Center, located in Fontana, California. The Company expects to complete the sale of this asset in 1999 and therefore the property was written down to its fair market value, less estimated closing costs.
During the fourth quarter of 1997, the Company recorded a $9.4 million non- recurring charge related to the Separation Agreement. This consists of $2.7 million in cash payment made in January 1998, vesting of outstanding stock options and restricted stock grants, granting and vesting of previously committed restricted stock awards and the value attributed to the Company's agreement to repurchase, or cause to have repurchased, substantially all of the Haagen Family's ownership in the Company at a minimum price of $17 per share.
During 1998, the Company sold a single tenant facility for a net gain on sale of $1.1 million.
During 1997, the Company incurred an extraordinary loss on the early extinguishment of debt of $422,000 related to the write-off of unamortized deferred financing costs.
Loss before other items increase by $4.7 million from $5.5 million at December 31, 1997 to $10.2 million at December 31, 1998.
Comparison of the year ended December 31, 1997, to the year ended December 31, 1996.
Operating revenues increased by $1.3 million to $89.0 million for the year ended December 31, 1997 from $87.7 million for the year ended December 31, 1996. The increase was primarily a result of the acquisition of eight properties during the third and fourth quarters of 1997. These increases were partially offset by the loss of revenue at the former Sears store at Covina Town Square and the loss of revenue resulting from the closure of the IKEA Store at Empire Center.
Interest expense increased by $0.6 million from $35.5 million for the year ended December 31, 1996 to $36.1 million for the year ended December 31, 1997. The increase is principally a function of borrowings on the Company's line of credit to finance its recent acquisitions.
Property operating costs were consistent from December 31, 1997 to 1996 decreasing from $27.8 million to $27.7 million. Increases related to acquisitions were offset by decreases resulting from two properties undergoing redevelopment.
Depreciation and amortization expense increased by $1.2 million from $17.1 million for the year ended December 31, 1996 to $18.3 million for the year ended December 31, 1997. This increase was a result of an overall increase in investment in rental properties.
During the fourth quarter of 1997, the Company recorded a $9.4 million charge related to the Separation Agreement. This consists of $2.7 million in cash payment made in January 1998, vesting of outstanding stock options and restricted stock grants, granting and vesting of previously committed restricted stock awards and the value attributed to the Company's agreement to repurchase, or cause to have repurchased, substantially all of the Haagen Family's ownership in the Company at a minimum price of $17 per share.
During 1996 the Company recorded a non-recurring non-cash charge of $6.9 million to increase the reserve against the receivable for straight-line rents. Also in 1996 the Company recorded a non-cash charge of $2.1 million related to the write-off of the net book value of a building which was demolished.
During 1996, the Company sold two single tenant facilities for a net gain on sale of $2.4 million.
During 1997, the Company incurred an extraordinary loss on the early extinguishment of debt of $422,000 related to the write-off of unamortized deferred financing costs.
Loss before other items increased by $0.8 million from $4.7 million for the year ended December 31, 1996 to $5.5 million for the year ended December 31, 1997 for the reasons stated above.
Selected Property Financial Information
Net Operating Income (defined as operating revenues less property operating costs) for the Company's properties was as follows:
The following summarizes the percentage of leased GLA (excluding non-owned GLA) as of:
During 1998 the Company signed leases for approximately 340,000 square feet and renewed approximately 196,000 square feet of community centers leases at rates approximately 4.0% higher than previous rates. Such signed leases resulted in an increase in the overall rent per square foot of the Company's portfolio to $11.23 per square foot at December 31, 1998 from $10.96 per square foot at December 31, 1997.
Liquidity Sources and Requirements
The Company intends to meet its short term cash requirements from cash generated from operations. The Company anticipates that revenues generated from the Company's real estate will be sufficient to cover operating expenses, debt service requirements and dividends to shareholders.
In December 1997, the Operating Partnership entered into a new revolving line of credit with a maximum borrowing limit of $250 million (the "Credit Facility"). The Credit Facility will primarily provide continued funding for the Company's acquisitions, stock repurchase program and redevelopment activities. The Credit Facility expires in December 2000. At February 28, 1999, outstanding borrowings on the Credit Facility were approximately $186.0 million, with an additional $4.8 million having been utilized to provide letters of credit.
To the extent that borrowings under the Credit Facility are less than the outstanding commitment from LFREI the interest rate on such portion will be London Inter-Bank Offering Rate ("LIBOR") plus 100 basis points. To the extent the borrowings are in excess of the outstanding LFREI commitment such excess will bear interest at LIBOR plus 137.5 basis points.
As of December 31, 1998, the Company had sold 13,406,434 shares, to LFREI under the terms of the Transaction for aggregate proceeds of $201.1 million. The Company will sell the remaining 2,260,232 shares to LFREI for proceeds of $33.9 million on or prior to May 19, 1999.
Mortgage loans maturing of $43.8 million in 1999 and $8.1 million in 2001, as well as significant amounts due from 2002 to 2015, may require refinancing. Additionally, the Company's secured line of credit is due in 2000 and the convertible debentures of $138.6 million and exchangeable debentures of $30.0 million are due in
2001 and 2003, respectively. The Company believes, based on the collateral available within the Properties, that it will be able to effect such refinancings.
The Company anticipates continuing to execute its Stock Repurchase program, acquisition and redevelopment strategy during the next 12 months. The Company believes that such activities will be funded from the LFREI Equity Commitment, the Company's Credit Facility, future debt refinancings and financings, and the disposition of certain non-strategic assets. The Company also expects that these proceeds will be used to fund the Haagen Obligation of $58.8 million.
Funds from Operations
The Company considers Funds From Operations ("FFO") to be an alternative measure of the performance of an equity REIT since such measure does not recognize depreciation and amortization expenses as operating expenses. FFO is defined, as outlined in the March 1995 white paper, by the National Association of Real Estate Investment Trusts ("NAREIT") as net income plus depreciation and amortization, excluding non-real estate assets, less gains on sales of properties. Additionally, the definition also permits FFO to be adjusted for significant non-recurring items.
The Company computes FFO on both a basic and a diluted basis. The diluted basis assumes the conversion of the convertible and exchangeable debentures into shares of common stock. The following table summarizes the Company's computation of FFO and provides certain additional disclosures (dollars in thousands):
Funds from operations, on a basic basis, increased to $36.3 million for the year ended December 31, 1998, as compared to $21.9 million for the same period in 1997. On a diluted basis, assuming conversion of the debentures and other common stock equivalents, funds from operations increased to $50.2 million from $35.8 million. The increase in funds from operations is principally a function of acquisitions made during 1998 and the latter part of 1997. During 1998 and 1997, the Company recorded a writedown on assets held for sale of $21.7 million and non-recurring charges of $9.4 million, respectively. The 1997 charge related to the retirement of the Haagen Family while the 1998 charge relates to the estimated loss on the pending sale of Empire Center. Such items were not included in the computation of FFO as the Company considers them to be significant non-recurring events that if deducted would materially distort the comparative measurement of Company performance.
Funds from operations do not represent cash flows from operations as defined by Generally Accepted Accounting Principles and should not be considered as an alternative to net income as an indicator of the Company's operating performance or to cash flows as a measure of liquidity. Further, the methodology for computing FFO utilized by the Company may differ from that utilized by other equity REITs and, accordingly may not be comparable to such other REITs.
Cash Flows
Net cash provided by operations for the year ended December 31, 1998 was $32.5 million compared to $19.6 million for the prior year, an increase of $12.9 million. The principal reason for the increase in net cash from operations is the properties acquired during 1998, as discussed in Results of Operations above.
Net cash used by investing activities increased by $109.2 million to $219.4 million from $110.2 million for the prior year. The increase is a direct result of the acquisitions made during 1998 of $309.9 million. In addition to cash, the Company also assumed mortgage debt and issued OP units in connection with certain of its acquisitions. Net cash provided by financing activities was $189.9 million for the year ended December 31, 1998, an increase of $101.6 million from the prior year. This increase includes $141 million in proceeds from the sale of common stock to LFREI. In addition, the Company increased by $92.2 million, the amount outstanding on its secured line of Credit.
Net cash provided by operations for the year ended December 31, 1997 was $19.6 million compared to $22.4 million for the prior year. The principal reasons for the decrease in net cash from operations are discussed in Results of Operations above.
Net cash used by investing activities increased by $89.7 million to $110.2 million from $20.5 million for the prior year. The increase is a direct result of the acquisitions made during 1997 of $91.4 million. Net cash provided by financing activities was $88.3 million for the year ended December 31, 1997, an increase of $87.9 million from the prior year. This increase includes $58.7 million in proceeds from the sale of common stock to LFREI. In addition, the Company drew an additional $44 million against its secured line of Credit. These increases were offset by increased restricted cash requirements, the costs of obtaining both equity and debt financing and an increase in dividends and distributions as a result of the issuance of common stock and OP units.
Inflation
The Company's long-term leases contain provisions designed to mitigate the adverse impact of inflation on its results from operations. Such provisions include clauses enabling the Company to receive percentage rents based upon tenants' gross sales, which generally increase as prices rise, and/or, in certain cases, escalation clauses, which generally increase rental rates during the terms of the leases. Such escalation clauses are often related to increases in the CPI or similar inflation indices. In addition, many of the Company's leases are for terms of less than ten years, which permits the Company to seek to increase rents upon re-rental at market rates if rents are below then existing market rates. Many of the Company's leases require the tenants to pay a pro rata share of operating expenses, including common area maintenance, real estate taxes, insurance and utilities, thereby reducing the Company's exposure to increases in costs and operating expenses resulting from inflation.
Adoption of Accounting Standards
In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities. This statement is effective for financial statements issued for fiscal years beginning after June 15, 1999. The Company has not yet analyzed the impact of adopting this statement.
In March 1998, the Emerging Issues Task Force issued EITF 97-11, "Accounting for Internal Costs Related to Real Estate Property Acquisitions." As a result, the Company no longer capitalizes internal costs incurred in
connection with its real estate acquisitions. This change resulted in an increase in general and administrative costs in 1998 of $1.5 million.
Year 2000 Compliance
The inability of computers, software and other equipment utilizing microprocessors to recognize and properly process information containing a 2 digit year is commonly referred to as the Year 2000 Compliance issue. As the year 2000 approaches, such systems may be unable to accurately process certain date-based information. This could result in a system failure or miscalculations causing disruptions of operations, including, among other things, a temporary inability to process transactions, send tenant invoices, provide building services or engage in similar normal business activities. In addition, there is a possibility that the Company may be unable to provide an adequate operating environment for some of its tenants due to the failure of building mechanical or security systems. The Company could be subject to litigation for failure to provide and adequate operating environment for its tenants as a result of such Year 2000 related system disruptions. More immediately, the tenants could cease paying rent which could impact the Company's liquidity. There is also a possibility that if any of the Company's major tenants do not become Year 2000 compliant on schedule, such tenant's operations and financial condition could be adversely affected, which may impact the tenant's ability to meet its rent obligations.
The Company has identified three areas of concern regarding Year 2000 Compliance; (i) internal information technology systems including the Company's network hardware and software; (ii) computer and other operational systems at its properties; and (iii) systems of significant third party vendors and tenants.
The Company has evaluated its internal information technology systems and has concluded that its most significant systems are currently Year 2000 compliant. The Company will continue to evaluate the readiness of its other less significant systems in order to identify and correct potential Year 2000 issues.
The Company is also in the process of evaluating computer and other operational systems at its properties that may have embedded microprocessors with potential Year 2000 issues. The potential Year 2000 issues at the properties principally relate to automated utility systems such as heating, ventilation and air conditioning systems and security and safety devices such as lighting systems and alarms. The Company is in the process of identifying the areas and systems that use embedded microprocessors to determine whether any modifications are necessary. The Company expects to make any necessary modifications by the end of the third quarter of 1999.
The Company places a high degree of reliance on computer systems of third parties such as vendors and tenants. The Company has completed a survey of all third parties with whom it does significant business to determine their Year 2000 Compliance readiness and the extent to which the Company is vulnerable to any third party Year 2000 issues. The Company has received statements of compliance from its primary third party vendors and tenants which state that their systems will be in compliance prior to December 31, 1999. However, there can be no guarantee that the systems of other companies on which the Company's systems rely will be timely converted, or that a failure to convert by another company, or a conversion that is incompatible with the Company's systems, would not have a material adverse effect on the Company. The Company believes it has viable alternatives for each of its significant vendors.
The total cost to the Company of these Year 2000 Compliance activities has not been and is not anticipated to be material to its financial position or results of operations in any given year. These costs and the date on which the Company plans to complete the Year 2000 modifications and testing processes are based on management's best estimates, which were derived utilizing numerous assumptions of future events including the continued availability of certain resources, third party modification plans and other factors. However, there can be no guarantee that these estimates will be achieved and actual results could differ from those plans as information not currently known to the Company becomes available.
The Company is in the process of developing contingency plans for its internal information technology systems, its properties and its significant third party vendors in the event that the Company experiences Year 2000 issues. It is anticipated that such plans will be complete in sufficient time prior to December 31, 1999.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
The Company is exposed to market risk primarily due to fluctuations in interest rates. Specifically, the risk resulting from increasing LIBOR based interest rates as interest on the Company's Credit Facility of $200.9 million is tied to various LIBOR interest rates. The Credit Facility matures December 31, 2000. The Company is also subject to market risk resulting from fluctuations in the general level of U.S. interest rates as $260.5 million of the Company's debt is based on a weighted average fixed rate of 9.321%. As a result, the Company will be obligated to pay contractually agreed upon rates of interest on its fixed rate debt, unless management refinances its existing fixed rate debt and potentially incur substantial prepayment penalties. The $36 million of tax-exempt certificates of participation are tied to a general index of AAA rated tax free municipal bonds.
The following table provides information about the Company's interest rate sensitive financial instruments, including, amounts due at maturity, principal amortization, weighted average interest rates and fair market values as of December 31, 1998 (in thousands):
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of Center Trust:
We have audited the accompanying consolidated balance sheets of Center Trust and subsidiaries (the "Company") as of December 31, 1998 and 1997, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1998. Our audits also included the financial statement schedules listed in the Index at Item 14.A.2. These financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on the financial statements and financial statement 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, such consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 1998 and 1997, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1998 in conformity with generally accepted accounting principles. Also, in our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein.
Deloitte & Touche LLP
Los Angeles, California March 2, 1999
CENTER TRUST
CONSOLIDATED BALANCE SHEETS
December 31, 1998 and 1997 (in thousands, except share data)
See Notes to Consolidated Financial Statements
CENTER TRUST
CONSOLIDATED STATEMENTS OF OPERATIONS
Three Years Ended December 31, 1998 (in thousands, except per share amounts)
See Notes to Consolidated Financial Statements.
CENTER TRUST
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Three Years Ended December 31, 1998 (in thousands, except share data)
See Notes to Consolidated Financial Statements.
CENTER TRUST
CONSOLIDATED STATEMENTS OF CASH FLOWS
Three Years Ended December 31, 1998 (in thousands)
See Notes to Consolidated Financial Statements.
CENTER TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Three Years Ended December 31, 1998
1. BUSINESS
CenterTrust Retail Properties, Inc., a Maryland corporation, dba Center Trust (the "Company") is a self-administered and self-managed real estate investment trust. The Company engages in the ownership, management, leasing, acquisition, development and redevelopment of retail shopping centers in the western United States.
As of December 31, 1998, the Company owned a portfolio comprised of interests in 63 retail shopping centers (the "Properties"). The Company is the sole general partner of CT Operating Partnership, L.P., a California limited partnership (the "Operating Partnership" or "OP") and owns an 83.6% interest therein. Of the 63 Properties, 55 are owned directly by the Operating Partnership. CT Finance, Inc., a Delaware corporation, is wholly owned by the Company and is the 1% general partner of CT Finance Partnership, L.P., a California limited partnership ("CTFP"). The Operating Partnership is the 99% Limited Partner of CTFP. CTFP owns six of the Properties. The Operating Partnership is the sole Member of King Mineral, LLC, a California limited liability company ("KMLLC") and CenterTrust Retail Properties Finance III, LLC, a Nevada limited liability company ("CTRPFIII"), each of which own one of the Properties. CTFP, KMLLC and CTRPFII are collectively referred to as the Finance Partnerships. The Company conducts substantially all of its operations through the Operating Partnership and generally has full, exclusive and complete responsibility and discretion in the management and control of the Operating Partnership.
On June 1, 1997 the Company entered into a Stock Purchase Agreement with LF Strategic Realty Investors, L.P. and Prometheus Western Retail, LLC, affiliates of Lazard Freres Real Estate Investors, LLC, (together "LFREI"), providing for LFREI to invest a total of up to $235 million in Common Stock of the Company (the "Transaction"). Pursuant to the Stock Purchase Agreement the Company will sell an aggregate of 15,666,666 shares of Common Stock to LFREI at a price of $15.00 per share, for an aggregate purchase price of $235 million (the "Total Equity Commitment"). On August 14, 1997, the Stockholders of the Company approved the Transaction.
As of December 31, 1998, the Company has sold 13,406,434 shares, to LFREI under the terms of the Transaction for aggregate proceeds of $201.1 million. The remaining 2,260,232 Shares of Common Stock for aggregate proceeds of $33.9 million will be sold on or prior to May 19, 1999. As of December 31, 1998, LFREI owned 52.9% of the outstanding Common Stock.
After LFREI acquires the remaining 2,260,232 shares (and assuming no other change in the number of outstanding shares), LFREI will own approximately 56.8% of the outstanding Common Stock (37.3% on a Diluted Basis assuming conversion of OP Units and Debentures).
Subject to certain restrictions, in the event that the Company issues or sells shares of common stock for cash, LFREI will be entitled to purchase or subscribe for, either as part of such issuance or in a concurrent issuance, that portion of the total number of shares to be issued equal to LFREI's proportionate holdings of Common Stock prior to such issuance (but not to exceed 37.5% of the offering).
For a period of five years from August 14, 1997 (the "Standstill Period") and any Standstill Extension Term, LFREI and its affiliates may not (i) acquire beneficial ownership of more than 49.9% of the outstanding shares of Common Stock, on an Adjusted Fully Diluted Basis (as defined below), (ii) sell, transfer or otherwise dispose of any shares of Common Stock except in accordance with certain specified limitations (including a requirement that the Company, in its sole and absolute discretion, approve any transfer in a negotiated transaction that would result in the transferee beneficially owning more than 9.8% of the Company's common stock). As
CENTER TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
used herein, the term Adjusted Fully Diluted Basis shall mean on a Diluted Basis, except that shares of Common Stock issuable upon conversion of the Company's outstanding convertible debt or upon exercise of options granted under management benefit plans shall not be included. After giving effect to the sale of 15,666,666 shares to LFREI, and assuming no other change in the number of outstanding shares, LFREI will own 48.1% of the Common Stock on an Adjusted Fully Diluted Basis. In the event that the number of outstanding shares were to increase for any reason (including as a result of issuance of Common Stock upon conversion or exercise of the outstanding convertible debt or management stock options), then LFREI would be allowed to acquire additional shares of Common Stock, up to 49.9% on an Adjusted Fully Diluted Basis. In addition to the above, LFREI has the right to nominate four members to the Company's Board of Directors. Further, LFREI is entitled to receive access to certain operating statements and other financial reports used in operating the Company on a monthly basis.
2. SIGNIFICANT ACCOUNTING POLICIES
The Company's significant accounting policies are as follows:
Basis of Presentation--The accompanying financial statements include the accounts of the Company, the OP and the Finance Partnerships on a consolidated basis. All significant intercompany transactions and balances have been eliminated in the consolidated presentation.
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.
Minority Interests--Included in minority interest for the years ended December 31, 1998, 1997 and 1996 is the 16.4%, 20.9% and 26.3% interests, respectively, in the results of the OP which are owned by various third parties. At December 31, 1998, 1997 and 1996, 4,978,240, 4,280,789 and 4,286,456 OP Units were held by the minority limited partners, respectively. The OP Units are exchangeable, subject to maintaining the Company's status as a REIT, on a one-for-one basis for shares of the Company's common stock or for cash, at the option of the Company.
In addition, adjustments have been made to minority interest in the OP. During 1998, 1997 and 1996, adjustments of $5,417,000, $5,737,000 and $31,509,000 were recorded, principally, as a result of the issuance of additional shares of common stock and OP Units and the conversion of OP Units into common stock.
Minority interest also includes the limited partners' share of equity in two properties. The two properties in which the OP has a general partner interest are Kenneth Hahn Plaza (75% interest) and Vermont-Slauson Shopping Center (34% interest). Consolidation accounting is applied to both of the above partnerships as the OP is deemed to have control over the operations of the properties.
Rental Properties--Rental properties are stated at cost less accumulated depreciation. Costs incurred for the acquisition, renovation and betterment of the properties are capitalized. Maintenance and repairs are charged to income as incurred. Costs incurred during the initial leasing period of a property (primarily representing interest, property taxes, and unrecoverable operating costs) are also capitalized as buildings and improvements. The initial leasing period is generally defined as that period beginning when basic construction of the building is complete and ending when substantially all tenant improvements and additional construction costs have been incurred; however, such initial leasing period cannot exceed one year.
The Company regularly reviews long-lived assets and intangible assets for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. If the sum of
CENTER TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
expected future cash flows is less than the carrying amount of the asset, the Company recognizes an impairment loss equal to the difference between the estimated fair value and the carrying amount of the asset.
Interest costs incurred with respect to qualified expenditures relating to the construction of assets are capitalized during the construction period. Interest capitalized during the years ended December 31, 1998, 1997 and 1996 amounted to $734,000, $843,000 and $400,000, respectively. Cash paid for interest, net of capitalized interest costs, was $45,218,000, $33,895,000 and $33,576,000, for the years ended December 31, 1998, 1997 and 1996, respectively.
Depreciation and Amortization--The cost of buildings and improvements is depreciated on the straight-line method over estimated useful lives, as follows:
Buildings--40 years Leasehold interests--shorter of lease term or useful life of the related property Improvements--shorter of lease term or useful life ranging from 10 to 20 years
Cash and Cash Equivalents--Cash and cash equivalents include highly liquid investments with original maturities of three months or less.
Deferred Charges--Deferred charges include deferred leasing costs and loan fees. Leasing costs include an allocation of internal costs associated with the execution of leases and third-party leasing commissions. Such costs are amortized on the straight-line basis over the initial lives of the leases, which range from 5 to 20 years. Deferred financing fees are amortized over the terms of the respective loans.
Deferred charges are summarized as follows:
CENTER TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Revenue Recognition and Tenant Receivables--Leases with tenants are accounted for as operating leases. Minimum annual rentals are recognized on a straight-line basis over the lease term. Unbilled deferred rent represents the amount by which expected straight-line rental income exceeds rents currently due under the lease agreement. During the first quarter of 1996 the Company recorded a non-recurring non-cash charge of $6.9 million to increase the reserve against the receivable for straight-line rents. The Company continually evaluates its reserve for unbilled deferred rent and may adjust its reserve in the future for changes in the retail environment. Total rents receivable consist of the following:
Included in billed tenant receivables are (1) additional rentals based on common area maintenance expenses and certain other expenses which are accrued in the period in which the related expense is incurred and (2) percentage rents which are accrued on the basis of reported tenant sales.
Other Receivables--In December, 1997 the Company extended a loan to an executive officer, who resigned from the Company in April 1998, in the amount of $3,126,000. Interest shall accrue on the unpaid balance of the loan at an annual rate of 7.45%. The loan is collateralized by all of the former officer's actual and beneficial ownership interests in the Company. The loan requires that quarterly payments, equal to the amount of dividends and distributions paid on the former officer's ownership interests, be made to the Company. The loan is due in full upon ninety days prior notice. The balance of the loan as of December 31, 1998 was $2,971,000.
Other Income--In connection with the development of the Media City Center, commitments in the form of notes receivable (terminating in 2016) were received from the Community Redevelopment Agency of the City of Burbank (the "Burbank Agency") aggregating $51,500,000 (plus interest, subject to certain reductions, as defined). Such commitments are repayable by the Burbank Agency out of incremental sales and property taxes associated with certain defined parcels within the property. Management considers amounts receivable under these notes to be contingent in nature and accordingly has not recorded the notes receivable. Other income has been recorded with respect to these commitments generally in proportion to the recording of property tax expense. Included in other income in connection with such commitments for the years ended December 31, 1998, 1997 and 1996 is $2,633,000, $2,656,000 and 2,797,000, respectively. At December 31, 1998 and 1997, $3,560,000 and $3,431,000, respectively, was recorded as other receivables with respect to such commitments from the Burbank Agency.
Under similar commitments from the Community Redevelopment Agencies of the Cities of Fullerton and Chino, other income was recognized for the years ended December 31, 1998, 1997 and 1996 from Fullerton Town Center of $52,000, $48,000 and $57,000, respectively, and Country Fair Shopping Center of $146,000, $147,000 and $146,000 respectively.
CENTER TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Income Taxes--The Company has elected to be taxed as a REIT under the Internal Revenue Code of 1986, as amended (the "Code"), commencing with the taxable year ended December 31, 1993. As a result, the Company generally will not be subject to federal and state income taxation at the corporate level to the extent it distributes annually at least 95% of its REIT taxable income, as defined in the Code, to its stockholders and satisfies certain other requirements. Accordingly, no provision has been made for federal and state income taxes in the accompanying consolidated financial statements.
As of December 31, 1998 and 1997, the net tax basis of Rental Properties of the Company was approximately $108,900,000 and $88,200,000, respectively, less than the net book basis of such assets.
Earnings Per Share--Basic earnings per share is based on the weighted average number of shares of common stock outstanding during the period and diluted earnings per share is based on the weighted average number of shares of common stock outstanding combined with the incremental weighted average shares that would have been outstanding if all dilutive potential common shares had been issued. The basic and diluted weighted average number of shares of common stock used in the computation for the years ended December 31, 1998, 1997 and 1996 were 21,519,034, 13,312,311 and 12,024,097, respectively. Units held by limited partners in the Operating Partnership may be exchanged for shares of common stock of Center Trust on a one-for-one basis in certain circumstances and therefore are not dilutive. Accordingly, the increase in weighted average shares outstanding under the diluted method over the basic method in every period presented is due entirely to the effect of outstanding options issued under Center Trust's Amended and Restated 1993 Stock Option and Incentive Plan. Basic and diluted earnings were the same for all periods presented.
Segment Information--The Company operates in one segment, Retail Operating Properties, and follows the requirements of SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information."
Accounting Pronouncements--In June 1998, the Financial Accounting Standards Board issued SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. This statement is effective for financial statements issued for fiscal years beginning after June 15, 1999. The Company has not yet analyzed the impact of adopting this statement.
In March 1998, the Emerging Issues Task Force issued EITF 97-11, "Accounting for Internal Costs Related to Real Estate Property Acquisitions." As a result, the Company no longer capitalizes internal costs incurred in connection with its real estate acquisitions. This change resulted in an increase in general and administrative costs in 1998 of $1.5 million.
Reclassifications--Certain amounts have been reclassified in the 1997 and 1996 financial statements to conform to the 1998 financial statement presentation.
3. RENTAL PROPERTIES
Rental properties consist of the following:
CENTER TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
In early 1999, the Company began to market Empire Center, a community shopping center comprised of 262,000 square feet of company owned GLA. Management expects that the property will be sold within one year. As such, the property has been written down to its estimated fair value, less estimated closing costs, resulting in a charge of $21,685,000 which has been recorded in the 1998 financial statements.
4. SECURED DEBT
On December 31, 1997, the OP entered into a new $250 million secured revolving line of credit with a financial institution (the "Credit Facility"). The Credit Facility expires on December 31, 2000 and borrowings under the Credit Facility bear interest at a floating rate equal to London Inter-Bank Offering Rate ("LIBOR") plus 100 basis points (5.63% at December 31, 1998). To the extent the borrowings are in excess of the remaining LFREI equity commitment such excess will bear interest at LIBOR plus 137.5 basis points.
Borrowings under the Credit Facility are secured by first mortgage liens on Montebello Town Square, The City Center, Media City Center, Empire Center, Medford Center, Pacific Linen Plaza, Ross Plaza, Vancouver Park Place, Sunrise Place, Frontier Village, Marshalls Plaza, Rheem Valley, Sixth Avenue, Madera Market Place, SouthPointe Plaza, Kyrene Village Vineyards Marketplace, Ross Plaza-Silverdale Covington Square and Torrance Promenade. As properties are acquired, they may be added to the security of the Credit Facility, thereby increasing the amount available to the Company. The Company has utilized $4.8 million of the Credit Facility to provide various letters of credit. The Credit Facility is subject to certain conditions, the violation of which may affect its terms.
Proceeds from the Credit Facility were used to repay amounts outstanding on the former credit facility. In connection with the repayment of the former credit facility, the Company incurred an extraordinary loss on the early extinguishment of debt of $422,000 related to unamortized deferred financing costs in 1997.
The notes payable are secured by deeds of trust and the assignment of rents and leases associated with the related properties. Certain of the non-recourse notes payable are subject to certain conditions, the violation of which may result in additional recourse being available to the lenders. Certain of the loans are subject to substantial prepayment penalties, as defined in the respective loan agreements (See Note 10).
CENTER TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The $6,078,000 Community Facilities District Special Tax Bonds were issued by the City of Fontana, California, to finance the construction of the infrastructure for Empire Center. Debt service is provided through a special tax assessment on the parcels of land within the development. As the amount of the liability is fixed and determinable and the related assets are subject to a lien, the liability and corresponding site improvement assets have been reflected in the financial statements.
Aggregate future principal payments as of December 31, 1998 are as follows:
Total amount excludes $200,895 outstanding on the secured line of credit which is due on December 31, 2000.
Restricted cash at December 31, 1998 and 1997 includes reserve funds established in connection with the tax exempt financing. In addition, at December 31, 1998 and 1997 restricted cash includes funds restricted for the completion of certain construction projects. Interest income on such funds accrues to the benefit of the Company. Restricted cash disbursements require the approval of the trustees of the respective obligations. The floating rate tax-exempt certificate of participation requires the Company to maintain letters of credit equal to the balance outstanding. The cost of such is factored into the effective rate on such notes.
5. SUBORDINATED DEBENTURES
In conjunction with the Company's formation, it issued 7 1/2% Convertible Subordinated Debentures, Series A and Series B which mature on January 15, 2001. The Convertible Debentures are convertible at any time after issuance and prior to maturity, into shares of Common Stock of the Company at a conversion price of $18.00 per share, subject to adjustment under certain conditions. The Convertible Debentures are not redeemable by the Company prior to maturity, except for certain reasons primarily intended to protect the Company's status as a REIT. Interest on the Convertible Debentures is payable semi-annually in arrears on January 15 and July 15.
The Convertible Debentures are unsecured general obligations of the Company, subordinate to all existing and future senior indebtedness of the Company, as defined. The Convertible Debentures are effectively subordinated to all indebtedness of the OP.
Concurrently, the OP issued 7 1/4% Exchangeable Subordinated Debentures which mature on December 27, 2003 and are secured by one of the Company's properties. The Exchangeable Debentures are exchangeable at any time for Common Stock of the Company at an exchange price of $18.00 per share, except for certain reasons, primarily intended to protect the Company's status as a REIT. Interest on the Exchangeable Debentures is payable semi-annually in arrears on June 27 and December 27.
The Exchangeable Debentures are redeemable by the OP at any time subsequent to December 27, 1998, at the option of the Company, at 100% of the principal amount thereof, together with accrued interest.
CENTER TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Exchangeable Debentures may be put to the OP for cash in the principal amount thereof together with accrued interest at the election of the holders at any time on or after December 27, 2000.
6. REDEEMABLE COMMON STOCK
In connection with the Separation Agreement, as described in Note 11 below, the Company has agreed to purchase, or cause to have purchased, from the Haagen Family, on May 25, 1999, an aggregate of 3,656,818 shares of common stock and Operating Partnership Units (the "Shares") at a price per share equal to the greater of $17 or the then current market price (as determined in accordance with the Separation Agreement). A portion of shares to be repurchased require that certain stock options be exercised by the Haagen Family resulting in a net obligation to the Company of $58.8 million. Under the terms of the Separation Agreement, the Haagen Family may not sell such shares other than in certain open market transactions on the New York Stock Exchange. Included in the Shares to be repurchased are 590,034 and 510,034 shares of Common Stock as of December 31, 1998 and 1997, respectively.
7. STOCKHOLDERS' EQUITY
In addition to Common Stock, the Company's Charter authorizes the issuance of 10,000,000 shares of Preferred Stock, par value $.01 per share. No such shares were issued or outstanding as of December 31, 1998 and 1997. During 1998, the shareholders of the Company approved an increase in the authorized shares of Common Stock from 50 million to 100 million.
During each of the years ended December 31, 1998, 1997 and 1996, the Company declared four quarterly distributions of $0.36 per share/unit.
In October 1998, the Board of Directors authorized the Company to repurchase up to $25 million of its common stock through the open market or in privately negotiated transactions over a period of twelve months. During 1998, the Company repurchased 436,700 shares for $5,181,000, including commissions and other costs.
8. STOCK OPTION AND INCENTIVE PLAN
The 1993 Stock Option and Incentive Plan, as amended, (the "Option Plan") enables executive officers, key employees and directors of the Company to participate in the ownership of the Company. The Option Plan provides for the award of a broad variety of stock-based compensation alternatives such as non- qualified stock options, incentive stock options, and restricted stock, and provides for the grant to Independent Directors and directors of HPMI of non- qualified stock options. Options are granted at prices which are not less than market at date of grant, expire ten years from the date of grant, and are generally exercisable 25% per year over four years. The Option Plan is administered by the Compensation Committee of the Board of Directors, which is authorized to determine the number of shares to be subject thereto and the terms and conditions thereof. Pursuant to the Option Plan, 2,000,000 shares of Common Stock were reserved for issuance to eligible participants.
CENTER TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Following is a summary of the stock option activity for the three years ended December 31, 1998:
In addition to the above, during 1998 and 1997, 207,459 and 101,000 shares, respectively, of restricted stock were issued.
As of December 31, 1998, 1997 and 1996 options exercisable totaled 606,758, 361,827 and 297,449, respectively.
The following table summarizes information about stock options outstanding at December 31, 1998:
CENTER TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The weighted average fair value of the stock options granted during 1998, 1997 and 1996 were $2.80, $12.98 and $12.25, respectively. The Company applies Accounting Principles Board Opinion No. 25 and related Interpretations in accounting for its stock option and incentive plan. Accordingly, no compensation cost has been recognized as a result of its initial granting of Stock Options. As a result of the retirement of the Haagen Family (see Note 11 below), the Company accelerated the vesting period of certain stock options and restricted stock and recorded a charge of approximately $2.7 million in connection with such acceleration. During 1998 and 1997, the Company recorded compensation expense of $958,000 and $299,000, respectively related to the amortization of deferred compensation related to Restricted Stock granted to certain officers of the Company. Had compensation cost for the Company's Option Plan been determined based on the fair value at the grant dates for awards during 1998, 1997, and 1996 consistent with the method of SFAS No. 123, the Company's net loss and loss per share for the years ended December 31, 1998, 1997, and 1996 would have been increased to the pro forma amounts indicated below:
The fair value of options granted under the Company's Option Plan was estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions used for 1998, 1997, and 1996, respectively: expected life of five years; risk free interest rate of 4.63%, 5.49% and 6.13%; expected dividend yield of 10.11% 8.3% and 9.0%; and expected volatility of 37.3%, 22.2% and 21.01%.
9. FUTURE MINIMUM RENT
The Company has operating leases with tenants that expire at various dates through 2037 and are either subject to scheduled fixed increases or adjustments based on the Consumer Price Index. Generally, the leases grant tenants renewal options and provide certain potential allowances during the initial lease-up period. Leases also provide for additional or contingent rents based on certain operating expenses as well as tenants sales volume. Future minimum rent under operating leases on a cash basis, excluding tenant reimbursements of certain costs, as of December 31, 1998 is summarized as follows:
The Properties are located throughout the western United States. The ability of the tenants to honor the terms of their respective leases is dependent upon the economic, regulatory and social factors affecting the communities and industries in which the tenants operate.
CENTER TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
10. FAIR VALUE DISCLOSURE OF FINANCIAL INSTRUMENTS
The following disclosure of estimated fair value was determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgment is necessary to interpret market data and develop the related estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts that could be realized upon disposition of the financial instruments. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.
Billed tenant and other receivables, accounts payable and other liabilities are carried at amounts which reasonably approximate their fair value.
The fixed rate mortgage notes payable totaling $260,491,000 and $168,933,000 as of December 31, 1998 and 1997, respectively, have fair values of $280,378,000 and $187,522,000, respectively (excluding prepayment penalties) as estimated based upon current interest rates available for the issuance of debt with similar terms and remaining maturities. These notes were subject to estimated prepayment penalties of $51,189,000 and $35,842,000 at December 31, 1998 and 1997, respectively, which would be required to retire these notes prior to maturity. The carrying value of floating rate tax-exempt certificates of participation and the secured line of credit at December 31, 1998 and 1997 approximates their fair value. The fair market values of the Convertible Debentures at December 31, 1998 and 1997 were $129,590,000 and $140,505,000, respectively, based on the trading price of the Series A Convertible Debentures as of December 31, 1998 and 1997. Assuming a trading value comparable to the Convertible Debentures, the fair value of the Exchangeable Debentures would be $28,050,000 and $30,413,000 at December 31, 1998 and 1997, respectively.
The fair value estimates presented herein are based on information available to management as of December 31, 1998 and 1997. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued for purposes of these financial statements since those dates, and current estimates of fair value may differ significantly from the amounts presented herein.
11. RELATED PARTY TRANSACTIONS
During 1998, the Company sold its Sears Hollywood facility, a single tenant facility for proceeds of $5.4 million which resulted in a net gain of $1.1 million. In addition, the Company purchased the Manhattan Beach, California building in which its corporate headquarters are located for $3.2 million. Both of the above transactions were with affiliates of Alexander Haagen, Sr., the Company's former chairman and were negotiated at arms-length.
On November 24, 1997, the Company entered into an agreement (the "Separation Agreement") with Alexander Haagen, Sr., Charlotte Haagen and Alexander Haagen, III (collectively the "Haagen Family") in connection with their retirement from the Company. Under the terms of the Separation Agreement, the Haagen Family received $2.7 million in cash, vesting of all granted stock options and restricted stock awards, and the granting and vesting of previously committed restricted stock awards. In addition, for certain defined periods the Company agreed to continue to provide the Haagen Family certain medical benefits and administrative assistance. Further, the Company has agreed to purchase, or cause to have purchased, substantially all of the Haagen Family's ownership interests in the Company on May 25, 1999 (see Note 6).
During 1997, the Company recorded a non-recurring charge of $9.4 million which reflects the consideration given to the Haagen Family in connection with the Separation Agreement. Included in accrued expenses as of December 31, 1998 and 1997 is approximately $1.5 million and $4.9 million, respectively, related to the
CENTER TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Separation Agreement of which $2.7 million in cash was paid on January 2, 1998. The remaining $4.5 million relates to noncash charges for the acceleration of the vesting of stock options and restricted stock, granting and acceleration of vesting of previously committed restricted stock awards, and the value attributed to the Company's obligation to repurchase the Haagen Family's ownership interests in the Company and has been charged directly to Additional Paid-in Capital.
Through December 31, 1997, Haagen Property Management, Inc. ("HPMI") conducted all of the executive, construction, leasing, legal, and property management functions pursuant to management agreements between the OP and HPMI. Prior to December 31, 1997, the OP owned a 95% interest in but did not control HPMI. The investment has been accounted for on the equity basis. No dividends were paid by HPMI during the two years ended December 31, 1997. HPMI provides leasing and property management services to other properties owned by certain third parties. In connection with the Separation Agreement (see above), the OP purchased the remaining 5% interest, including the voting interest. As such, the balance sheet of HPMI has been consolidated as of December 31, 1997.
Summary financial information for HPMI is presented as follows:
Revenues include services provided by HPMI to the OP which are summarized as follows:
Management fees are expensed by the OP as incurred. Leasing, legal, acquisition, and construction fees are capitalized and amortized over the useful lives of the related leases or assets.
CENTER TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
12. COMMITMENTS AND CONTINGENCIES
Operating Leases--The Company leases certain of its Properties under long- term ground leases which are accounted for as operating leases and which generally provide for contingent rents based on the Company's tenants' sales volume and renewal options. Five leases expire between 2001 and 2018 and provide for options to renew for additional periods of 20 to 30 years. Two additional leases expire in 2012 and 2050. Future minimum rental payments required during noncancelable lease terms as of December 31, 1998 are summarized as follows:
Assuming exercise of all renewal options, aggregate future rental payments as of December 31, 1998 are $53.3 million. Certain of the Company's ground leases contain participation features. Participation rents paid in accordance with such terms were $54,000, $51,000 and $105,000 for the years ended December 31, 1998, 1997, and 1996, respectively.
Litigation--The Company is subject to various legal proceedings and claims that arise in the ordinary course of business. These matters are generally covered by insurance. While the resolution of these matters cannot be predicted with certainty, management believes, based on currently available information, that the final outcome of such matters will not have a material adverse effect on the financial statements of the Company.
CENTER TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
13. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
The following table sets forth the selected quarterly financial data for the Company for the years ended December 31, 1998 and 1997 (in thousands, except per share data):
Included in the fourth quarter of 1998 is the $21.7 million charge related to the asset held for sale, as described in Note 3. The fourth quarter of 1997 includes the $9.4 million charge related to the Haagen Settlement as described in Note 11.
14. SUBSEQUENT EVENTS
Subsequent to December 31, 1998, the Company sold two of its Properties, the 194,000 square foot City Center in San Francisco, California and 119,000 square foot Sam's Club in Fountain Valley, California, one of the Company's single tenant facilities. The sales generated proceeds of $47 million which resulted in a combined net gain of approximately $21.1 million. In addition, the Company purchased Randolph Plaza, a 179,000 square foot community center located in Tucson, Arizona for approximately $9.5 million. The acquisition was funded with proceeds from the Company's credit facility. The Center is anchored by Fry's, Walgreen's and MacFrugal's.
On February 3, 1999 the Company commenced trading its Common Stock on the New York Stock Exchange under the ticker symbol CTA.
CENTER TRUST
SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS
Each of Three Years Ended December 31, 1998 (in thousands)
CENTER TRUST
SCHEDULE III--REAL ESTATE AND ACCUMULATED DEPRECIATION
December 31, 1998 (in thousands)
- ----- (1) Excludes the secured line of credit of $200,895 at December 31, 1998 which is secured by various properties.
The aggregate gross cost of rental property included above for federal income tax purposes approximated $1,041,000,000 as of December 31, 1998.
The following table reconciles the Historical Cost of Properties from January 1, 1996 to December 31, 1998:
The following table reconciles the Accumulated Depreciation from January 1, 1996 to December 31, 1998:
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information called for by this Item 10 is incorporated herein by reference to the information included under the captions "Election of Directors" and "Executive Officers" in the Company's definitive Proxy Statement for the 1999 Annual Meeting of Stockholders (the "Proxy Statement").
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information called for by this Item 11 is incorporated herein by reference to the information included under the caption "Executive Compensation" in the Company's Proxy Statement.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information called for by this Item 12 is incorporated herein by reference to the information included under the caption "Security Ownership of Certain Beneficial Owners and Management" in the Company's Proxy Statement.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information called for by this Item 13 is incorporated herein by reference to the information included under the caption "Certain Relationships and Related Transactions" in the Company's Proxy Statement.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
A. The following documents are filed as part of this report:
Schedules other than those listed above are omitted because they are not applicable, not required, or the information required to be set forth therein is included in the financial statements or the notes thereto.
The following exhibits are included as part of this Annual Report on Form 10-K as required by Item 601 of Regulation S-K. The exhibits identified by asterisks are the management contracts and compensatory plans or arrangements required to be filed as exhibits to this Annual Report on Form 10-K.
B. Reports on Form 8-K
None
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Manhattan Beach, State of California, on the 30th day of March, 1999.
CENTERTRUST RETAIL PROPERTIES, INC.
/s/ Edward D. Fox By: _________________________________ Edward D. Fox Chief Executive Officer and President
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
S-1