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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
(MARK ONE)
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2000
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ______________ TO ______________
COMMISSION FILE NO. 1-10150
--------------------------
ISTAR FINANCIAL INC. *
(Exact name of registrant as specified in its charter)
MARYLAND 95-6881527
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
1114 AVENUE OF THE AMERICAS, 27(TH) FLOOR 10036
NEW YORK, NY 10036 (Zip Code)
(Address of principal executive offices)
Registrant's telephone number, including area code: (212)930-9400
--------------------------
Securities registered pursuant to Section 12(b) of the Act:
Title of each class: Name of Exchange on which registered:
COMMON STOCK, $0.001 PAR VALUE NEW YORK STOCK EXCHANGE
9.375% SERIES B CUMULATIVE REDEEMABLE NEW YORK STOCK EXCHANGE
PREFERRED STOCK, $0.001 PAR VALUE
9.200% SERIES C CUMULATIVE REDEEMABLE NEW YORK STOCK EXCHANGE
PREFERRED STOCK, $0.001 PAR VALUE
8.000% SERIES D CUMULATIVE REDEEMABLE NEW YORK STOCK EXCHANGE
PREFERRED STOCK, $0.001 PAR VALUE
Securities registered pursuant to Section 12(g) of the Act: NONE
Indicate by check mark whether the registrant; (i) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports); and (ii) has been subject to such
filing requirements for the past 90 days. Yes /X/ No / /
As of May 5, 2000, there were 85,279,088 shares of common stock of IStar
Financial Inc., $0.001 par value per share outstanding ("Common Stock").
* On November 4, 1999, the registrant completed a transaction in which its
name was changed from Starwood Financial Trust to Starwood Financial Inc., it
issued Common Stock in exchange for the class A and class B shares then
outstanding, and the registrant listed its Common Stock on the New York Stock
Exchange. Further, effective on April 30, 2000, the registrant changed its name
to IStar Financial Inc.
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ISTAR FINANCIAL INC.
INDEX TO FORM 10-Q
PAGE
--------
PART I. CONSOLIDATED FINANCIAL INFORMATION.......................... 3
Item 1. FINANCIAL STATEMENTS:
CONSOLIDATED BALANCE SHEETS AT MARCH 31, 2000 AND
DECEMBER 31, 1999......................................... 3
CONSOLIDATED STATEMENTS OF OPERATIONS--FOR THE THREE MONTHS
ENDED MARCH 31, 2000 AND 1999............................. 4
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS'
EQUITY--FOR THE THREE MONTHS ENDED MARCH 31, 2000......... 5
CONSOLIDATED STATEMENTS OF CASH FLOWS--FOR THE THREE MONTHS
ENDED MARCH 31, 2000 AND 1999............................. 6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.................. 7
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF
OPERATIONS................................................ 32
PART II. OTHER INFORMATION........................................... 39
Item 1. LEGAL PROCEEDINGS........................................... 39
Item 2. CHANGES IN SECURITIES AND USE OF PROCEEDS................... 39
Item 3. DEFAULTS UPON SENIOR SECURITIES............................. 39
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS......... 39
Item 5. OTHER INFORMATION........................................... 39
Item 6. EXHIBITS AND REPORTS ON FORM 8-K............................ 39
SIGNATURES.................................................. 40
2
ISTAR FINANCIAL INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE AND SHARE DATA)
AS OF AS OF
MARCH 31, DECEMBER 31,
2000 1999
----------- ------------
(UNAUDITED)
ASSETS
Loans and other lending investments, net.................... $2,120,744 $2,003,506
Real estate subject to operating leases, net................ 1,664,350 1,714,284
Cash and cash equivalents................................... 41,710 34,408
Restricted cash............................................. 11,256 10,195
Marketable securities....................................... 95 4,344
Accrued interest and operating lease income receivable...... 17,624 16,211
Deferred operating lease income receivable.................. 3,429 1,147
Deferred expenses and other assets.......................... 37,081 29,074
Investment in IStar Operating Inc........................... 251 383
---------- ----------
Total assets.............................................. $3,896,540 $3,813,552
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Accounts payable, accrued expenses and other liabilities.... $ 52,154 $ 54,773
Dividends payable........................................... 5,225 53,667
Debt obligations............................................ 1,987,394 1,901,204
---------- ----------
Total liabilities......................................... 2,044,773 2,009,644
---------- ----------
Commitments and contingencies............................... -- --
Minority interests in consolidated entities................. 2,565 2,565
Shareholders' equity:
Series A Preferred Stock, $0.001 par value, liquidation
preference $50.00 per share, 4,400,000 shares authorized
and outstanding at March 31, 2000 and December 31, 1999,
respectively.............................................. 4 4
Series B Preferred Stock, $0.001 par value, liquidation
preference $25.00 per share, 2,000,000 shares issued and
outstanding at March 31, 2000 and December 31, 1999,
respectively.............................................. 2 2
Series C Preferred Stock, $0.001 par value, liquidation
preference $25.00 per share, 1,300,000 shares issued and
outstanding at March 31, 2000 and December 31, 1999,
respectively.............................................. 1 1
Series D Preferred Stock, $0.001 par value, liquidation
preference $25.00 per share, 4,000,000 shares issued and
outstanding at March 31, 2000 and December 31, 1999,
respectively.............................................. 4 4
Common Stock, $0.001 par value, 200,000,000 shares
authorized, 85,279,088 and 84,985,392 shares issued and
outstanding at March 31, 2000 and December 31, 1999,
respectively.............................................. 85 85
Warrants and options........................................ 17,935 17,935
Accumulated other comprehensive income (losses)............. -- (229)
Additional paid in capital.................................. 1,958,946 1,953,972
Retained earnings (deficit)................................. (87,230) (129,992)
Treasury stock (at cost).................................... (40,545) (40,439)
---------- ----------
Total shareholders' equity................................ 1,849,202 1,801,343
---------- ----------
Total liabilities and shareholders' equity................ $3,896,540 $3,813,552
========== ==========
The accompanying notes are an integral part of the financial statements.
3
ISTAR FINANCIAL INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
FOR THE THREE MONTHS
ENDED MARCH 31,
---------------------
2000 1999
--------- ---------
REVENUE:
Interest income........................................... $ 60,083 $ 49,919
Operating lease income.................................... 46,272 3,727
Other income.............................................. 4,533 1,778
-------- --------
Total revenue........................................... 110,888 55,424
-------- --------
COSTS AND EXPENSES:
Interest expense.......................................... 37,789 19,693
Property operating costs.................................. 3,325 --
Depreciation and amortization............................. 9,009 1,365
General and administrative................................ 6,903 484
Provision for possible credit losses...................... 1,500 1,000
Stock option compensation expense......................... 548 --
Advisory fees............................................. -- 4,665
-------- --------
Total costs and expenses................................ 59,074 27,207
-------- --------
Net income before minority interest, gain on sale and
extraordinary loss........................................ 51,814 28,217
Minority interest in consolidated entities.................. (41) --
Gain on sale of net lease assets............................ 533 --
-------- --------
Net income before extraordinary loss........................ 52,306 28,217
Extraordinary loss on early extinguishment of debt.......... (317) --
-------- --------
Net income.................................................. $ 51,989 $ 28,217
======== ========
Preferred dividend requirements............................. $ (9,227) $ (5,308)
-------- --------
Net income allocable to common shareholders................. $ 42,762 $ 22,909
======== ========
Basic earnings per common share(1).......................... $ 0.50 $ 0.43
======== ========
Diluted earnings per common share(1)........................ $ 0.50 $ 0.41
======== ========
EXPLANATORY NOTE:
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(1) Net income per basic common share excludes 1% of net income allocable to
the Company's class B shares prior to November 4, 1999. These shares were
exchanged for Common Stock in connection with the TriNet acquisition and
related transactions on November 4, 1999. As a result, the Company now has
a single class of Common Stock outstanding.
The accompanying notes are an integral part of the financial statements.
4
ISTAR FINANCIAL INC.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(IN THOUSANDS)
(UNAUDITED)
ACCUMULATED
SERIES A SERIES B SERIES C SERIES D COMMON WARRANTS OTHER
PREFERRED PREFERRED PREFERRED PREFERRED STOCK AND COMPREHENSIVE TREASURY
STOCK STOCK STOCK STOCK AT PAR OPTIONS INCOME STOCK
--------- --------- --------- --------- -------- -------- ------------- ---------
Balance at December 31, 1999...... $ 4 $ 2 $ 1 $ 4 $ 85 $ 17,935 $ (229) $ (40,439)
Dividends declared - preferred
stock........................... -- -- -- -- -- -- -- --
Acquisition of ACRE Partners...... -- -- -- -- -- -- -- --
Restricted stock units issued to
employees in lieu of cash
bonuses......................... -- -- -- -- -- -- -- --
Restricted stock units granted to
employees....................... -- -- -- -- -- -- -- --
Treasury stock.................... -- -- -- -- -- -- -- (106)
Change in accumulated other
comprehensive income............ -- -- -- -- -- -- 229 --
Net income for the period......... -- -- -- -- -- -- -- --
-------- -------- -------- -------- -------- -------- ---------- ---------
Balance at March 31, 2000......... $ 4 $ 2 $ 1 $ 4 $ 85 $ 17,935 $ -- $ (40,545)
======== ======== ======== ======== ======== ======== ========== =========
ADDITIONAL RETAINED
PAID-IN EARNINGS
CAPITAL (DEFICIT) TOTAL
----------- --------- ----------
Balance at December 31, 1999...... $ 1,953,972 $(129,992) $1,801,343
Dividends declared - preferred
stock........................... -- (9,227) (9,227)
Acquisition of ACRE Partners...... 3,637 -- 3,637
Restricted stock units issued to
employees in lieu of cash
bonuses......................... 1,125 -- 1,125
Restricted stock units granted to
employees....................... 212 -- 212
Treasury stock.................... -- -- (106)
Change in accumulated other
comprehensive income............ -- -- 229
Net income for the period......... -- 51,989 51,989
----------- --------- ----------
Balance at March 31, 2000......... $ 1,958,946 $ (87,230) $1,849,202
=========== ========= ==========
The accompanying notes are an integral part of the financial statements.
5
ISTAR FINANCIAL INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
FOR THE THREE MONTHS
ENDED MARCH 31,
-----------------------
2000 1999
--------- -----------
Cash flows from operating activities:
Net income.................................................. $ 51,989 $ 28,217
Adjustments to reconcile net income to cash flows provided
by operating activities:
Minority interest......................................... 41 --
Equity in (earnings) loss of unconsolidated joint ventures
and subsidiaries........................................ (324) 105
Depreciation and amortization............................. 11,134 2,905
Amortization of discounts/premiums, deferred interest and
costs on lending investments............................ (7,067) (7,302)
Distributions from operating joint ventures............... 952 --
Straight-line operating lease income adjustments.......... (2,282) --
Realized (gains) losses on sales of securities............ 229 --
Gain on sale of net lease assets.......................... (533) --
Extraordinary loss on early extinguishment of debt........ 317 --
Provision for possible credit losses...................... 1,500 1,000
Changes in assets and liabilities:
(Increase) decrease in restricted cash.................. (1,061) 1,553
(Increase) decrease in accrued interest and operating
lease income receivable................................ (1,413) 156
Increase in deferred expenses and other assets.......... (2,895) (411)
Decrease in accounts payable, accrued expenses and other
liabilities............................................ (4,756) (3,707)
--------- -----------
Cash flows provided by operating activities............... 45,831 22,516
--------- -----------
Cash flows from investing activities:
New loan or investment originations/acquisitions............ (211,925) (154,318)
Principal fundings on existing loan commitments............. (16,542) (7,127)
Net proceeds from sale of net lease assets.................. 45,291 --
Repayments of and principal collections from loans and other
lending investments....................................... 121,803 56,668
Net investments in and advances to unconsolidated joint
ventures.................................................. (668) --
Capital expenditures on real estate subject to operating
leases.................................................... (1,858) --
--------- -----------
Cash flows used in investing activities................... (63,899) (104,777)
--------- -----------
Cash flows from financing activities:
Net borrowings under revolving credit facilities............ 65,177 87,148
Borrowings under term loans................................. 30,000 29,717
Repayments under term loans................................. (9,726) --
Repayments under repurchase agreements...................... (119) (453)
Common dividends paid....................................... (48,441) (21,704)
Preferred dividends paid.................................... (9,144) (929)
Minority interest........................................... (41) --
Extraordinary loss on early extinguishment of debt.......... (317) --
Payment for deferred financing costs........................ (1,913) (4,813)
Purchase of treasury stock.................................. (106) --
Proceeds from exercise of options........................... -- 722
--------- -----------
Cash flows provided by financing activities............... 25,370 89,688
--------- -----------
Increase in cash and cash equivalents....................... 7,302 7,427
Cash and cash equivalents at beginning of period............ 34,408 10,110
--------- -----------
Cash and cash equivalents at end of period.................. $ 41,710 $ 17,537
========= ===========
Supplemental disclosure of cash flow information:
Cash paid during the period for interest.................. $ 36,850 $ 18,797
========= ===========
The accompanying notes are an integral part of the financial statements.
6
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1--ORGANIZATION AND BUSINESS
ORGANIZATION--IStar Financial Inc.(1) (the "Company") began its business in
1993 through private investment funds (collectively, the "Starwood Investors")
formed to capitalize on inefficiencies in the real estate finance market. In
March 1998, these funds contributed their approximately $1.1 billion of assets
to the Company's predecessor, Starwood Financial Trust, in exchange for a
controlling interest in that company. Since that time, the Company has grown by
originating new lending and leasing transactions, as well as through corporate
acquisitions. Specifically, in September 1998, the Company acquired the loan
origination and servicing business of a major insurance company, and in
December 1998, the Company acquired the mortgage and mezzanine loan portfolio of
its largest private competitor. Additionally, in November 1999, the Company
acquired TriNet Corporate Realty Trust, Inc. ("TriNet"), the largest publicly
traded company specializing in the net leasing of corporate office and
industrial facilities. The TriNet acquisition was structured as a
stock-for-stock merger of TriNet with a subsidiary of the Company. Concurrent
with the TriNet acquisition, the Company also acquired its external advisor (the
"Advisor Transaction") in exchange for shares of common stock, $0.001 par value,
of the Company ("Common Stock"), and converted its organizational form to a
Maryland corporation (the "Incorporation Merger"). As part of the conversion to
a Maryland corporation, the Company replaced its dual class common share
structure with a single class of Common Stock. The Company's Common Stock began
trading on the New York Stock Exchange under the symbol "SFI" in November 1999.
During 1993 through 1997, the Company did not qualify as a real estate
investment trust ("REIT") under the Internal Revenue Code of 1986, as amended
(the "Code"). However, pursuant to a closing agreement with the Internal Revenue
Service (the "IRS") obtained in March 1998, the Company was eligible and elected
to be taxed as a REIT for the taxable year beginning January 1, 1998.
BUSINESS--The Company believes it is the largest publicly traded finance
company in the United States focused exclusively on the commercial real estate
industry. The Company, which is taxed as a real estate investment trust,
provides structured mortgage, mezzanine and lease financing through its
nationwide origination, acquisition and servicing platform. The Company's
investment strategy targets specific sectors of the real estate credit markets
in which it can deliver value-added, flexible financial solutions to its
customers, thereby differentiating its financial products from those offered by
other capital providers.
The Company has implemented its investment strategy by: (i) focusing on the
origination of large, highly structured mortgage, mezzanine and lease financings
where customers require flexible financial solutions, and avoiding commodity
businesses in which there is significant direct competition from other providers
of capital; (ii) developing direct relationships with borrowers and corporate
tenants as opposed to sourcing transactions through intermediaries;
(iii) adding value beyond simply providing capital by offering borrowers and
corporate tenants specific lending expertise, flexibility, speed, certainty and
continuing relationships beyond the closing of a particular financing
transaction; and (iv) taking advantage of market anomalies in the real estate
financing markets when the Company believes credit is mispriced by other
providers of capital such as the spread between lease yields and the yields on
corporate tenants' underlying credit obligations.
The Company intends to continue to emphasize a mix of portfolio financing
transactions to create built-in diversification and single-asset financings for
properties with strong, long-term positioning.
EXPLANATORY NOTE:
- ------------------------------
(1) As more fully discussed in Note 4, on November 4, 1999, the Company changed
its form and became a corporation under Maryland law and changed its name
from Starwood Financial Trust to Starwood Financial Inc. Further, effective
on April 30, 2000, the registrant changed its name to IStar Financial Inc.
7
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 2--BASIS OF PRESENTATION
The accompanying unaudited Consolidated Financial Statements have been
prepared in conformity with the instructions to Form 10-Q and Article 10, Rule
10-01 of Regulation S-X for interim financial statements. Accordingly, they do
not include all of the information and footnotes required by generally accepted
accounting principles ("GAAP") for complete financial statements. The
Consolidated Financial Statements include the accounts of the Company, its
qualified REIT subsidiaries, and its majority-owned and controlled partnership.
Certain third-party mortgage servicing operations are conducted through IStar
Operating Inc. ("IStar Operating"), a taxable corporation which is not
consolidated with the Company for financial reporting or income tax purposes.
The Company owns all of the preferred stock and a 95% economic interest in IStar
Operating, which is accounted for under the equity method for financial
reporting purposes. In addition, the Company has an investment in TriNet
Management Operating Company, Inc. ("TMOC"), a taxable noncontrolled subsidiary
of the Company, which is also accounted for under the equity method. Further,
certain other investments in partnerships or joint ventures which the Company
does not control are also accounted for under the equity method. All significant
intercompany balances and transactions have been eliminated in consolidation.
In the opinion of management, the accompanying financial statements contain
all adjustments, consisting of normal and recurring accruals, necessary for a
fair presentation of the Company's financial condition at March 31, 2000 and
December 31, 1999 and the results of its operations, changes in shareholders'
equity and its cash flows for the three-month periods ended March 31, 2000 and
1999, respectively. Such operation results are not necessarily indicative of the
results that may be expected for any other interim periods or the entire year.
NOTE 3--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
LOANS AND OTHER LENDING INVESTMENTS, NET--As described in Note 5 "Loans and
Other Lending Investments," includes the following investments: senior
mortgages, subordinate mortgages, partnership loans/ unsecured notes, loan
participations and other lending investments. In general, management considers
its investments in this category as held-to-maturity and, accordingly, reflects
such items at amortized historical cost.
REAL ESTATE SUBJECT TO OPERATING LEASES AND DEPRECIATION--Real estate
subject to operating leases is generally recorded at cost. Certain improvements
and replacements are capitalized when they extend the useful life, increase
capacity or improve the efficiency of the asset. Repairs and maintenance items
are expensed as incurred. The Company capitalizes interest costs incurred during
the land development or construction period on qualified development projects
including investments in joint ventures accounted for under the equity method.
Depreciation is computed using the straight line method of cost recovery over
estimated useful lives of 40.0 years for buildings, seven years for furniture
and equipment, the shorter of the remaining lease term or expected life for
tenant improvements, and the remaining life of the building for building
improvements.
Real estate assets to be disposed of are reported at the lower of their
carrying amount or fair value less cost to sell. The Company also periodically
reviews long-lived assets to be held and used for an impairment in value
whenever events or changes in circumstances indicate that the carrying amount of
such assets may not be recoverable. In management's opinion, real estate assets
to be held and used are not carried at amounts in excess of their estimated
recoverable amounts.
8
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 3--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
CASH AND CASH EQUIVALENTS--Cash and cash equivalents include cash held in
banks or invested in money market funds with original maturity terms of less
than 90 days.
MARKETABLE SECURITIES--From time to time, the Company invests excess working
capital in marketable securities such as those issued by the Government National
Mortgage Association (GNMA), Federal National Mortgage Association (FNMA), and
Federal Home Loan Mortgage Corporation (FHLMC). Although the Company generally
intends to hold such investments for investment purposes, it may, from time to
time, sell any of its investments in these securities as part of its management
of liquidity. Accordingly, the Company considers such investments as
"available-for-sale" and reflects such investments at fair market value with
changes in fair market value reflected as a component of shareholders' equity.
REPURCHASE AGREEMENTS--The Company may enter into sales of securities or
loans under agreements to repurchase the same security or loan. The amounts
borrowed under repurchase agreements are carried on the balance sheet as part of
debt obligations at the amount advanced plus accrued interest. Interest incurred
on the repurchase agreements is reported as interest expense.
REVENUE RECOGNITION--The Company's revenue recognition policies are as
follows:
LOANS AND OTHER LENDING INVESTMENTS: The Company generally intends to hold
all of its loans and other lending investments to maturity. Accordingly, it
reflects all of these investments at amortized cost less allowance for loan
losses, acquisition premiums or discounts, deferred loan fees and undisbursed
loan funds. The Company may acquire loans at either premiums or discounts based
on the credit characteristics of such loans. These premiums or discounts are
recognized as yield adjustments over the lives of the related loans. If loans
that were acquired at a premium or discount are prepaid, the Company immediately
recognizes the unamortized premium or discount as a decrease or increase in the
prepayment gain or loss, respectively. Loan origination or exit fees, as well as
direct loan origination costs, are also deferred and recognized over the lives
of the related loans as a yield adjustment. Interest income is recognized using
the effective interest method applied on a loan-by-loan basis.
Certain of the Company's loans provide for accrual of interest at specified
rates which differ from current payment terms. Interest is recognized on such
loans at the accrual rate subject to management's determination that accrued
interest and outstanding principal are ultimately collectible, based on the
underlying collateral and operations of the borrower.
Prepayment penalties or yield maintenance payments from borrowers are
recognized as additional income when received. Certain of the Company's loan
investments provide for additional interest based on the borrower's operating
cash flow or appreciation of the underlying collateral. Such amounts are
considered contingent interest and are reflected as income only upon certainty
of collection.
LEASING INVESTMENTS: Operating lease revenue is recognized on the
straight-line method of accounting from the later of the date of the origination
of the lease or the date of acquisition of the facility subject to existing
leases. Accordingly, contractual lease payment increases are recognized evenly
over the term of the lease. The difference between lease revenue recognized
under this method and actual cash receipts is recorded as a deferred rent
receivable on the balance sheet.
PROVISION FOR POSSIBLE CREDIT LOSSES--The Company's accounting policies
require that an allowance for estimated credit losses be maintained at a level
that management, based upon an evaluation of known and inherent risks in the
portfolio, considers adequate to provide for possible credit losses. Specific
valuation allowances are established for impaired loans in the amount by which
the carrying value, before allowance
9
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 3--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
for estimated losses, exceeds the fair value of collateral less disposition
costs on an individual loan basis. Management considers a loan to be impaired
when, based upon current information and events, it believes that it is probable
that the Company will be unable to collect all amounts due according to the
contractual terms of the loan agreement on a timely basis. Management measures
these impaired loans at the fair value of the loans' underlying collateral less
estimated disposition costs. Impaired loans may be left on accrual status during
the period the Company is pursuing repayment of the loan, however, these loans
are placed on non-accrual status at such time that the loans either: (i) become
90 days delinquent; or (ii) management determines the borrower is incapable of,
or has ceased efforts toward, curing the cause of the impairment. While on
non-accrual status, interest income is recognized only upon actual receipt.
Impairment losses are recognized as direct write-downs of the related loan with
a corresponding charge to the provision for possible credit losses. Charge-offs
occur when loans, or a portion thereof, are considered uncollectible and of such
little value that further pursuit of collection is not warranted. Management's
periodic evaluation of the allowance for possible credit losses is based upon an
analysis of the portfolio, historical and industry loss experience, economic
conditions and trends, collateral values and quality and other relevant factors.
INCOME TAXES--The Company did not qualify as a REIT from 1993 through 1997;
however, it did not incur any material tax liabilities as a result of its
operations. See Note 10 to the Consolidated Financial Statements for more
information.
As confirmed in a closing agreement with the IRS obtained in March 1998, the
Company was eligible and elected to be taxed as a REIT for its tax year
beginning January 1, 1998. As a REIT, the Company will be subject to federal
income taxation at corporate rates on its REIT taxable income; however, the
Company is allowed a deduction for the amount of dividends paid to its
stockholders, thereby subjecting the distributed net income of the Company to
taxation at the shareholder level only. IStar Operating and TMOC are not
consolidated for federal income tax purposes and are taxed as corporations. For
financial reporting purposes, current and deferred taxes are provided for in the
portion of earnings recognized by the Company with respect to its interest in
IStar Operating and TMOC.
NET INCOME ALLOCABLE TO COMMON SHARES--Net income allocable to common shares
excludes 1% of net income allocable to the class B shares prior to November 4,
1999. The class A and class B shares were exchanged for Common Stock in
connection with the TriNet acquisition, as more fully described in Note 4.
EARNINGS (LOSS) PER COMMON SHARES--In February 1997, the Financial
Accounting Standards Board ("FASB") issued Statement of Financial Accounting
Standards No. 128, "Earnings per Share" ("SFAS No. 128") effective for periods
ending after December 15, 1997. SFAS No. 128 simplifies the standard for
computing earnings per share and makes them comparable with international
earnings per share standards. The statement replaces primary earnings per share
with basic earnings per share ("Basic EPS") and fully-diluted earnings per share
with diluted earnings per share ("Diluted EPS").
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.
NEW ACCOUNTING STANDARDS--In June 1997, the FASB issued Statement of
Financial Accounting Standards No. 131, "Disclosure about Segments of an
Enterprise and Related Information" ("SFAS No. 131")
10
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 3--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
effective for financial statements issued for periods beginning after
December 15, 1997. SFAS No. 131 requires disclosures about segments of an
enterprise and related information regarding the different types of business
activities in which an enterprise engages and the different economic
environments in which it operates. The Company adopted the requirements of this
pronouncement in its financial statements beginning with its reporting for
fiscal 1999. As of March 31, 2000, the Company maintains two basic business
segments for reporting purposes: real estate lending and credit tenant leasing.
In June 1998, the FASB issued Statement of Financial Accounting Standards
No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS
No. 133"). On June 23, 1999 the FASB voted to defer the effectiveness of
SFAS 133 for one year. SFAS 133 is now effective for fiscal years beginning
after June 15, 2000, but earlier application is permitted as of the beginning of
any fiscal quarter subsequent to June 15, 1998. SFAS No. 133 establishes
accounting and reporting standards for derivative financial instruments and
hedging activities. It requires that an entity recognize all derivatives as
either assets or liabilities in the statement of financial position and measure
those instruments as fair value. If certain conditions are met, a derivative may
be specifically designated as: (i) a hedge of the exposure to changes in the
fair value of a recognized asset or liability or an unrecognized firm
commitment; (ii) a hedge of the exposure to variable cash flows of a forecasted
transaction; or (iii) in certain circumstances a hedge of a foreign currency
exposure. The Company currently plans to adopt this pronouncement as required
effective January 1, 2001. The adoption of SFAS 133 is not expected to have a
material financial impact on the financial position or results of operations of
the Company.
NOTE 4--CAPITAL TRANSACTIONS
PRIOR TRANSACTIONS WITH AFFILIATES--Through a series of transactions
beginning in November 1993 and through March 18, 1998, the date of the
Recapitalization Transactions described in the following section, Starwood
Mezzanine Investors, L.P. ("Starwood Mezzanine") and certain other affiliates
(collectively, the "Starwood Investors") had acquired controlling interests in
the Company represented by an aggregate of 874,016 class A shares, or 69.46% of
the then total class A shares outstanding, and 629,167 class B shares,
representing 100% of the then total class B shares outstanding. Together, the
class A and class B shares held by the Starwood Investors represented 79.64% of
the voting interests of the Company.
During the quarter ended March 31, 1998, the Company consummated certain
transactions and entered into agreements which significantly recapitalized and
expanded its capital resources, as well as modified future operations, including
those described herein below in "Recapitalization Transactions" and "Advisor
Transaction."
RECAPITALIZATION TRANSACTIONS--As more fully discussed above, pursuant to a
series of transactions beginning in March 1994 and including the exercise of the
Class A and Class B Warrants in January 1997, the Starwood Investors acquired
joint ownership of 69.46% and 100% of the outstanding class A shares and
class B shares of the Company, respectively, through which they controlled
approximately 79.64% of the voting interests in the Company as of December 31,
1997. Prior to the consummation of these transactions (collectively, the
"Recapitalization Transactions"), Starwood Mezzanine also owned 761,491 units
which represented the remaining 91.95% of APMT Limited Partnership not held by
the Company. Those units were convertible into cash, an additional 761,491
class A shares of the Company, or a combination of the two, as determined by the
Company.
11
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 4--CAPITAL TRANSACTIONS (CONTINUED)
On March 18, 1998, each outstanding unit held by Starwood Mezzanine was
exchanged for one class A share of the Company and, concurrently, the
partnership was liquidated through a distribution of its net assets to the
Company, its then sole partner.
Simultaneously, Starwood Mezzanine contributed various real estate loan
investments to the Company in exchange for 9,191,333 class A shares and
$25.5 million in cash, as adjusted. Starwood Opportunity Fund IV, L.P., one of
the Starwood Investors ("SOF IV"), contributed loans and other lending
investments, $17.9 million in cash and certain letters of intent in exchange for
41,179,133 class A shares of the Company and a cash payment of $324.3 million.
Concurrently, the holders of the class B shares who were affiliates of the
Starwood Investors acquired 25,565,979 additional class B shares sufficient to
maintain existing voting preferences pursuant to the Company's Amended and
Restated Declaration of Trust. Immediately after these transactions, the
Starwood Investors owned approximately 99.27% of the outstanding class A shares
of the Company and 100% of the class B shares. Assets acquired from Starwood
Mezzanine have been reflected using step acquisition accounting at predecessor
basis adjusted to fair value to the extent of post-transaction third-party
ownership. Assets acquired from SOF IV have been reflected at their fair market
value.
ADVISORY AGREEMENT--In connection with the Recapitalization Transactions,
the Company and the Advisor, an affiliate of the Starwood Investors, entered
into an Advisory Agreement (the "Advisory Agreement") pursuant to which the
Advisor managed the affairs of the Company, subject to the Company's purpose and
investment policy, the investment restrictions and the directives of the Board
of Directors. The services provided by the Advisor included the following:
(i) identifying investment opportunities for the Company; (ii) advising the
Company with respect to and effecting acquisitions and dispositions of the
Company's investments; (iii) monitoring, managing and servicing the Company's
loan portfolio; and (iv) arranging debt financing for the Company. The Advisor
was prohibited from acting in a manner inconsistent with the express direction
of the Board of Directors, and reported to the Board of Directors and the
officers of the Company with respect to its activities.
The Company paid the Advisor a quarterly base management fee of 0.3125%
(1.25% per annum) of the "Book Equity Value" of the Company determined as of the
last day of each quarter but estimated and paid in advance subject to
recomputation. "Book Equity Value" was generally defined as the excess of the
book value of the assets of the Company over all liabilities of the Company.
In addition, the Company paid the Advisor a quarterly incentive fee of 5.00%
of the Company's "Adjusted Net Income" during each quarter that the Adjusted Net
Income for such quarter (restated and annualized as a rate of return on the
Company's Book Equity Value for such quarter) equaled or exceeded the "Benchmark
BB Rate." "Adjusted Net Income" was generally defined as the Company's gross
income less the Company's expenses for the applicable quarter (including the
base fee for such quarter but not the incentive fee for such quarter). In
calculating both Book Equity Value and Adjusted Net Income, real estate-related
depreciation and amortization (other than amortization of financing costs and
other prepaid expenses to the extent such costs and prepaid expenses have
previously been booked as an asset of the Company) were not deducted. The
Advisor was also reimbursed for certain expenses it incured on behalf of the
Company.
The Advisory Agreement had an initial term of three years subject to
automatic renewal for one-year periods unless the Company had been liquidated or
a Termination Event (as defined in the Advisory Agreement and which generally
included violations of the Advisory Agreement by the Advisor, a
12
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 4--CAPITAL TRANSACTIONS (CONTINUED)
bankruptcy event of the Advisor or the imposition of a material liability on the
Company as a result of the Advisor's bad faith, willful misconduct, gross
negligence or reckless disregard of duties) had occurred and was continuing. In
addition, the Advisor could have terminated the Advisory Agreement on 60 days'
written notice to the Company and the Company could have terminated the Advisory
Agreement upon 60 days' written notice if a Termination Event had occurred or if
the decision to terminate were based on affirmative vote of the holders of two
thirds or more of the voting shares of the Company at the time outstanding.
Prior to the transactions described below through which, among other things,
the Company became internally-managed, the Company was dependent on the services
of the Advisor and its officers and employees for the successful execution of
its business strategy.
1999 TRANSACTIONS--On November 3, 1999, consistent with previously announced
terms, the Company's shareholders approved a series of transactions including:
(i) the acquisition, through a merger, of TriNet; (ii) the acquisition, through
a merger and a contribution of interests, of 100% of the ownership interests in
the Advisor; and (iii) the change in form, through a merger, of the Company's
organization into a Maryland corporation. TriNet stockholders also approved the
TriNet acquisition on November 3, 1999. These transactions were consummated on
November 4, 1999. As part of these transactions, the Company also changed its
name to Starwood Financial Inc. and replaced its dual class common share
structure with a single class of Common Stock.
TRINET ACQUISITION--TriNet merged with and into a subsidiary of the Company,
with TriNet surviving as a wholly-owned subsidiary of the Company (the "Leasing
Subsidiary"). In the TriNet acquisition, each share of TriNet common stock was
converted into 1.15 shares of Common Stock, resulting in an aggregate issuance
of 28.9 million shares of Common Stock. Each share of TriNet Series A, Series B
and Series C Cumulative Redeemable Preferred Stock was converted into a share of
Series B, Series C or Series D (respectively) Cumulative Redeemable Preferred
Stock of the Company. The Company's preferred stock issued to the former TriNet
preferred stockholders has substantially the same terms as the TriNet preferred
stock, except that the new Series B, C, and D preferred stock has additional
voting rights not associated with the TriNet preferred stock. The holders of the
Company's Series A preferred stock will retain the same rights and preferences
as existed prior to the TriNet acquisition.
The TriNet acquisition was accounted for as a purchase. Because the
Company's stock prior to the transaction was largely held by the Starwood
Investors, and, as a result, the stock was not widely traded relative to the
amount of shares outstanding, the pro forma financial information presented
below was prepared utilizing a stock price of $28.14 per TriNet share, which was
the average stock price of TriNet during the five-day period before and after
the TriNet acquisition was agreed to and announced.
ADVISOR TRANSACTION--Contemporaneously with the consummation of the TriNet
acquisition, the Company acquired 100% of the interests in the Advisor in
exchange for total consideration of four million shares of Common Stock. For
accounting purposes, the Advisor Transaction was not considered the acquisition
of a "business" in applying Accounting Principles Board Opinion No. 16,
"Business Combinations" and, therefore, the market value of the Common Stock
issued in excess of the fair value of the net tangible assets acquired of
approximately $94.5 million was charged to operating income as a one-time item
in the fourth quarter of 1999, rather than capitalized as goodwill.
INCORPORATION MERGER--Prior to the consummation of the TriNet acquisition
and the Advisor Transaction, the Company changed its form from a Maryland trust
to a Maryland corporation in the Incorporation
13
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 4--CAPITAL TRANSACTIONS (CONTINUED)
Merger, which technically involved a merger of the Company with a wholly-owned
subsidiary formed solely to effect such merger. In the Incorporation Merger, the
class B shares were converted into shares of Common Stock on a 49-for-one basis
(the same ratio at which class B shares were previously convertible into
class A shares), and the class A shares were converted into shares of Common
Stock on a one-for-one basis. As a result, the Company no longer has multiple
classes of common shares. The Incorporation Merger was treated as a transfer of
assets and liabilities under common control. Accordingly, the assets and
liabilities transferred from Starwood Financial Trust to Starwood
Financial Inc. were reflected at their predecessor basis and no gain or loss was
recognized.
The Company declared and paid a special dividend of one million shares of
its Common Stock payable pro rata to all holders of record of its Common Stock
following completion of the Incorporation Merger, but prior to the effective
time of the TriNet acquisition and the Advisor Transaction.
PRO FORMA INFORMATION--The summary unaudited pro forma consolidated
statement of operations for the three-month period ended March 31, 1999 is
presented as if the following transactions, consummated in November 1999, had
occurred on January 1, 1999: (i) the TriNet acquisition; (ii) the Advisor
Transaction; and (iii) the borrowing necessary to consummate the aforementioned
transactions. The unaudited pro forma information is based upon the historical
consolidated results of operations of the Company and TriNet for the three-month
period ended March 31, 1999, after giving effect to the events described above.
14
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 4--CAPITAL TRANSACTIONS (CONTINUED)
PRO FORMA
CONSOLIDATED STATEMENT OF OPERATIONS
(IN THOUSANDS, EXCEPT FOR PER SHARE DATA)
FOR THE THREE
MONTHS ENDED
MARCH 31, 1999
------------------
(UNAUDITED)
REVENUE:
Interest income........................................... $ 52,089
Operating lease income.................................... 47,275
Other income.............................................. 2,127
--------
Total revenue........................................... 101,491
--------
EXPENSES:
Interest expense.......................................... 32,830
Property operating costs.................................. 2,897
Depreciation and amortization............................. 9,010
General and administrative................................ 5,241
Provision for possible credit losses...................... 1,000
Stock option compensation expense......................... 549
--------
Total expenses.......................................... 51,527
--------
Income before minority interest........................... 49,964
Minority interest in consolidated entities................ (41)
--------
Net income from continuing operations..................... $ 49,923
Preferred dividend requirements........................... (9,227)
--------
Net income from continuing operations allocable to common
shareholders............................................ $ 40,696
========
BASIC EARNINGS PER SHARE:
Basic earnings per common share........................... $ 0.47
========
Weighted average number of common shares outstanding...... 87,245
========
Investments and dispositions are assumed to have taken place as of
January 1, 1999; however, loan originations and acquisitions are not reflected
in these pro forma numbers until the actual origination or acquisition date by
the Company. General and administrative costs represent estimated expense levels
as an internally-managed Company.
The pro forma financial information is not necessarily indicative of what
the consolidated results of operations of the Company would have been as of and
for the periods indicated, nor does it purport to represent the results of
operations for future periods.
15
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 5--LOANS AND OTHER LENDING INVESTMENTS
The following is a summary description of the Company's loans and other
lending investments (in thousands):
CARRYING VALUE AS OF
# OF ORIGINAL PRINCIPAL --------------------------
BORROWERS COMMITMENT BALANCES MARCH 31, DECEMBER 31,
TYPE OF INVESTMENT UNDERLYING PROPERTY TYPE IN CLASS AMOUNT OUTSTANDING 2000 1999
- --------------------------- --------------------------- --------- ------------ ----------- ----------- ------------
(UNAUDITED)
Senior Mortgages Office/Hotel/Mixed Use/ 19 $ 975,493 $ 880,989 $ 880,904 $ 938,040
Apartment/Retail/Resort
Subordinated Mortgages (4) Office/Hotel/Mixed Use/ 18 580,835 544,192 527,493 540,441
Retail/Conference Center
Partnership Loans/Unsecured Office/Hotel/Residential/Land 14 408,273 400,685 398,312 309,768
Notes
Loan Participations Office/Retail 4 168,747 133,031 132,886 152,782
Other Lending Investments Real Estate-Related N/A N/A N/A 190,149 69,975
Securities/Ventures
---------- ----------
Gross Carrying Value $2,129,744 $2,011,006
Provision for Possible ) )
Credit Losses (9,000 (7,500
---------- ----------
Total, Net $2,120,744 $2,003,506
========== ==========
EFFECTIVE PRINCIPAL PARTICI-
MATURITY CONTRACTUAL INTEREST CONTRACTUAL INTEREST AMORTIZ- PATION
TYPE OF INVESTMENT DATES PAYMENT RATES(1) ACCRUAL RATES(3) ATION FEATURES
- --------------------------- ------------- ----------------------- ----------------------- --------- --------
Senior Mortgages 2000 to 2009 Fixed: 7.28% to 18.00% Fixed: 7.28% to 20.00% Yes (2) Yes (3)
Variable: LIBOR + 1.25% Variable: LIBOR + 1.25%
to 5.00% to 5.00%
Subordinated Mortgages (4) 2000 to 2007 9.53% to 15.25% 9.53% to 17.00% Yes (2) Yes (3)
Variable: LIBOR + 4.50% Variable: LIBOR + 4.00%
to 5.80% to 5.80%
Partnership Loans/Unsecured 2000 to 2028 8.00% to 15.00% 8.50% to 17.50% Yes Yes (3)
Notes Variable: LIBOR + 5.37% Variable: LIBOR + 5.37%
to 7.50% to 7.50%
Loan Participations 2000 to 2005 Fixed: 10.00% to 13.60% Fixed: 10.00% to 13.60% No Yes (3)
Variable: LIBOR + 4.00% Variable: LIBOR + 4.00%
to 6.00% to 6.00%
Other Lending Investments 2002 and 2007 Fixed: 10.00% to 12.75% Fixed: 10.00% to 12.75% No No
Gross Carrying Value
Provision for Possible
Credit Losses
Total, Net
EXPLANATORY NOTES:
- ----------------------------------
(1) Substantially all variable-rate loans are based on 30-day LIBOR and reprice
monthly.
(2) The loans require fixed payments of principal and interest resulting in
partial principal amortization over the term of the loan with the remaining
principal due at maturity. In addition, one of the loans permits additional
annual prepayments of principal of up to $1.3 million without penalty at the
borrower's option.
(3) Under some of these loans, the lender receives additional payments
representing additional interest from participation in available cash flow
from operations of the property and the proceeds, in excess of a base
amount, arising from a sale or refinancing of the property.
(4) As of March 31, 2000 and December 31, 1999, the unfunded commitment amount
on one of the Company's construction loans, included in subordinated
mortgages, was $8.9 million and $16.2 million, respectively.
16
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 5--LOANS AND OTHER LENDING INVESTMENTS (CONTINUED)
During the three-month periods ended March 31, 2000 and 1999, respectively,
the Company and its affiliated ventures originated or acquired an aggregate of
approximately $211.9 million and $152.1 million in loans and other lending
investments, funded $16.5 million and $7.1 million under existing loan
commitments and received principal repayments of $117.6 million and
$56.7 million.
The Company has reflected additional provisions for possible credit losses
of approximately $1.5 million and $1.0 million in its results of operations
during the three months ended March 31, 2000 and 1999, respectively. There was
no other activity in the Company's reserve balances during this period. These
provisions represent portfolio reserves based on management's evaluation of
general market conditions, the Company's and industry loss experience,
likelihood of delinquencies or defaults and the underlying collateral. No direct
impairment reserves on specific loans were considered necessary. Management may
transfer reserves between general and specific reserves as considered necessary.
NOTE 6--REAL ESTATE SUBJECT TO OPERATING LEASES
The Company's investments in real estate subject to operating leases, at
cost, were as follows (in thousands):
MARCH 31, DECEMBER 31,
2000 1999
----------- ------------
(UNAUDITED)
Buildings and improvements.......................... $1,346,564 $1,390,933
Land and land improvements.......................... 271,367 277,872
Less accumulated depreciation....................... (13,737) (14,627)
---------- ----------
1,604,194 1,654,178
Investments in unconsolidated joint ventures........ 60,156 60,106
---------- ----------
Real estate subject to operating leases,
net......................................... $1,664,350 $1,714,284
========== ==========
Under certain leases, the Company receives additional participating lease
payments to the extent gross revenues of the tenant exceed a base amount. The
Company earned no such additional participating lease payments in the
three-month period ended March 31, 2000.
At March 31, 2000, the Company had investments in five joint ventures:
(i) TriNet Sunnyvale Partners L.P. ("Sunnyvale") whose external partners are
John D. O'Donnell, Trustee, John W. Hopkins, and Donald S. Grant;
(ii) Corporate Technology Associates LLC ("CTC I") whose external member is
Corporate Technology Centre Partners LLC; (iii) Sierra Land Ventures ("Sierra"),
whose external joint venture partner is Sierra-LC Land, Ltd.; (iv) Corporate
Technology Centre Associates II LLC ("CTC II") whose external joint venture
member is Corporate Technology Centre Partners II LLC; and (v) TriNet Milpitas
Associates, LLC ("Milpitas") whose external member is The Prudential Insurance
Company of America, for the purpose of operating, acquiring and in certain
cases, developing properties. Effective November 22, 1999, the joint venture
partners, who are affiliates of Whitehall Street Real Estate Limted Partnership,
IX and The Goldman Sachs Group L.P. (the "Whitehall Group") in W9/TriNet
Poydras, LLC ("Poydras") elected to exercise their right under the partnership
agreement, which was accelerated as a result of the TriNet acquisition, to
exchange all of their membership units for 350,746 shares of Common Stock of the
Company and a $767,000 distribution of available cash. As a consequence, Poydras
is now wholly owned and is reflected on a consolidated basis in these financial
statements.
17
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 6--REAL ESTATE SUBJECT TO OPERATING LEASES (CONTINUED)
At March 31, 2000, the ventures comprised 25 net leased facilities totaling
1.7 million square feet, 18.3 acres of land under development and 28.4 acres of
land held for development and sale. The Company's combined investment in these
joint ventures at March 31, 2000 was $60.2 million. The joint ventures' purchase
price for the 25 operating facilities owned at March 31, 2000 was
$269.9 million. The purchase price of the land, both under development, or held
for development, was approximately $38.6 million. In the aggregate, the joint
ventures had total assets of $343.3 million, total liabilities of
$261.4 million, and net income of $0.7 million. The Company accounts for these
investments under the equity method because its joint venture partners have
certain participating rights which limit the Company's control. The Company's
investments in and advances to unconsolidated joint ventures, its percentage
ownership interests, its respective income and pro rata share of third-party
debt as of March 31, 2000 are presented below (in thousands):
ACCRUED JOINT
UNCONSOLIDATED OWNERSHIP EQUITY NOTES INTEREST TOTAL VENTURE INTEREST TOTAL
JOINT VENTURE % INVESTMENT RECEIVABLE RECEIVABLE INVESTMENT INCOME INCOME INCOME
- ---------------------- ---------- ---------- ---------- ---------- ---------- -------- -------- --------
Operating:
Sunnyvale........... 44.7% $ 13,616 $ -- $ -- $ 13,616 $ 310 $ -- $ 310
CTC II.............. 50.0% 4,320 21,205 4,790 30,315 (273) 1,312 1,039
Milpitas............ 50.0% 20,647 -- -- 20,647 629 -- 629
Development:
Sierra.............. 50.0% 5,354 -- -- 5,354 (155) -- (155)
CTC I............... 50.0% 16,219 -- -- 16,219 (55) -- (55)
-------- -------- -------- -------- -------- ------- --------
Total $ 60,156 $ 21,205 4,790 $ 86,151 $ 456 $ 1,312 $ 1,768
======== ======== ======== ======== ======== ======= ========
PRO RATA
SHARE OF
UNCONSOLIDATED THIRD-PARTY
JOINT VENTURE DEBT
- ---------------------- -----------
Operating:
Sunnyvale........... $ 7,416
CTC II.............. 8,240
Milpitas............ 41,011
Development:
Sierra.............. 2,588
CTC I............... 35,390
--------
Total $ 94,645
========
At March 31, 2000 the Company was the guarantor for 50% of CTC I's
$70.8 million construction loan. Additionally, if the Company agrees with its
joint venture partner to commence the development of phase II of the project. As
a result, it has an additional commitment to fund further development costs in
the amount of approximately $10.0 million. This amount will vary depending upon
the amount of senior third-party financing obtained.
Currently, the limited partners of the Sunnyvale partnership have the option
to convert their partnership interest into cash; however, the Company may elect
to deliver 297,728 shares of Common Stock in lieu of cash. Additionally,
commencing in February 2002, subject to acceleration under certain
circumstances, partnership units held by certain partners of Milpitas may be
converted into 984,476 shares of Common Stock.
18
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 7--DEBT OBLIGATIONS
As of March 31, 2000 and December 31, 1999, the Company has debt obligations
under various arrangements with financial institutions as follows (in
thousands):
MAXIMUM CARRYING VALUE AS OF STATED SCHEDULED
AMOUNT MARCH 31, DECEMBER 31, INTEREST MATURITY
AVAILABLE 2000 1999 RATES DATE
---------- ----------- ------------- -------------------------- ----------------------
(UNAUDITED)
SECURED REVOLVING CREDIT
FACILITIES:
Line of credit............... $ 675,000 $ 649,249 $ 592,984 LIBOR + 1.50% March 2001
Line of credit............... 500,000 203,964 169,952 LIBOR + 1.50% - 1.75%(1) August 2002(1)
---------- ---------- ----------
Total secured revolving 1,175,000 853,213 762,936
credit facilities...........
UNSECURED REVOLVING CREDIT
FACILITIES:
Line of credit............... 350,000 144,600 186,700 LIBOR + 1.55% May 2001
Line of credit............... 50,000 17,000 -- LIBOR + 2.00% - 2.25% January 2002
---------- ---------- ----------
Total revolving credit $1,575,000 1,014,813 949,636
facilities..................
==========
SECURED TERM LOANS:
Secured by real estate under operating 152,865 153,618 7.44% March 2009
leases..................................
Secured by senior and subordinate 109,062 109,398 LIBOR + 1.00% August 2000
mortgage investments....................
Secured by senior mortgage investment.... 90,623 90,902 LIBOR + 1.00% August 2000
Secured by mezzanine investment.......... 30,000 -- LIBOR + 3.50% June 2000
Secured by real estate under operating 78,610 78,610 LIBOR + 1.38% June 2001
leases..................................
Secured by real estate under operating 64,925 73,279 Fixed: 6.00% + 11.30% (3)
leases.................................. Variable: LIBOR + 1.00%
Secured by senior mortgage investment.... 54,000 54,000 LIBOR + 1.75% (2) May 2000(2)
---------- ----------
Total term loans......................... 580,085 559,807
Less debt discounts...................... (388) (521)
---------- ----------
Total secured term loans................. 579,697 559,286
UNSECURED NOTES:
6.75% Dealer Remarketable Securities 125,000 125,000 6.75% March 2013
(4).....................................
7.30% Notes.............................. 100,000 100,000 7.30% March 2001
7.70% Notes.............................. 100,000 100,000 7.70% July 2017
7.95% Notes.............................. 50,000 50,000 7.95% May 2006
---------- ----------
Total unsecured notes.................... 375,000 375,000
Less debt discount (5)................... (20,756) (21,481)
---------- ----------
Total unsecured notes.................... 354,244 353,519
OTHER DEBT OBLIGATIONS....................... 38,640 38,763 Various Various
---------- ----------
TOTAL DEBT OBLIGATIONS....................... $1,987,394 $1,901,204
========== ==========
EXPLANATORY NOTES:
- ----------------------------------
(1) On February 4, 2000, the Company extended the term of its $500.0 million
facility to August 2002 and increased pricing under the facility to LIBOR +
1.50% to 1.75%.
(2) Based on a 12-month LIBOR contract currently at 5.317%, repricing in May
2000. Subsequent to quarter end, the Company extended its $54.0 million term
loan to November 2000.
(3) Other mortgage loans mature at various dates through 2010.
(4) Subject to mandatory tender on March 31, 2003, to either the Dealer or the
Leasing Subsidiary. The initial coupon of 6.75% applies to first five-year
term through the mandatory tender date. If tendered to the Dealer, the notes
must be remarketed. The rates reset upon remarketing.
(5) These obligations were assumed as part of the TriNet acquisition. As part of
the accounting for the purchase, these fixed rate obligations were
considered to have stated interest rates which were below the then
prevailing market rates at which the Leasing Subsidiary could issue new debt
obligations and, accordingly, the Company ascribed a market discount to each
obligation. Such discounts will be amortized as an adjustment to interest
expense using the effective interest method over the related term of the
obligations. As adjusted, the effective annual interest rates on these
obligations were 8.81%, 8.75%, 9.51% and 9.04%, for the 6.75% Dealer
Remarketable Securities, 7.30% Notes, 7.70% Notes and 7.95% Notes,
respectively.
19
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 7--DEBT OBLIGATIONS (CONTINUED)
Availability of amounts under the secured revolving credit facilities are
based on percentage borrowing base calculations. Except as indicated above, all
debt obligations are based on 30-day LIBOR and reprice monthly.
Certain of the Leasing Subsidiary's debt obligations contain financial
covenants pertaining to the subsidiary. Such obligations also establish
restrictions on certain intercompany transactions between the Leasing Subsidiary
and other Company affiliates. Further, such obligations also provide for a limit
on distributions from the Leasing Subsidiary at 85% of cash flow from operations
on a rolling four-quarter basis.
On January 31, 2000, the Company closed a new unsecured revolving credit
facility. The facility is led by a major commercial bank, which has committed
$50.0 million of the facility amount and intends to increase the facility to
$100.0 million through syndication. The new facility has a two-year primary term
and one-year extension at the Company's option, and bears interest at LIBOR plus
2.00% to 2.25%, depending upon certain conditions.
On February 4, 2000, the Company extended the term of its existing $500.0
million secured credit facility. The Company extended the original August 2000
maturity date to August 2002, through a one-year extension to the facility's
draw period and an additional one-year "term out" period during which
outstanding principal amortizes 25% per quarter. In connection with the
extension, the Company and the facility lender also expanded the range of assets
that the lender would accept as collateral under the facility. In exchange for
the extension and expansion, the Company agreed to increase the facility's
interest rate from LIBOR plus 1.25% to 1.50%, to a revised rate of LIBOR plus
1.50% to 1.75%, depending upon certain conditions.
During the three-month period ended March 31, 2000, the Company incurred an
extraordinary loss of approximately $0.3 million as a result of the early
retirement of certain debt obligations of its Leasing Subsidiary.
Future maturities of outstanding long-term debt obligations are as follows
(in thousands):
2000 (remaining nine months)................................ $ 298,745
2001........................................................ 1,176,423
2002........................................................ 32,256
2003........................................................ --
2004........................................................ 36,296
Thereafter.................................................. 464,818
----------
Total principal maturities.................................. 2,008,538
Net unamortized debt (discounts)/premiums................... (21,144)
----------
Total debt obligations...................................... $1,987,394
==========
NOTE 8--STOCKHOLDERS' EQUITY
Prior to November 4, 1999, the Company was authorized to issue
105.0 million shares, representing 70.0 million class A shares and 35.0 million
class B shares, with a par value of $1.00 and $0.01 per share, respectively.
Class B shares were required to be issued by the Company in an amount equal to
one half of the number of class A shares outstanding. Class A and class B shares
were each entitled to one vote per
20
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 8--STOCKHOLDERS' EQUITY (CONTINUED)
share with respect to the election of directors and other matters. Pursuant to
the Declaration of Trust, the class B shares were convertible at the option of
the class B shareholders into class A shares on the basis of 49 class B shares
for one class A share. However, the holder of class B shares had agreed with the
Company that it would not convert the class B shares into class A shares without
the approval of a majority of directors that were not affiliated with such
holder. All distributions of cash were made 99% to the holders of class A shares
and 1% to the holders of class B shares.
On December 15, 1998, for an aggregate purchase price of $220.0 million, the
Company issued 4.4 million shares of Series A Preferred Stock and warrants to
acquire 6.1 million common shares of Common Stock, as adjusted for dilution, at
$35.00 per share. The warrants are exercisable on or after December 15, 1999 at
a price of $35.00 per share and expire on December 15, 2005. The proceeds were
allocated between the two securities issued based on estimated relative fair
values.
As more fully described in Note 4, the Company consummated a series of
transactions on November 4, 1999, in which its class A and class B shares were
exchanged into a single class of Common Stock. The Company's charter now
provides for the issuance of up to 200.0 million shares of Common Stock, par
value $0.001 per share, and 30.0 million shares of preferred stock. As part of
these transactions, the Company adopted articles supplementary creating four
series of preferred stock designated as 9.5% Series A Cumulative Redeemable
Preferred Stock, consisting of 4.4 million shares, 9.375% Series B Cumulative
Redeemable Preferred Stock, consisting of 2.3 million shares, 9.20% Series C
Cumulative Redeemable Preferred Stock, consisting of approximately 1.5 million
shares, and 8.0% Series D Cumulative Redeemable Preferred Stock, consisting of
4.6 million shares. The Series B, C and D Cumulative Redeemable Preferred Stock
were issued in the TriNet acquisition in exchange for similar issuances of
TriNet stock then outstanding. The Series A, B, C and D Cumulative Redeemable
Preferred Stock are redeemable without premium at the option of the Company at
their respective liquidation preferences beginning on December 15, 2003,
June 15, 2001, August 15, 2001 and October 8, 2002, respectively.
STOCK REPURCHASE PROGRAM: The Board of Directors approved, and the Company
has implemented, a stock repurchase program under which the Company is
authorized to repurchase up to 5.0 million shares of its Common Stock from time
to time, primarily using proceeds from the disposition of assets and excess cash
flow from operations, but also using borrowings under its credit facilities if
the Company determines that it is advantageous to do so. As of March 31, 2000
and December 31, 1999, the Company had repurchased approximately 2.3 million
shares, at an aggregate cost of approximately $40.5 and $40.4 million,
respectively.
NOTE 9--RISK MANAGEMENT AND USE OF FINANCIAL INSTRUMENTS
RISK MANAGEMENT--In the normal course of its on-going business operations,
the Company encounters economic risk. There are three main components of
economic risk: interest rate risk, credit risk and market risk. The Company is
subject to interest rate risk to the degree that its interest-bearing
liabilities mature or reprice at different speeds, or different bases, than its
interest-earning assets. Credit risk is the risk of default on the Company's
loan assets that results from a property's, borrower's or tenant's inability or
unwillingness to make contractually required payments. Market risk reflects
changes in the value of loans, securities available for sale and purchased
mortgage servicing rights due to changes in interest rates or other market
factors, including the rate of prepayments of principal and the value of the
collateral underlying loans and the valuation of real estate held by the
Company.
21
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 9--RISK MANAGEMENT AND USE OF FINANCIAL INSTRUMENTS (CONTINUED)
USE OF DERIVATIVE FINANCIAL INSTRUMENTS--The Company's use of derivative
financial instruments is primarily limited to the utilization of interest rate
agreements or other instruments to manage interest rate risk exposure. The
principal objective of such arrangements is to minimize the risks and/or costs
associated with the Company's operating and financial structure as well as to
hedge specific anticipated transactions. The counterparties to these contractual
arrangements are major financial institutions with which the Company and its
affiliates may also have other financial relationships. The Company is
potentially exposed to credit loss in the event of nonperformance by these
counterparties. However, because of their high credit ratings, the Company does
not anticipate that any of the counterparties will fail to meet their
obligations.
The Company has entered into LIBOR interest rate caps struck at 9.00%, 7.50%
and 7.50% in notional amounts of $300.0 million, $40.4 million and $38.3
million, respectively, which expire in March 2001, January 2001 and June 2001,
respectively. In addition, in connection with the TriNet acquisition, the
Company acquired LIBOR interest rate caps currently struck at 7.75%, 7.75%, and
7.50% in notional amounts of $75.0 million, $35.0 million, and $75.0 million,
respectively, which expire in December 2004, December 2004, and August 2001,
respectively. At March 31, 2000 and December 31, 1999, the fair value of the
Company's interest rate caps were $1.8 and $2.2 million, respectively.
The Company has entered into approximately $205.0 million of interest rate
swaps to effectively fix the interest rate on a portion of the Company's
floating-rate term loan obligations. In addition, in connection with the TriNet
acquisition, the Company acquired an interest rate swap agreement which,
together with certain existing interest rate cap agreements, effectively fix the
interest rate on $75.0 million of the Leasing Subsidiary's LIBOR-based
borrowings at 5.58% plus the applicable margin through December 1, 2004.
Management expects that it will have aggregate LIBOR-based borrowings at the
Leasing Subsidiary in excess of the notional amount for the duration of the
swap. The actual borrowing cost to the Company with respect to indebtedness
covered by the swap will depend upon the applicable margin over LIBOR for such
indebtedness, which will be determined by the terms of the relevant debt
instruments. At March 31, 2000 and December 31, 1999, the fair value of the
Company's interest rate swaps were $4.1 and $3.4 million, respectively.
The Company is currently pursuing or recently consummated certain
anticipated long-term fixed rate borrowings and had entered into certain
derivative instruments based on U.S. Treasury securities to hedge the potential
effects of interest rate movements on these transactions. Under these
agreements, the Company would generally receive additional cash flow at
settlement if interest rates rise and pay cash if interest rates fall. The
effects of such receipts or payments will be deferred and amortized over the
term of the specific related fixed-rate borrowings. During the year ended
December 31, 1999, the Company settled an aggregate notional amount of
approximately $63.0 million that was outstanding under such agreements,
resulting in a receipt of approximately $0.6 million to be amortized over the
term of the anticipated borrowing.
During the year ended December 31, 1999, the Company refinanced its
$125.0 million term loan maturing March 15, 1999 with a $155.4 million term loan
maturing March 5, 2009. The new term loan bears interest at 7.44% per annum,
payable monthly, and amortizes over an approximately 22-year schedule. The new
term loan represented one of the forecasted transactions for which the Company
had previously entered into U.S. Treasury-based hedging transactions. The net
$3.4 million cost of the settlement of the related interest rate hedges has been
deferred and will be amortized as an increase to the effective financing cost of
the new term loan over its effective 10-year term.
22
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 9--RISK MANAGEMENT AND USE OF FINANCIAL INSTRUMENTS (CONTINUED)
In the event that, in the opinion of management, it is no longer probable
that the remaining forecasted transaction will occur under terms substantially
equivalent to those projected, the Company will cease recognizing such
transactions as hedges and immediately recognize related gains or losses based
on actual settlement or estimated settlement value of the underlying derivative
contract. No such gains or losses have been recognized by the Company.
CREDIT RISK CONCENTRATIONS--Concentrations of credit risks arise when a
number of borrowers or tenants related to the Company's investments are engaged
in similar business activities, or activities in the same geographic region, or
have similar economic features that would cause their ability to meet
contractual obligations, including those to the Company, to be similarly
affected by changes in economic conditions. The Company regularly monitors
various segments of its portfolio to assess potential concentrations of credit
risks. Management believes the current credit risk portfolio is reasonably well
diversified and does not contain any unusual concentration of credit risks.
Substantially all of the Company's real estate subject to operating leases
(including those held by joint ventures), loans and other lending investments
are collateralized by properties located in the United States, with significant
concentrations (i.e., greater than 10%) as of March 31, 2000 in California
(25.6%) and Texas (14.3%). As of March 31, 2000, the Company's investments also
contain significant concentrations in the following asset/collateral types:
office (50.5%), hotel/resorts (13.1%), retail (7.6%) and industrial (7.6%).
The Company underwrites the credit of prospective borrowers and tenants and
often requires them to provide some form of credit support such as corporate
guarantees or letters of credit. Although the Company's loans and other lending
investments and net lease assets are geographically diverse and the borrowers
and tenants operate in a variety of industries, to the extent the Company has a
significant concentration of interest or operating lease revenues from any
single borrower or tenant, the inability of that borrower or tenant to make its
payment could have an adverse effect on the Company. As of March 31, 2000, the
Company's five largest borrowers or tenants collectively accounted for
approximately 17.1% of the Company's annualized interest and operating lease
revenue.
NOTE 10--INCOME TAXES
Although originally formed to qualify as a REIT under the Code for the
purpose of making and acquiring various types of mortgage and other loans,
during 1993 through 1997, the Company failed to qualify as a REIT. As confirmed
by a closing agreement with the Internal Revenue Service (the "IRS") obtained in
March 1998, the Company was eligible and elected to be taxed as a REIT for the
tax years commencing on January 1, 1998. The Company did not incur any material
tax liabilities as a result of its operations during such years.
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amount of assets and liabilities for financial reporting
purposes and income tax purposes, as well as operating loss and tax credit carry
forwards. A valuation allowance is recorded if, based on the weight of available
evidence, it is more likely than not that some portion or all of the deferred
income tax asset will not be realized. Given the limited nature of the Company's
operations and assets and liabilities from 1993 through 1997, the only deferred
tax assets were net operating loss carry forwards ("NOL's") of approximately
$4.0 million, which arose during such periods. Since the Company has elected to
be treated as a REIT for its tax years beginning January 1, 1998, the NOL's have
expired unutilized. Accordingly, no net
23
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 10--INCOME TAXES (CONTINUED)
deferred tax asset value, after consideration of a 100% valuation allowance, has
been reflected in these financial statements as of March 31, 2000 or
December 31, 1999 nor a net tax provision for the three-month periods ended
March 31, 2000 and 1999.
NOTE 11--STOCK OPTION PLANS AND EMPLOYEE BENEFITS
The Company's 1996 Long-Term Incentive Plan (the "Plan") is designed to
provide incentive compensation for officers, other key employees and directors
of the Company. The Plan provides for awards of stock options and restricted
stock and other performance awards. The maximum number of shares of Common Stock
available for awards under the Plan is 9% of the outstanding shares of Common
Stock, calculated on a fully diluted basis, from time to time; provided that,
the number of shares of Common Stock reserved for grants of options designated
as incentive stock options is 5.0 million, subject to certain antidilution
provisions in the Plan. All awards under the Plan, other than automatic awards
to non-employee directors, are at the discretion of the Board or a committee of
the Board. At March 31, 2000, a total of approximately 7.7 million shares of
Common Stock were available for awards under the Plan, of which options to
purchase approximately 5.4 million shares of Common Stock were outstanding.
Concurrently with the Recapitalization Transactions, the Company issued
approximately 2.5 million fully vested (as adjusted) and immediately exercisable
options to purchase class A shares at $15.00 per share to the Advisor with a
term of ten years. The Advisor granted a portion of these options to its
employees and the remainder allocated to an affiliate. In general, the grants to
the Advisor's employees provided for scheduled vesting over a predefined service
period of three to five years and in some cases provided for accelerated vesting
based on a change in control of the Advisor or completion of certain liquidity
transactions. These options expire concurrently with the original option grant
to the Advisor. Upon consummation of the Advisor Transaction these individuals
became employees of the Company.
In connection with the TriNet acquisition, outstanding options to purchase
TriNet stock under TriNet's stock option plans were converted into options to
purchase shares of Common Stock on substantially the same terms, except that
both the exercise price and number of shares issuable upon exercise of the
TriNet options were adjusted to give effect to the merger exchange ratio of 1.15
shares of Common Stock for each share of TriNet common stock. In addition,
options held by the directors of TriNet and certain executive officers became
fully vested as a result of the transaction.
The TriNet directors received a number of options of the Company to purchase
Common Stock on a fully vested basis on substantially the same terms as the
TriNet options, in each case giving effect to the 1.15 exchange ratio for their
options.
Also, as a result of the TriNet acquisition, TriNet terminated its dividend
equivalent rights program. The program called for immediate vesting and cash
redemption of all dividend equivalent rights upon a change of control of 50% or
more of the voting common stock. Concurrent with the TriNet acquisition, all
dividend equivalent rights were vested and amounts due to former TriNet
employees of approximately $8.3 million were paid by the Company. Such payments
were included as part of the purchase price paid by the Company to acquire
TriNet for financial reporting purposes.
24
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 11--STOCK OPTION PLANS AND EMPLOYEE BENEFITS (CONTINUED)
Changes in options outstanding during the three months ended March 31, 2000
was as follows:
NUMBER OF SHARES
--------------------------------------- AVERAGE
NON-EMPLOYEE STRIKE
EMPLOYEES DIRECTORS OTHER PRICE
---------- ------------ ----------- --------
OPTIONS OUTSTANDING, DECEMBER 31, 1999......... 3,001,270 183,177 764,146 $19.08
Granted in 2000.............................. 1,626,683 80,000 50,000 $17.00
Exercised in 2000............................ -- -- -- $ --
Forfeited in 2000............................ (316,212) -- -- $25.25
--------- ------- -----------
OPTIONS OUTSTANDING, MARCH 31, 2000............ 4,311,741 263,177 814,146 $17.29
========= ======= ===========
The following table summarizes information concerning outstanding and
exercisable options as of March 31, 2000:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------ ----------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
OPTIONS CONTRACTUAL EXERCISE CURRENTLY EXERCISE
EXERCISE PRICE RANGE OUTSTANDING LIFE PRICE EXERCISABLE PRICE
- -------------------- ----------- ----------- -------- ----------- --------
$15.00 2,473,714 7.95 $15.00 1,303,803(1) $15.00
$16.88 1,104,990 9.77 $16.88 -- $ --
$17.00-$17.38 600,750 9.94 $17.36 -- $ --
$21.09 86,250 3.18 $21.09 86,250 $21.09
$22.45 149,500 1.11 $22.45 149,500 $ --
$23.32 167,325 1.99 $23.32 167,325 $ --
$23.64 109,020 4.15 $23.64 -- $ --
$24.13-$24.57 239,657 3.61 $24.38 212,632 $24.36
$24.67 56,322 0.86 $25.33 52,872 $25.33
$27.88-$28.37 122,764 1.57 $28.33 108,102 $28.35
$29.63 10,185 8.10 $30.18 10,185 $29.63
$30.33 253,145 2.16 $30.33 197,967 $30.33
$33.15-$33.70 10,350 4.94 $33.39 7,475 $33.49
$57.50 5,092 9.65 $58.58 5,092 $57.50
--------- ---- ------ --------- ------
5,389,064 7.39 $18.19 2,301,203 $19.58
========= ==== ====== ========= ======
EXPLANATORY NOTE:
- ------------------------------
(1) Includes approximately 764,000 options which were granted, on a fully
exercisable basis, in connection with the Recapitalization Transactions to
an entity related to Starwood Capital Group, and which were subsequently
regranted by that entity to employees of Starwood Capital Group subject to
vesting and exercisability requirements. As a result of those requirements,
less than 2,000 of these options are currently exercisable by the beneficial
owners. In the event that these employees forfeit such options, they revert
to such entity, which may regrant them at its discretion.
The Company has elected to use the intrinsic method for accounting for
options issued to employees or directors, as allowed under Statement of
Financial Accounting Standards No. 123 "Accounting for Stock Based Compensation"
("SFAS 123") and, accordingly, recognizes no compensation charge in connection
with these options to the extent that the options exercise price equals or
exceeds the quoted price of the
25
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 11--STOCK OPTION PLANS AND EMPLOYEE BENEFITS (CONTINUED)
Company's common shares at the date of grant or measurement date. In connection
with the Advisor Transaction, as part of the computation of the one-time charge
to earnings, the Company calculated a deferred compensation charge of
approximately $5.1 million. This deferred charge represents the difference of
the closing sales price of the shares of Common Stock on the date of the Advisor
Transaction of $20.25 over the strike price of the options of $15.00 for the
unvested portion of the options granted to former employees of the Advisor who
are now employees of the Company. This deferred charge will be amortized over
the related remaining vesting terms to the individual employees as additional
compensation expense.
In connection with the original grant of options to the Advisor, the Company
utilized the option value method as required by SFAS 123 to account for the
initial grant of options to the Advisor. An independent financial advisory firm
estimated the value of these options at date of grant to be approximately $2.40
per share using a Black-Scholes valuation model. In the absence of comparable
historical market information for the Company, the advisory firm utilized
assumptions consistent with activity of a comparable peer group of companies
including an estimated option life of five years, a 27.5% volatility rate and an
estimated annual dividend rate of 8.5%. The resulting charge to earnings was
calculated as the number of options allocated to the Advisor multiplied by the
estimated value at consummation. A charge of approximately $6.0 million had been
reflected in the Company's first quarter 1998 financial results for this
original grant.
Future charges may be taken to the extent of additional option grants, which
are at the discretion of the Board of Directors.
Effective November 4, 1999, the Company implemented a savings and retirement
plan (the "401 (k) Plan"), which is a voluntary, defined contribution plan. All
employees are eligible to participate in the 401 (k) Plan following completion
of six months of continuous service with the Company. Each participant may
contribute on a pretax basis between 2% and 15% of such participant's
compensation. At the discretion of the Board of Directors, the Company may make
matching contributions on the participant's behalf up to 50% of the first 10% of
the participant's annual contribution. The Company made contributions of
approximately $0.1 million to the 401 (k) Plan for the three-month period ended
March 31, 2000.
NOTE 12--EARNINGS PER SHARE
Prior to November 4, 1999, basic EPS was computed based on the income
allocable to class A shares (net income reduced by accrued dividends on
preferred shares and by 1% allocated to class B shares) divided by the weighted
average number of class A shares outstanding during the period. Diluted EPS was
based on the net earnings allocable to class A shares plus dividends on class B
shares which were convertible into class A shares, divided by the weighted
average number of class A shares and dilutive potential class A shares that were
outstanding during the period. Dilutive potential class A shares included the
class B shares, which were convertible into class A shares at a rate of 49
class B shares for one class A share, and potentially dilutive options to
purchase class A shares issued to the Advisor and the Company's directors and
warrants to acquire class A shares.
As more fully described in Note 4, in the Incorporation Merger, the class B
shares were converted into shares of Common Stock on a 49-for-one basis (the
same ratio at which class B shares were previously convertible into class A
shares), and the class A shares were converted into shares of Common Stock on a
one-for-one basis. As a result, the Company no longer has multiple classes of
common shares. Basic and
26
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 12--EARNINGS PER SHARE (CONTINUED)
diluted earnings per share are based upon the following weighted average shares
outstanding during the three-month periods ended March 31, 2000 and 1999,
respectively (in thousands):
THREE-MONTH
PERIODS ENDED
MARCH 31,
-------------------
2000 1999
-------- --------
(UNAUDITED)
Weighted average common shares outstanding for basic
earnings per common share................................. 85,087 52,447
Add effect of assumed shares issued under treasury stock
method for stock options and restricted stock units....... 362 1,715
Add effects of conversion of class B shares (49-for-one).... -- 535
Add effects of assumed warrants exercised under treasury
stock method for stock options............................ -- 1,849
------ ------
Weighted average common shares outstanding for diluted
earnings per common share................................. 85,449 56,546
====== ======
NOTE 13--COMPREHENSIVE INCOME
In June 1997, the FASB issued Statement of Financial Accounting Standards
No. 130, "Reporting Comprehensive Income" ("SFAS No. 130") effective for fiscal
years beginning after December 15, 1997. The statement changes the reporting of
certain items currently reported as changes in the shareholders' equity section
of the balance sheet and establishes standards for the reporting and display of
comprehensive income and its components in a full set of general-purpose
financial statements. SFAS No. 130 requires that all components of comprehensive
income shall be reported in the financial statements in the period in which they
are recognized. Furthermore, a total amount for comprehensive income shall be
displayed in the financial statements. The Company has adopted this standard
effective January 1, 1998. Total comprehensive income was $51.7 million and
$28.1 million for the three-month periods ended March 31, 2000 and 1999,
respectively. The primary component of comprehensive income other than net
income was the change in value of certain investments in marketable securities
classified as available-for-sale.
27
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 14--DIVIDENDS
In order to maintain its election to qualify as a real estate investment
trust, the Company must distribute, at a minimum, an amount equal to 95% of its
taxable income and must distribute 100% of its taxable income to avoid paying
corporate federal income taxes. Accordingly, the Company anticipates it will
distribute all of its taxable income to its shareholders. Because taxable income
differs from cash flow from operations due to non-cash revenues or expenses, in
certain circumstances, the Company may be required to borrow to make sufficient
dividend payments to meet this anticipated dividend threshold.
On November 4, 1999, the class A shares were converted into shares of Common
Stock on a one-for-one basis. Total dividends declared by the Company aggregated
$116.1 million, or $1.86 per common share, for the year ended December 31, 1999.
On April 3, 2000, the Company declared a dividend of approximately
$51.2 million, or $0.60 per common share applicable to the three-month period
ended March 31, 2000 and payable to shareholders of record on April 14, 2000.
The Company also declared dividends aggregating $5.2 million, $1.2 million,
$0.7 million, and $2.0 million, respectively, on its Series A, B, C and D
preferred stock, respectively, for the three-month period ended March 31, 2000.
There are no dividend arrearages on any of the preferred shares currently
outstanding.
In November 1999, the Company declared and paid a dividend of a total of one
million shares of Common Stock pro rata to all holders of record of Common Stock
as of the close of business on November 3, 1999.
The Series A preferred stock has a liquidation preference of $50.00 per
share and carry an initial dividend yield of 9.50% per annum. The dividend rate
on the preferred shares will increase to 9.75% on December 15, 2005, to 10.00%
on December 15, 2006 and to 10.25% on December 15, 2007 and thereafter.
Dividends on the Series A preferred shares are payable quarterly in arrears and
are cumulative.
Holders of shares of the Series B preferred stock are entitled to receive,
when and as declared by the Board of Directors, out of funds legally available
for the payment of dividends, cumulative preferential cash dividends at the rate
of 9.375% per annum of the $25.00 liquidation preference, equivalent to a fixed
annual rate of $2.34 per share. Dividends are cumulative from the date of
original issue and are payable quarterly in arrears on or before the 15th day of
each March, June, September and December or, if not a business day, the next
succeeding business day. Any dividend payable on the Series B preferred stock
for any partial dividend period will be computed on the basis of a 360-day year
consisting of twelve 30-day months. Dividends will be payable to holders of
record as of the close of business on the first day of the calendar month in
which the applicable dividend payment date falls or on another date designated
by the Board of Directors of the Company for the payment of dividends that is
not more than 30 nor less than 10 days prior to the dividend payment date.
Holders of shares of the Series C preferred stock are entitled to receive,
when and as declared by the Board of Directors, out of funds legally available
for the payment of dividends, cumulative preferential cash dividends at the rate
of 9.20% of the $25.00 liquidation preference per year, equivalent to a fixed
annual rate of $2.30 per share.
Holders of shares of the Series D preferred stock are entitled to receive,
when and as declared by the Board of Directors, out of funds legally available
for the payment of dividends, cumulative preferential cash dividends at the rate
of 8.00% of the $25.00 liquidation preference per year, equivalent to a fixed
annual rate of $2.00 per share.
28
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 14--DIVIDENDS (CONTINUED)
The exact amount of future quarterly dividends to common shareholders will
be determined by the Board of Directors based on the Company's actual and
expected operations for the fiscal year and the Company's overall liquidity
position.
NOTE 15--SEGMENT REPORTING
Statement of Financial Accounting Standard No. 131 ("SFAS 131") establishes
standards for the way the public business enterprises report information about
operating segments in annual financial statements and requires that those
enterprises report selected financial information about operating segments in
interim financial reports issued to stockholders.
The Company has two reportable segments: real estate lending and credit
tenant leasing. The Company does not have substantial foreign operations. The
accounting policies of the segments are the same as those described in Note 3.
The Company has no single customer that accounts for 10% or more of revenues
(see Note 9 for other information regarding concentrations of credit risk).
29
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 15--SEGMENT REPORTING (CONTINUED)
The Company evaluates performance based on the following financial measures
for each segment. Selected results of operations for the three months ended
March 31, 2000 and 1999 and selected asset information as of March 31, 2000 and
December 31, 1999 regarding the Company's operating segments are as follows (in
thousands):
CREDIT
REAL ESTATE TENANT CORPORATE/ COMPANY
LENDING LEASING (1) OTHER (2) TOTAL
----------- ----------- ---------- ----------
(UNAUDITED)
Total revenues(3):
Three months ended:
March 31, 2000 $ 60,083 $ 46,272 $ 4,533 $ 110,888
March 31, 1999 49,919 3,727 1,778 55,424
Total operating and interest expense(4):
Three months ended:
March 31, 2000 $ 22,517 $ 29,080 $ 7,477 $ 59,074
March 31, 1999 18,379 3,679 5,149 27,207
Net operating income before minority
interests(5):
Three months ended:
March 31, 2000 $ 37,566 $ 17,192 $ (2,944) $ 51,814
March 31, 1999 31,540 48 (3,371) 28,217
Total long-lived assets(6):
March 31, 2000 $2,120,744 $1,664,350 N/A $3,785,094
December 31, 1999 2,003,506 1,714,284 N/A 3,717,790
Total assets:
March 31, 2000 N/A N/A $3,896,540 $3,896,540
December 31, 1999 N/A N/A 3,813,552 3,813,552
EXPLANATORY NOTES:
- ------------------------------
(1) Includes the Company's pre-existing Credit Tenant Leasing investments
acquired in the Recapitalization Transactions since March 18, 1998 and the
Credit Tenant Leasing business acquired in the TriNet acquisition since
November 4, 1999.
(2) Corporate and Other represents all corporate-level items, including,
general and administrative expenses and any intercompany eliminations
necessary to reconcile to the consolidated Company totals. This caption also
includes the Company's servicing business, which is not considered a
material separate segment.
(3) Total revenues represents all revenues earned during the period from the
assets in each segment. Revenue from the Real Estate Lending Business
primarily represents interest income and revenue from the Credit Tenant
Leasing business primarily represents operating lease income.
(4) Total operating and interest expense represents provision for possible
credit losses for the Real Estate Lending business and property operating
costs (including real estate taxes) for the Credit Tenant Leasing business.
Interest expense, general and administrative, advisory fees and stock option
compensation expense is included in Corporate and Other for all periods.
Depreciation and amortization of $9,009 and $1,365 for the three-month
periods ended March 31, 2000 and 1999, respectively, are included in the
amounts presented above.
(5) Net operating income before minority interests represents total revenues, as
defined in note (3) above, less total operating and interest expense, as
defined in note (4) above, for each period.
(6) Long-lived assets is comprised of Loans and Other Lending Investments, net
and Real Estate Subject to Operating Leases, net, for each respective
segment.
30
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 16--SUBSEQUENT EVENTS
On April 14, 2000, the Company announced that its Board of Directors
appointed Jay Sugarman, president and chief executive officer, to the added post
of chairman of the board. In connection with the appointment, Barry S.
Sternlicht stepped down as chairman, but remains a board member. In addition, on
April 30, 2000, the Company changed its name from Starwood Financial Inc. to
IStar Financial Inc.
In May 2000 the Company expects to close the inaugural offering under its
proprietary matched funding program, IStar Asset Receivables, Series 2000-1
("STARS"). In the initial transaction, a trust which is wholly owned by the
Company will issue $886.0 million of investment grade bonds secured by the
trust's assets. The maturity of the bonds will match fund the maturity of the
underlying assets financed under the program.
31
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
As more fully discussed in Note 4 to the Company's Consolidated Financial
Statements, on March 18, 1998, the Company completed the Recapitalization
Transactions which, among other things, substantially recapitalized the Company
and modified its investment policy. Effective June 18, 1998, the Company (which
was organized under California law) changed its domicile to Maryland by merging
with a newly-formed subsidiary organized under Maryland law, and issued new
shares of the subsidiary to the Company's shareholders in exchange for their
shares in the Company. Concurrently, the Company consummated a one-for-six
reverse stock split.
Immediately prior to the consummation of the Recapitalization Transactions,
the Company's assets primarily consisted of approximately $11.0 million in
short-term, liquid real estate investments, cash and cash equivalents.
On December 15, 1998, the Company sold $220.0 million of preferred shares
and warrants to purchase class A shares to a group of investors affiliated with
Lazard Freres. Concurrent with the sale of the preferred shares and warrants,
the Company purchased $280.3 million in real estate loans and participation
interests from a group of investors also affiliated with Lazard Freres. These
transactions are referred to collectively as the "Lazard Transaction."
As more fully discussed in Note 4 to the Company's Consolidated Financial
Statements, on November 3, 1999, the Company's shareholders approved a series of
transactions including: (i) the acquisition of TriNet; (ii) the acquisition of
the Company's external advisor; and (iii) the reorganization of the Company from
a trust to a corporation and the exchange of the class A and class B shares for
Common Stock. Pursuant to the TriNet acquisition, TriNet merged with and into a
subsidiary of the Company, with TriNet surviving as a wholly-owned subsidiary of
the Company. In the acquisition, each share of common stock of TriNet was
converted into 1.15 shares of Common Stock. Each share of TriNet Series A,
Series B and Series C Cumulative Redeemable Preferred Stock was converted into a
share of Series B, Series C or Series D (respectively) Cumulative Redeemable
Preferred Stock of the Company. The Company's preferred stock issued to the
former TriNet preferred stockholders has substantially the same terms as the
TriNet preferred stock, except that the new Series B, C, and D preferred stock
have additional voting rights not associated with the TriNet preferred stock.
The Company's Series A Preferred Stock remained outstanding with the same rights
and preferences as existed prior to the TriNet acquisition. As a consequence of
the acquisition of its external advisor, the Company is now internally-managed
and will no longer pay external advisory fees.
The transactions described above and other related transactions have
materially impacted the historical operations of the Company and will continue
to impact the Company's future operations. Accordingly, the reported historical
financial information for periods prior to these transactions is not believed to
be fully indicative of the Company's future operating results or financial
condition.
RESULTS OF OPERATIONS
THREE-MONTH PERIOD ENDED MARCH 31, 2000 COMPARED TO THE THREE-MONTH PERIOD ENDED
MARCH 31, 1999
During the three-month period ended March 31, 2000, total revenue increased
by approximately $55.5 million over total revenue for the same period in 1999.
This increase is a result of the interest generated by $211.9 million of loan
investments newly-originated or acquired by the Company during 2000, an
additional $16.5 million funded under existing loan commitments, and
approximately $42.1 million in operating lease income generated from net lease
assets acquired in the TriNet acquisition. The increase was partially offset by
a reduction in interest earned as a result of principal repayments of
approximately $117.6 million made to the Company on its loan investments during
the three months ended March 31, 2000. Included in other income for fiscal year
1999 are prepayment fees of approximately $3.1 million
32
resulting from the partial repayments of three loans, a forbearance fee of
$1.1 million resulting from the purchase of a sub-performing loan and subsequent
restructuring of such loan to fully performing status, and approximately
$0.5 million in additional revenue from certain cash flow participation features
on four of the Company's loan investments.
The Company's total costs and expenses during the three-month period ended
March 31, 2000 increased by approximately $31.9 million compared to the same
period in 1999, as explained in more detail below. These increases were
generally the result of the increased scope of the Company's operations as a
result of costs associated with additional lending operations and the TriNet
acquisition.
The Company's interest expense increased by $18.1 million for the
three-month period ended March 31, 2000 over the same period in the prior year.
This was in part the result of higher interest rates and higher average
borrowings by the Company on its credit facilities and other term loans, the
proceeds of which were used to fund additional loan origination and acquisition
activities. Further, interest expense in fiscal 2000 includes interest incurred
by the Leasing Subsidiary subsequent to its acquisition.
Property operating costs represent unreimbursed property operating expenses
incurred by the Leasing Subsidiary subsequent to its acquisition. All costs of
this kind were borne directly by the tenant on the Company's pre-existing credit
tenant leasing portfolio prior to the TriNet acquisition.
Depreciation and amortization increased approximately $7.6 million for the
three-month period ended March 31, 2000 over the same period in the prior year,
primarily as a result of depreciation and amortization on the Leasing
Subsidiary's net leased assets subsequent to its acquisition.
General and administrative costs increased by approximately $6.4 million for
the three-month period ended March 31, 2000 as a result of additional costs
incurred subsequent to the acquisition of the Company's external advisor, as
well as additional administrative expenses associated with the Leasing
Subsidiary subsequent to its acquisition.
There were no advisory fees during the three-month period ended March 31,
2000 as, subsequent to the acquisition of the Company's external advisor, the
Company is now internally-managed and no further advisory fees will be incurred.
The Company's charge for provision for possible credit losses increased to
$1.5 million from $1.0 million as a result of expanded lending operations as
well as additional seasoning of the Company's existing lending portfolio. As
more fully discussed in Note 5 to the Company's Consolidated Financial
Statements, the Company has not realized any actual losses on any of its loan
investments to date.
Stock compensation expense increased by approximately $0.5 million as a
result of charges relating to grants of stock options to the Company's
employees.
During the three-month period ended March 31, 2000, the Company incurred an
extraordinary loss of approximately $0.3 million as a result of the early
retirement of certain debt obligations of its Leasing Subsidiary.
INTEREST RATE RISK MANAGEMENT
Market risk is the exposure to loss resulting from changes in interest
rates, foreign currency exchange rates, commodity prices and equity prices. In
pursuing its business plan, the primary market risk to which the Company is
exposed is interest rate risk. Consistent with its expected election to qualify
as a REIT, the Company has implemented an interest rate risk management policy
based on match funding, with the objective that floating-rate assets be
primarily financed by floating-rate liabilities and fixed-rate assets be
primarily financed by fixed-rate liabilities.
33
The Company's operating results will depend in part on the difference
between the interest and related income earned on its assets and the interest
expense incurred in connection with its interest-bearing liabilities.
Competition from other providers of real estate financing may lead to a decrease
in the interest rate earned on the Company's interest-bearing assets, which the
Company may not be able to offset by obtaining lower interest costs on its
borrowings. Changes in the general level of interest rates prevailing in the
financial markets may affect the spread between the Company's interest-earning
assets and interest-bearing liabilities. Any significant compression of the
spreads between interest-earning assets and interest-bearing liabilities could
have a material adverse effect on the Company. In addition, an increase in
interest rates could, among other things, reduce the value of the Company's
interest-bearing assets and its ability to realize gains from the sale of such
assets, and a decrease in interest rates could reduce the average life of the
Company's interest-earning assets.
A substantial portion of the Company's loan investments are subject to
significant prepayment protection in the form of lock-outs, yield maintenance
provisions or other prepayment premiums which provide substantial yield
protection to the Company. Those assets generally not subject to prepayment
penalties include: (i) variable-rate loans based on LIBOR, originated or
acquired at par, which would not result in any gain or loss upon repayment; and
(ii) discount loans and loan participations acquired at discounts to face
values, which would result in gains upon repayment. Further, while the Company
generally seeks to enter into loan investments which provide for substantial
prepayment protection, in the event of declining interest rates, the Company
could receive such prepayments and may not be able to reinvest such proceeds at
favorable returns. Such prepayments could have an adverse effect on the spreads
between interest-earning assets and interest-bearing liabilities.
While the Company has not experienced any significant credit losses,
delinquencies or defaults, in the event of a significant rising interest rate
environment and/or economic downturn, defaults could increase and result in
credit losses to the Company which adversely affect its liquidity and operating
results. Further, such delinquencies or defaults could have an adverse effect on
the spreads between interest-earning assets and interest-bearing liabilities.
Interest rates are highly sensitive to many factors, including governmental
monetary and tax policies, domestic and international economic and political
conditions, and other factors beyond the control of the Company. As more fully
discussed in Note 9 to the Company's Consolidated Financial Statements, the
Company employs match funding-based hedging strategies to limit the effects of
changes in interest rates on its operations, including engaging in interest rate
caps, floors, swaps, futures and other interest rate-related derivative
contracts. These strategies are specifically designed to reduce the Company's
exposure, on specific transactions or on a portfolio basis, to changes in cash
flows as a result of interest rate movements in the market. The Company does not
enter into derivative contracts for speculative purposes nor as a hedge against
changes in credit risk of its borrowers or of the Company itself.
Each interest rate cap or floor agreement is a legal contract between the
Company and a third party (the "counterparty"). When the Company purchases a cap
or floor contract, the Company makes an up-front payment to the counterparty and
the counterparty agrees to make payments to the Company in the future should the
reference rate (typically one- or three-month LIBOR) rise above (cap agreements)
or fall below (floor agreements) the "strike" rate specified in the contract.
Each contract has a notional face amount. Should the reference rate rise above
the contractual strike rate in a cap, the Company will earn cap income. Should
the reference rate fall below the contractual strike rate in a floor, the
Company will earn floor income. Payments on an annualized basis will equal the
contractual notional face amount multiplied by the difference between actual
reference rate and the contracted strike rate. The cost of the up-front payment
is amortized over the term of the contract.
Interest rate swaps are agreements in which a series of interest rate flows
are exchanged over a prescribed period. The notional amount on which swaps are
based is not exchanged. In general, the
34
Company's swaps are "pay fixed" swaps involving the exchange of floating-rate
interest payments from the counterparty for fixed interest payments from the
Company.
Interest rate futures are contracts, generally settled in cash, in which the
seller agrees to deliver on a specified future date the cash equivalent of the
difference between the specified price or yield indicated in the contract and
the value of that of the specified instrument (e.g., U.S. Treasury securities)
upon settlement. The Company generally uses such instruments to hedge forecasted
fixed-rate borrowings. Under these agreements, the Company will generally
receive additional cash flow at settlement if interest rates rise and pay cash
if interest rates fall. The effects of such receipts or payments will be
deferred and amortized over the term of the specific related fixed-rate
borrowings. In the event that, in the opinion of management, it is no longer
probable that a forecasted transaction will occur under terms substantially
equivalent to those projected, the Company will cease recognizing such
transactions as hedges and immediately recognize related gains or losses based
on actual settlement or estimated settlement value. No such gains or losses have
been recognized by the Company.
While a REIT may freely utilize the types of derivative instruments
discussed above to hedge interest rate risk on its liabilities, the use of
derivatives for other purposes, including hedging asset-related risks such as
credit, prepayment or interest rate exposure on the Company's loan assets, could
generate income which is not qualified income for purposes of maintaining REIT
status. As a consequence, the Company may only engage in such instruments to
hedge such risks on a limited basis.
There can be no assurance that the Company's profitability will not be
adversely affected during any period as a result of changing interest rates. In
addition, hedging transactions using derivative instruments involve certain
additional risks such as counterparty credit risk, legal enforceability of
hedging contracts and the risk that unanticipated and significant changes in
interest rates will cause a significant loss of basis in the contract. With
regard to loss of basis in a hedging contract, indices upon which contracts are
based may be more or less variable than the indices upon which the hedged assets
or liabilities are based, thereby making the hedge less effective. The
counterparties to these contractual arrangements are major financial
institutions with which the Company and its affiliates may also have other
financial relationships. The Company is potentially exposed to credit loss in
the event of nonperformance by these counterparties. However, because of their
high credit ratings, the Company does not anticipate that any of the
counterparties will fail to meet their obligations. There can be no assurance
that the Company will be able to adequately protect against the foregoing risks
and that the Company will ultimately realize an economic benefit from any
hedging contract it enters into which exceeds the related costs incurred in
connection with engaging in such hedges.
LIQUIDITY AND CAPITAL RESOURCES
The Company requires capital to fund its investment origination and
acquisition activities and operating expenses. The Company's capital sources
include cash flow from operations, borrowings under lines of credit, additional
term borrowings, long-term financing secured by the Company's assets, unsecured
financing and the issuance of common, convertible and/or preferred equity
securities.
As a result of the Recapitalization Transactions, the Lazard Transaction,
the TriNet acquisition, the acquisition of the Company's external advisor, and
other transactions completed by the Company, the Company has significant access
to capital resources to fund its existing business plan, which includes the
expansion of its real estate lending and credit tenant leasing businesses.
Further, the Company may acquire other businesses or assets using its capital
stock, cash or a combination thereof.
The distribution requirements under the REIT provisions of the Code restrict
the Company's ability to retain earnings and thereby replenish capital committed
to its operations. However, the Company believes that its significant capital
resources and access to financing will provide it with financial flexibility and
market responsiveness at levels sufficient to meet current and anticipated
capital requirements, including expected new lending and leasing transactions.
35
The Company's ability to meet its long-term (i.e., beyond one year)
liquidity requirements is subject to the renewal of its credit lines and/or
obtaining other sources of financing, including issuing additional debt or
equity from time to time. Any decision by the Company's lenders and investors to
enter into such transactions with the Company will depend upon a number of
factors, such as compliance with the terms of its existing credit arrangements,
the Company's financial performance, industry or market trends, the general
availability of and rates applicable to financing transactions, such lenders'
and investors' resources and policies concerning the terms under which they make
such capital commitments and the relative attractiveness of alternative
investment or lending opportunities.
Based on its monthly interest and other expenses, monthly cash receipts,
existing investment commitments and funding plans, the Company believes that its
existing sources of funds will be adequate to purposes of meeting its short- and
long-term liquidity needs. Material increases in monthly interest expense or
material decreases in monthly cash receipts would negatively impact the
Company's liquidity. On the other hand, material decreases in monthly interest
expense would positively affect the Company's liquidity.
As more fully discussed in Note 7 to the Company's Consolidated Financial
Statements, at March 31, 2000, the Company had existing fixed-rate borrowings of
approximately $152.7 million secured by real estate under operating leases which
mature in 2009, an aggregate of approximately $283.7 million in LIBOR-based,
variable-rate loans secured by various senior and subordinate mortgage
investments which mature in fiscal 2000, fixed-rate corporate debt obligations
aggregating approximately $354.2 million which mature between 2001 and 2017, and
other variable- and fixed-rate secured debt obligations aggregating
approximately $143.5 million which mature at various dates through 2010.
In addition, the Company has entered into LIBOR-based secured revolving
credit facilities of $675.0 and $500.0 million which expire in fiscal 2001 and
2002 respectively. As of March 31, 2000, the Company had drawn approximately
$649.2 million and $204.0 million under these facilities. Availability under
these facilities is based on collateral provided under a borrowing base
calculation. In addition, the Leasing Subsidiary has an agreement with a group
of 13 banks led by Bank of America, N.A. which provides it with a
$350.0 million unsecured revolving credit facility. This facility matures on
May 31, 2001 and has a one-year extension period at the Company's option.
Interest incurred on the facility is LIBOR-based with a margin dependent on the
Company's credit ratings. Facility fees under the credit facility are also tied
to its credit ratings. All of the available commitment under the facility may be
borrowed for general corporate and working capital needs of the Leasing
Subsidiary, as well as for investments. Under the terms of this facility, the
Leasing Subsidiary is generally permitted to make cash distributions to the
Company in an amount equal to 85% of cash flow from operations in any rolling
four-quarter period. The facility requires interest-only payments until
maturity, at which time outstanding borrowings are due and payable. As of
March 31, 2000, the Company had $144.6 million drawn and $205.4 million
available under this facility.
The Company has entered into LIBOR interest rate caps struck at 9.00%, 7.50%
and 7.50% in notional amounts of $300.0 million, $40.4 million and
$38.3 million, respectively, which expire in March 2001, January 2001 and June
2001, respectively. In addition, in connection with the TriNet acquisition, the
Company acquired LIBOR interest rate caps currently struck at 7.75%, 7.75%, and
7.50% in notional amounts of $75.0 million, $35.0 million, and $75.0 million,
respectively, which expire in December 2004, December 2004, and August 2001,
respectively. At March 31, 2000, the fair value of the Company's interest rate
caps was $1.8 million.
The Company has originated or acquired certain assets using proceeds from
LIBOR-based borrowings. In connection with such borrowings, the Company entered
into approximately $205.0 million of interest rate swaps to effectively fix the
interest rate on such obligations. In addition, in connection with the TriNet
acquisition, the Company acquired an interest rate swap which, together with
certain existing interest rate cap agreements, effectively fix the interest rate
on $75.0 million of the Leasing Subsidiary's LIBOR-based borrowings at 5.58%
plus the applicable margin through December 1, 2004. Management
36
expects that it will have aggregate LIBOR based borrowings at the Leasing
Subsidiary in excess of the notional amount for the duration of the swap. The
actual borrowing cost to the Company with respect to indebtedness covered by the
swap will depend upon the applicable margin over LIBOR for such indebtedness,
which will be determined by the terms of the relevant debt instruments. At
March 31, 2000, the fair value of the Company's interest rate swaps was
$4.1 million.
The Company is currently pursuing or has consummated certain anticipated
long-term fixed-rate borrowings and had entered into certain derivative
instruments based on U.S. Treasury securities to hedge the potential effects of
interest rate movements on these transactions. Under these agreements, the
Company would generally receive additional cash flow at settlement if interest
rates rise and pay cash if interest rates fall. The effects of such receipts or
payments will be deferred and amortized over the term of the specific related
fixed-rate borrowings. During the year ended December 31, 1999, the Company
settled an aggregate notional amount of approximately $63.0 million that was
outstanding under such agreements, resulting in a receipt of approximately
$0.6 million to be amortized over the term of the anticipated borrowing.
During the year ended December 31, 1999, the Company refinanced its
$125.0 million term loan maturing March 15, 1999 with a $155.4 million term loan
maturing March 5, 2009. The new term loan bears interest at 7.44% per annum,
payable monthly, and amortizes over an approximately 22-year schedule. The new
term loan represented one of the forecasted transactions for which the Company
had previously entered into U.S. Treasury-based hedging transactions. The net
$3.4 million cost of the settlement of such hedges has been deferred and will be
amortized as an increase to the effective financing costs of the new term loan
over its 10-year term.
In the event that, in the opinion of management, it is no longer probable
that the remaining forecasted transactions will occur under terms substantially
equivalent to those projected, the Company will cease recognizing such
transactions as hedges and immediately recognize related gains or losses based
on actual settlement or estimated settlement value. No such gains or losses have
been recognized by the company.
STOCK REPURCHASE PROGRAM: The Board of Directors approved, and the Company
has implemented, a stock repurchase program under which the Company is
authorized to repurchase up to 5.0 million shares of its Common Stock from time
to time, primarily using proceeds from the disposition of assets and excess cash
flow from operations, but also using borrowings under its credit facilities if
the Company determines that it is advantageous to do so. As of March 31, 2000
and December 31, 1999, the Company had repurchased approximately 2.3 million
shares, at an aggregate cost of approximately $40.5 and $40.4 million,
respectively.
NEW ACCOUNTING STANDARDS
In June 1997, the FASB issued Statement of Financial Accounting Standards
No. 131, "Disclosure about Segments of an Enterprise and Related Information"
("SFAS No. 131") effective for financial statements issued for periods beginning
after December 15, 1997. SFAS No. 131 requires disclosures about segments of an
enterprise and related information regarding the different types of business
activities in which an enterprise engages and the different economic
environments in which it operates. The Company adopted the requirements of this
pronouncement in its financial statements beginning with its reporting for
fiscal 1999. As of December 31, 1999, the Company is currently segmented between
its lending and credit tenant lease businesses.
In June 1998, the FASB issued Statement of Financial Accounting Standards
No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS
No. 133"). On June 23, 1999 the FASB voted to defer the effectiveness of
SFAS 133 for one year. SFAS 133 is now effective for fiscal years beginning
after June 15, 2000, but earlier application is permitted as of the beginning of
any fiscal quarter subsequent to June 15, 1998. SFAS No. 133 establishes
accounting and reporting standards for derivative financial
37
instruments and hedging activities. It requires that an entity recognize all
derivatives as either assets or liabilities in the statement of financial
position and measure those instruments at fair value. If certain conditions are
met, a derivative may be specifically designated as: (i) a hedge of the exposure
to changes in the fair value of a recognized asset or liability or an
unrecognized firm commitment; (ii) a hedge of the exposure to variable cash
flows of a forecasted transaction; or (iii) in certain circumstances a hedge of
a foreign currency exposure. The Company currently plans to adopt this
pronouncement as required effective January 1, 2001. The adoption of SFAS 133 is
not expected to have a material financial impact on the financial position or
results of operations of the Company.
OTHER MATTERS
1940 ACT EXEMPTION
The Company at all times intends to conduct its business so as to not become
regulated as an investment company under the Investment Company Act of 1940. If
the Company were to become regulated as an investment company, then the
Company's ability to use leverage would be substantially reduced. The Investment
Company Act exempts entities that are "primarily engaged in the business of
purchasing or otherwise acquiring mortgages and other liens on and interests in
real estate" (i.e., "Qualifying Interests"). Under the current interpretation of
the staff of the SEC, in order to qualify for this exemption, the Company must
maintain at least 55% of its assets directly in Qualifying Interests. As of
March 31, 2000, the Company calculates that it is in and has maintained
compliance with this requirement.
FORWARD LOOKING STATEMENTS
When used in this Form 10-Q, in future SEC filings or in press releases or
other written or oral communications, the words or phrases "will likely result",
"are expected to", "will continue", "is anticipated", "estimate", "project" or
similar expressions are intended to identify "forward looking statements" within
the meaning of the Private Securities Litigation Reform Act of 1995. The Company
cautions that such forward looking statements speak only as of the date made and
that various factors including regional and national economic conditions,
changes in levels of market interest rates, credit and other risks of lending
and investment activities, and competitive and regulatory factors could affect
the Company's financial performance and could cause actual results for future
periods to differ materially from those anticipated or projected.
The Company does not undertake and specifically disclaims any obligation to
update any forward-looking statements to reflect events or circumstances after
the date of such statements except as required by law.
38
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM-8-K
A. EXHIBITS
3.1 Amended and Restated Charter of the Company (including the Articles
Supplementary for the Series A, B, C and D Preferred Stock).
3.2 Bylaws of the Company.
27.1 Financial Data Schedule.
B. REPORTS ON FORM 8-K
None.
39
SIGNATURES
Pursuant to the requirements of Securities Exchange Act of 1934, the Company
has duly caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
ISTAR FINANCIAL INC.
------------------------------------------------
REGISTRANT
Date: May 15, 2000 /s/ JAY SUGARMAN
------------------------------------------------
Jay Sugarman
CHAIRMAN OF THE BOARD OF DIRECTORS,
CHIEF EXECUTIVE OFFICER AND PRESIDENT
Date: May 15, 2000 /s/ SPENCER B. HABER
------------------------------------------------
Spencer B. Haber
EXECUTIVE VICE PRESIDENT--FINANCE,
CHIEF FINANCIAL OFFICER, DIRECTOR AND SECRETARY
40