UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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 September 30, 2003
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 number 1-9106
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Brandywine Realty Trust
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(Exact name of registrant as specified in its charter)
Maryland 23-2413352
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State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization
401 Plymouth Road, Plymouth Meeting, Pennsylvania 19462
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(Address of principal executive offices) (Zip Code)
(610) 325-5600
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Registrant's telephone number
Indicate by check mark whether the registrant (1) 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 (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [X] No [ ]
A total of 39,946,960 Common Shares of Beneficial Interest, par value $.01 per
share, were outstanding as of November 12, 2003.
BRANDYWINE REALTY TRUST
TABLE OF CONTENTS
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PART I - FINANCIAL INFORMATION
Page
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Item 1. Financial Statements (unaudited)
Condensed Consolidated Balance Sheets as of September 30, 2003 and December 31,
2002........................................................................................... 3
Condensed Consolidated Statements of Operations for the three- and nine-month periods ended
September 30, 2003 and September 2002.......................................................... 4
Condensed Consolidated Statements of Cash Flows for the nine-month periods ended
September 30, 2003 and September 30, 2002...................................................... 5
Notes to Condensed Consolidated Financial Statements........................................... 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations..................................................................................... 19
Item 3. Quantitative and Qualitative Disclosures about Market Risk..................................... 27
Item 4. Controls and Procedures........................................................................ 27
PART II - OTHER INFORMATION
Item 1. Legal Proceedings.............................................................................. 28
Item 4. Submission of Matters to a Vote of Security Holders............................................ 28
Item 6. Exhibits and Reports on Form 8-K............................................................... 28
Signatures..................................................................................... 30
2
PART I - FINANCIAL INFORMATION
Item 1. - Financial Statements
BRANDYWINE REALTY TRUST
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share information)
September 30, December 31,
2003 2002
---------- ----------
(unaudited)
ASSETS
Real estate investments:
Operating properties $1,904,795 $1,890,009
Accumulated depreciation (272,859) (245,230)
---------- ----------
1,631,936 1,644,779
Construction-in-progress 36,842 58,127
Land held for development 45,654 43,075
---------- ----------
1,714,432 1,745,981
Cash and cash equivalents 7,493 26,801
Escrowed cash 13,349 16,318
Accounts receivable, net 2,439 3,657
Accrued rent receivable, net 32,284 28,333
Marketable securities 11,945 11,872
Assets held for sale 25,037 7,666
Investment in unconsolidated real estate ventures 13,154 14,842
Deferred costs, net 27,664 29,271
Other assets 42,746 34,547
---------- ----------
Total assets $1,890,543 $1,919,288
========== ==========
LIABILITIES AND BENEFICIARIES' EQUITY
Mortgage notes payable $ 517,555 $ 597,729
Borrowings under Credit Facility 327,000 307,000
Unsecured term loan 100,000 100,000
Accounts payable and accrued expenses 24,746 27,576
Distributions payable 22,106 21,186
Tenant security deposits and deferred rents 19,958 22,276
Other liabilities 17,227 22,006
Liabilities related to assets held for sale 275 20
---------- ----------
Total liabilities 1,028,867 1,097,793
Minority interest 133,413 135,052
Commitments and contingencies
Beneficiaries' equity:
Preferred Shares (shares authorized-10,000,000):
7.25% Series A Cumulative Convertible Preferred
Shares, $.01 par value; issued and outstanding-
750,000 in 2003 and 2002 8 8
8.75% Series B Cumulative Convertible Preferred
Shares, $.01 par value; issued and outstanding-
4,375,000 in 2003 and 2002 44 44
Common Shares of Beneficial Interest, $0.01 par value;
shares authorized-100,000,000; issued and outstanding-
37,359,131 in 2003 and 35,226,315 in 2002 373 352
Additional paid-in capital 894,696 841,659
Share warrants 401 401
Cumulative earnings 268,744 225,010
Accumulated other comprehensive loss (3,547) (6,402)
Cumulative distributions (432,456) (374,629)
---------- ----------
Total beneficiaries' equity 728,263 686,443
---------- ----------
Total liabilities and beneficiaries' equity $1,890,543 $1,919,288
========== ==========
The accompanying notes are an integral part of these condensed consolidated financial statements.
3
BRANDYWINE REALTY TRUST
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited and in thousands, except per share information)
Three-Month Periods Nine-Month Periods
Ended September 30, Ended September 30,
---------------------- -----------------------
2003 2002 2003 2002
---------- --------- --------- ----------
Revenue:
Rents $ 64,512 $ 63,367 $ 193,044 $ 183,946
Tenant reimbursements 9,094 8,637 26,248 24,098
Other 3,604 2,443 7,687 8,028
---------- --------- --------- ----------
Total revenue 77,210 74,447 226,979 216,072
Expenses:
Property operating expenses 19,267 18,918 59,748 55,115
Real estate taxes 7,346 6,649 20,692 18,424
Interest 13,746 16,329 44,293 48,164
Depreciation and amortization 15,311 13,652 45,004 41,085
Administrative expenses 3,630 3,971 10,953 11,812
---------- --------- --------- ----------
Total operating expenses 59,300 59,519 180,690 174,600
Income from continuing operations before equity in income of unconsolidated
real estate ventures, net gain on sales of
interests in real estate and
minority interest 17,910 14,928 46,289 41,472
Equity in income of unconsolidated real estate ventures (531) 359 38 1,052
---------- --------- --------- ----------
Income from continuing operations before gain on sale of interests
in real estate and minority interest 17,379 15,287 46,327 42,524
Gain on sale of interests in real estate - - 1,152 -
Minority interest attributable to continuing operations (2,365) (2,350) (6,973) (6,947)
---------- --------- --------- ----------
Income from continuing operations 15,014 12,937 40,506 35,577
Discontinued operations:
Income from discontinued operations 756 1,086 1,852 6,957
Gains on disposition of discontinued operations 1,741 - 2,692 8,562
Minority interest (111) (55) (209) (859)
---------- --------- --------- ----------
Income from discontinued operations 2,386 1,031 4,335 14,660
---------- --------- --------- ----------
Net income 17,400 13,968 44,841 50,237
Income allocated to Preferred Shares (2,976) (2,976) (8,928) (8,930)
---------- --------- --------- ----------
Income allocated to Common Shares $ 14,424 $ 10,992 $ 35,913 $ 41,307
========== ========= ========= ==========
Basic earnings per Common Share:
Continuing operations $ 0.32 $ 0.27 $ 0.84 $ 0.72
Discontinued operations 0.06 0.03 0.12 0.41
---------- --------- --------- ----------
$ 0.38 $ 0.30 $ 0.96 $ 1.13
========== ========= ========= ==========
Diluted earnings per Common Share:
Continuing operations $ 0.31 $ 0.27 $ 0.84 $ 0.72
Discontinued operations 0.06 0.03 0.12 0.41
---------- --------- --------- ----------
$ 0.37 $ 0.30 $ 0.96 $ 1.13
========== ========= ========= ==========
The accompanying notes are an integral part of these condensed
consolidated financial statements.
4
BRANDYWINE REALTY TRUST
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited and in thousands)
Nine-Month Periods Ended
September 30,
---------------------------------
2003 2002
---------------- ----------------
Cash flows from operating activities:
Net income $ 44,841 $ 50,237
Adjustments to reconcile net income to net cash from
operating activities:
Depreciation 40,489 39,419
Amortization:
Deferred financing costs 1,533 1,543
Deferred leasing costs 5,224 4,006
Deferred compensation costs 2,191 2,417
Straight-line rent (4,429) (4,211)
Provision for doubtful accounts 300 894
Net gain on sale of interests in real estate (3,844) (8,562)
Impairment loss on real estate venture 861 -
Minority interest 7,182 7,806
Changes in assets and liabilities:
Accounts receivable 1,156 3,967
Other assets (3,674) 7,884
Accounts payable and accrued expenses (3,189) (9,960)
Tenant security deposits and deferred rents (2,021) (999)
Other liabilities (1,276) (1,276)
---------------- ----------------
Net cash from operating activites 85,344 93,165
Cash flows from investing activities:
Acquisitions of properties - (25,146)
Dispositions of properties 6,819 78,019
Capital expenditures (33,500) (29,042)
Investment in real estate ventures (511) (404)
Escrowed cash 2,969 4,140
Cash distributions from real estate ventures in excess
of equity in income 1,338 834
Leasing costs (5,858) (10,354)
---------------- ----------------
Net cash from investing activities (28,743) 18,047
Cash flows from financing activites:
Proceeds from notes payable, Credit Facility 96,000 115,000
Repayments of notes payable, Credit Facility (76,000) (102,325)
Proceeds from mortgage notes payable - 13,860
Repayments of mortgage notes payable (80,174) (46,472)
Debt financing costs (112) (622)
Repayments on employee stock loans 1,857 1,658
Proceeds from issuance of shares, net 47,042 -
Repurchases of Common Shares and minority interest units - (20,164)
Distributions paid to shareholders (56,883) (56,391)
Distributions to minority interest holders (7,639) (8,006)
---------------- ----------------
Net cash from financing activities (75,909) (103,462)
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(Decrease) increase in cash and cash equivalents (19,308) 7,750
Cash and cash equivalents at beginning of period 26,801 13,459
---------------- ----------------
Cash and cash equivalents at end of period $ 7,493 $ 21,209
================ ================
The accompanying notes are an integral part of these condensed
consolidated financial statements.
5
BRANDYWINE REALTY TRUST
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NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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SEPTEMBER 30, 2003
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1. THE COMPANY
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Brandywine Realty Trust (collectively with its subsidiaries, the "Company") is a
self-administered and self-managed real estate investment trust (a "REIT")
active in acquiring, developing, redeveloping, leasing and managing office and
industrial properties. As of September 30, 2003, the Company's portfolio
included 207 office properties, 25 industrial properties and one mixed-use
property (collectively, the "Properties") that contained an aggregate of 16.0
million net rentable square feet. The Properties are located in the office and
industrial markets in and surrounding Philadelphia, Pennsylvania, New Jersey and
Richmond, Virginia. As of September 30, 2003, the Company also held economic
interests in nine unconsolidated real estate ventures (the "Real Estate
Ventures") formed with third parties to develop commercial properties.
The Company owns its assets and conducts its operations through Brandywine
Operating Partnership, L.P. (the "Operating Partnership"). The Company is the
sole general partner of the Operating Partnership and, as of September 30, 2003,
was entitled to approximately 95.6% of the Operating Partnership's distributions
after distributions by the Operating Partnership to holders of its Series B
Preferred Units (defined below). The Operating Partnership owns a 95% interest
in Brandywine Realty Services Corporation (the "Management Company"), a taxable
REIT subsidiary that, as of September 30, 2003, was performing management and
leasing services for 39 properties owned by third-parties.
Minority interest is comprised of Class A Units of limited partnership interest
("Class A Units") and Series B Preferred Units of limited partnership interest
("Series B Preferred Units"). The Operating Partnership issued these Units to
persons that contributed assets to the Operating Partnership. The Operating
Partnership is obligated to redeem each Class A Unit, at the request of the
holder, for cash or one Common Share, at the option of the Company. Each Series
B Preferred Unit has a stated value of $50.00 and is convertible, at the option
of the holder, into Class A Units at a conversion price of $28.00. The
conversion price declines to $26.50, if the average trading price of the Common
Shares during the 60-day period ending December 31, 2003 is $23.00 or less. The
Series B Preferred Units bear a cumulative preferred distribution of 7.25% per
annum ($3.625 per unit per annum), subject to an increase in the event quarterly
distributions paid to holders of Common Shares exceed $0.51 per share. Income
allocated to minority interest includes the amount of the Series B Preferred
Unit distribution and the pro rata share of net income of the Operating
Partnership allocated to the Class A Units held by third parties. As of
September 30, 2003, 1,737,203 Class A Units and 1,950,000 Series B Preferred
Units were outstanding and held by third party investors. Minority interest also
includes the 5% interest in the Management Company that is owned by a
partnership comprised of two Company executives.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
------------------------------------------
Basis of Presentation
- ---------------------
The condensed consolidated financial statements have been prepared by the
Company without audit except as to the balance sheet as of December 31, 2002,
which has been prepared from audited data, pursuant to the rules and regulations
of the Securities and Exchange Commission. Certain information and footnote
disclosures normally included in the financial statements prepared in accordance
with accounting principles generally accepted in the United States of America
have been condensed or omitted pursuant to such rules and regulations, although
the Company believes that the included disclosures are adequate to make the
information presented not misleading. In the opinion of management, all
adjustments (consisting solely of normal recurring matters) necessary to fairly
present the financial position of the Company as of September 30, 2003, the
results of its operations for the three- and nine-month periods ended September
30, 2003 and 2002, and its cash flows for the nine-month periods ended September
30, 2003 and 2002 have been included. The results of operations for such interim
periods are not necessarily indicative of the results for a full year. For
further information, refer to the Company's consolidated financial statements
and footnotes included in the Annual Report on Form 10-K for the year ended
December 31, 2002. Certain prior period amounts have been reclassified to
conform with the current period presentation.
6
Principles of Consolidation
- ---------------------------
The accompanying consolidated financial statements include all accounts of the
Company, its majority-owned and/or controlled subsidiaries, which consist
principally of the Operating Partnership as well as the Management Company
(consolidated subsequent to January 1, 2001, see below). The portion of these
entities not owned by the Company is presented as minority interest as of and
during the periods consolidated. All intercompany accounts and transactions have
been eliminated in consolidation.
See Investments in Unconsolidated Real Estate Ventures in Note 4 for the
Company's treatment of unconsolidated real estate venture interests. All
significant intercompany accounts and transactions have been eliminated.
Use of Estimates
- ----------------
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenue and expenses during
the reporting period. Actual results could differ from those estimates.
Management makes significant estimates regarding revenue, impairment of
long-lived assets, allowance for doubtful accounts and deferred costs.
Operating Properties
- --------------------
Operating properties are carried at historical cost less accumulated
depreciation and impairment losses. The cost of operating properties reflects
their purchase price or development cost. Costs incurred for the acquisition and
renovation of an operating property are capitalized to the Company's investment
in that property. Ordinary repairs and maintenance are expensed as incurred;
major replacements and betterments, which improve or extend the life of the
asset, are capitalized and depreciated over their estimated useful lives.
Fully-depreciated assets are removed from the accounts.
Depreciation and Amortization
- -----------------------------
The costs of buildings and improvements are depreciated using the straight-line
method based on the following useful lives: buildings and improvements (five to
40 years) and tenant improvements (the shorter of the lease term or the life of
the asset).
Construction in Progress
- ------------------------
Project costs directly associated with the development and construction of a
real estate project are capitalized as construction in progress. In addition,
interest, real estate taxes and general and administrative expenses that are
directly associated with the Company's development activities are capitalized
until completion of the building shell. Once the building shell of a real estate
project is completed, the costs capitalized to construction in progress are
transferred to land and buildings. The Company capitalized direct construction
costs totaling $.5 million and $1.4 million for the three- and nine-month
periods ended September 30, 2003, and $.2 million and $.8 million for the three-
and nine-month periods ended September 30, 2002. The Company capitalized
interest totaling $.6 million and $1.2 million for the three- and nine-month
periods ended September 30, 2003 and $.7 million and $2.3 million for the three-
and nine-month periods ended September 30, 2002 related to development of
certain Properties and land holdings.
Impairment of Long-Lived Assets
- -------------------------------
In accordance with Statement of Financial Accounting Standards No. 144 ("SFAS
144"), Accounting for the Impairment or Disposal of Long-Lived Assets,
long-lived assets, such as real estate investments and purchased intangibles
subject to amortization, are reviewed for impairment whenever events or changes
in circumstances indicate that the carrying amount of an asset may not be
recoverable. Recoverability of assets to be held and used is measured by a
comparison of the carrying amount of an asset to estimated undiscounted future
cash flows expected to be generated by the asset. If the carrying amount of an
asset exceeds its estimated future cash flows, an impairment charge is
recognized by the amount by which the carrying amount of the asset exceeds the
fair value of the asset. Assets to be disposed of are separately presented in
the balance sheet and reported at the lower of the carrying amount or fair value
less costs to sell, and are no longer depreciated. The other assets and
liabilities related to assets classified as held-for-sale are presented
separately in the consolidated balance sheet.
7
No impairment losses were recorded for the three- and nine-month periods ended
September 30, 2003 and 2002.
Cash and cash equivalents
- -------------------------
Cash and cash equivalents are highly-liquid investments with original maturities
of three months or less. The Company maintains cash equivalents in financial
institutions in excess of insured limits, but believes this risk is mitigated by
only investing in or through major financial institutions.
Investments in Unconsolidated Real Estate Ventures
- --------------------------------------------------
The Company accounts for its investments in unconsolidated Real Estate Ventures
under the equity method of accounting as the Company exercises significant
influence, but does not control these entities under the provisions of the
entities' governing agreements. These investments are recorded initially at
cost, as Investments in Real Estate Ventures, and subsequently adjusted for
equity in earnings and cash contributions and distributions.
On a periodic basis, management assesses whether there are any indicators that
the value of the Company's investments in unconsolidated Real Estate Ventures
may be impaired. An investment is impaired only if management's estimate of the
value of the investment is less than the carrying value of the investment. To
the extent impairment has occurred, the loss shall be measured as the excess of
the carrying amount of the investment over the value of the investment. During
the three-month period ended September 30, 2003, the Company recorded an
impairment charge associated with an investment in a non-operating real estate
venture (see Note 4).
Deferred Costs
- --------------
Costs incurred in connection with property leasing are capitalized as deferred
leasing costs. Deferred leasing costs consist primarily of leasing commissions
that are amortized on the straight-line method over the term of the respective
lease. Lease terms generally range from one to 15 years. Management re-evaluates
the deferred leasing costs for potential impairment as economic and market
conditions change. Internal direct leasing costs deferred totaled $1.0 million
and $2.9 million for the three-and nine-month periods ended September 30, 2003,
and $.9 million and $2.6 million for the three-and nine-month periods ended
September 30, 2002.
Costs incurred in obtaining long-term financing are amortized and charged to
interest expense over the terms of the related debt agreements. This approach
approximates the effective interest rate method.
Purchase Price Allocation
- -------------------------
The Company allocates the purchase price of properties acquired to tangible and
identified intangible assets based on their fair values in accordance with
Statement of Financial Accounting Standards No. 141, Business Combinations.
Amounts allocated to buildings and improvements are calculated and recorded as
if the building was vacant upon purchase. The value associated with any in-place
or above or below-market leases are allocated based on fair value derived as
follows:
The Company records above-market and below-market in-place lease values for
acquired properties based on the present value (using a market interest rate
which reflects the risks associated with the leases acquired) of the difference
between (1) the contractual amounts to be paid pursuant to the in-place leases
and (2) management's estimate of fair market lease rates for the corresponding
in-place leases, measured over a period equal to the remaining non-cancelable
term of the lease for above-market leases and the initial term plus the term of
the fixed rate renewal option, if any for below-market leases. The Company
performs this analysis on a lease (tenant) by lease (tenant) basis. The
capitalized above-market lease values are amortized as a reduction to rental
income over the remaining non-cancelable terms of the respective leases. The
capitalized below-market lease values are amortized over the initial term plus
the term of the fixed rate renewal option, if any, of the respective leases.
The aggregate value of other intangible assets (in-place leases) acquired is
determined by applying a fair value model. The estimates of fair value for other
intangibles (in-place leases) includes an estimate of carrying costs during the
expected lease-up periods for the respective spaces considering current market
conditions, and the costs to execute similar leases. In estimating the carrying
costs that would have otherwise been incurred had the leases not been in place,
8
the Company includes such items as real estate taxes, insurance and other
operating expenses, as well as lost rental revenue during the expected lease-up
period based on current market conditions. Costs to execute similar leases
include leasing commissions, legal and other related costs. The value of
in-place leases is amortized to expense over the remaining non-cancelable term
of the respective leases. Should a tenant terminate its lease, the unamortized
portion of the in-place lease value would be charged to expense.
Revenue Recognition
- -------------------
Rental revenue is recognized on the straight-line basis from the later of the
date of the origination of the lease or the date of acquisition of the facility
subject to existing leases, which averages minimum rents over the terms of the
leases. The cumulative difference between lease revenue recognized under this
method and contractual lease payment terms is recorded as "accrued rent
receivable" on the accompanying balance sheets. The straight-line rent
adjustment increased revenue by approximately $1.5 million and $4.4 million for
the three- and nine-month periods ended September 30, 2003 and approximately
$1.3 million and $4.2 million for the three- and nine-month periods ended
September 30, 2002. Tenant receivables and accrued rent receivables are carried
net of the allowances for doubtful accounts of $1.7 million and $2.5 million as
of September 30, 2003 and $2.3 million and $2.3 million as of December 31, 2002.
The allowance is based on management's evaluation of the collectability of
receivables, taking into account tenant specific considerations as well as the
overall tenant credit portfolio. The leases also typically provide for tenant
reimbursement of common area maintenance and other operating expenses. Deferred
rental revenue represents rental revenue received from tenants prior to their
due dates.
Stock-Based Compensation Plans
- ------------------------------
In December 2002, the Financial Accounting Standards Board issued SFAS 148
("SFAS 148"), Accounting for Stock-Based Compensation - Transition and
Disclosure. SFAS 148 amends SFAS 123 ("SFAS 123"), Accounting for Stock-Based
Compensation, to provide alternative methods of transition for an entity that
voluntarily adopts the fair value recognition method of recording stock option
expense. SFAS 148 also amends the disclosure provisions of SFAS 123 and APB
Opinion No. 28, Interim Financial Reporting, to require disclosure in the
summary of significant accounting policies of the effects of an entity's
accounting policy with respect to stock options on reported net income and
earnings per share in annual and interim financial statements. The Company
adopted SFAS 148 on a prospective basis for all grants subsequent to January 1,
2002.
Prior to 2002, the Company accounted for stock options issued under the
recognition and measurement provisions of APB Opinion No. 25, Accounting for
Stock Issued to Employees and Related Interpretations. The following table
illustrates the effect on net income and earnings per share if the fair value
based method had been applied to all outstanding and unvested awards in each
period (in thousands, except per share amounts):
Three-month periods Nine-month periods
ended September 30, ended September 30,
--------------------------- ---------------------------
2003 2002 2003 2002
------------ ------------ ------------ -------------
Net income available to Common Shares, as reported $ 14,424 $ 10,992 $ 35,913 $ 41,307
Add: Stock based compensation expense included in reported net income 692 689 2,064 1,917
Deduct: Total stock based compensation expense determined under
fair value recognition method for all awards 805 852 2,401 2,441
------------ ------------ ------------ -------------
Pro forma net income available to Common Shares $ 15,921 $ 12,533 $ 40,378 $ 45,665
============ ============ ============ =============
Earnings per Common Share
Basic - as reported $ 0.38 $ 0.30 $ 0.96 $ 1.13
============ ============ ============ =============
Basic - pro forma $ 0.37 $ 0.30 $ 0.95 $ 1.11
============ ============ ============ =============
Diluted - as reported $ 0.37 $ 0.30 $ 0.96 $ 1.13
============ ============ ============ =============
Diluted - pro forma $ 0.37 $ 0.29 $ 0.95 $ 1.11
============ ============ ============ =============
Accounting for Derivative Instruments and Hedging Activities
- ------------------------------------------------------------
The Company accounts for its derivative instruments and hedging activities under
SFAS No. 133 ("SFAS 133"), Accounting for Derivative Instruments and Hedging
Activities, and its corresponding amendments under SFAS No. 138, Accounting for
Certain Derivative Instruments and Hedging Activities - An Amendment of SFAS
133. SFAS 133 requires the Company to measure every derivative instrument
(including certain derivative instruments embedded in other contracts) at fair
9
value and record them in the balance sheet as either an asset or liability. For
derivatives designated as fair value hedges, the changes in fair value of both
the derivative instrument and the hedged item are recorded in earnings. For
derivatives designated as cash flow hedges, the effective portions of changes in
the fair value of the derivative are reported in other comprehensive income.
Changes in fair value of derivative instruments and ineffective portions of
hedges are recognized in earnings in the current period. For the nine-month
period ended September 30, 2003, the Company was not party to any derivative
contract designated as a fair value hedge.
The Company actively manages its ratio of fixed-to-floating rate debt. To manage
its fixed and floating rate debt in a cost-effective manner, the Company, from
time to time, enters into interest rate swap agreements as cash flow hedges,
under which it agrees to exchange various combinations of fixed and/or variable
interest rates based on agreed upon notional amounts.
Income Taxes
- ------------
The Company has elected to be treated as a REIT under Sections 856 through 860
of the Internal Revenue Code of 1986, as amended (the "Code"). In order to
maintain its qualification as a REIT, among other things, the Company is
required to distribute at least 90% of its REIT taxable income to its
shareholders and meet certain tests regarding the nature of its income and
assets. As a REIT, the Company is not subject to federal income tax with respect
to that portion of its income which meets certain criteria and is distributed
annually to the shareholders. Accordingly, no provision for federal income taxes
is included in the accompanying consolidated financial statements. The Company
plans to continue to operate so that it meets the requirements for taxation as a
REIT. Many of these requirements, however, are highly technical and complex. If
the Company were to fail to meet these requirements, the Company would be
subject to federal income tax. The Company is subject to certain state and local
taxes. Provision for such taxes has been included in general and administrative
expenses in the Company's consolidated statement of operations.
Recently Issued Accounting Standards
- ------------------------------------
In January 2003, the FASB issued FASB Interpretation No. 46 ("FIN 46"),
"Consolidation of Variable Interest Entities," an interpretation of ARB 51. FIN
46 provides guidance on identifying entities for which control is achieved
through means other than through voting rights (a "variable interest entity" or
"VIE"), and how to determine when and which business enterprise should
consolidate a VIE. This new models for consolidation applies to an entity which
either (1) the equity investors (if any) do not have a controlling financial
interest or (2) the equity investment at risk is insufficient to finance that
entity's activities without receiving additional subordinated financial interest
from other parties. The provisions of this interpretation apply to the first
fiscal year or interim period ending after December 15, 2003.
The Company was originally required to implement the consolidation guidance
established in Interpretation No. 46 ("FIN 46"), Consolidation of Variable
Interest Entities, immediately for new or modified transactions and by July 1,
2003 for the Variable Interest Entities ("VIEs") with which the Company became
involved prior to February 1, 2003. However, in October 2003, the FASB deferred
application of FIN 46 from July 1, 2003 to December 31, 2003, for VIEs entered
into prior to February 1, 2003. The Company has not entered into any new
ventures since February 1, 2003 and is in process of determining whether it will
need to consolidate previously unconsolidated VIEs or to deconsolidate
previously consolidated VIEs. Based upon its relationships with such entities,
the Company believes that the implementation of the consolidation guidance will
not have a material effect on the Company's consolidated financial position.
In May 2003, the FASB issued SFAS No. 150 ("SFAS 150"), Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity. SFAS
150 generally applies to instruments that are mandatorily redeemable, that
represent obligations that will be settled with a variable number of the
Company's shares, or that represent an obligation to purchase a fixed number of
the Company's shares. For instruments within its scope, the statement requires
classification as a liability with initial measurement at fair value. Subsequent
measurement depends upon the certainty of the terms of the settlement (amount,
timing) and whether the obligation will be settled by a transfer of assets or by
issuance of a fixed or variable number of equity shares. SFAS 150 is applicable
now for instruments issued since SFAS 150 was issued, and as of July 1, 2003,
for instruments that predate SFAS 150's issuance. On November 7, 2003, the FASB
issued Financial Statement Position 150-3 which among other things deferred
indefinitely certain portions of SFAS 150 affecting the accounting for minority
interests representing non-controlling interests in finite life entities. The
adoption of SFAS 150, as modified, did not have a significant effect at adoption
nor is it expected to have a significant prospective impact on the Company's
financial position, results of operations or comprehensive income.
10
3. ACQUISITIONS AND DISPOSITIONS OF REAL ESTATE INVESTMENTS
--------------------------------------------------------
2003
- ----
During the nine-month period ended September 30, 2003, the Company sold two
office properties and two industrial properties containing 172,000 net rentable
square feet and one parcel of land containing 3.1 acres for an aggregate of
$13.0 million, realizing a net gain of $3.8 million. During the three-month
period ended September 30, 2003, the Company sold one office property and two
industrial properties containing an aggregate of 141,000 net rentable square
feet for $8.3 million, realizing a gain of $1.7 million.
2002
- ----
During the nine-month period ended September 30, 2002, the Company sold 23
office properties containing an aggregate of 1.4 million net rentable square
feet, 20 industrial properties containing an aggregate of .9 million net
rentable square feet and two parcels of land containing an aggregate of 12.8
acres for an aggregate of $190.8 million, realizing a net gain of $8.6 million.
The Company also purchased seven office properties containing 617,000 net
rentable square feet and one parcel of land containing 9.0 acres for an
aggregate of $99.1 million. During the three-month period ended September 30,
2002, the Company sold seven office properties containing an aggregate of
288,000 net rentable square feet for an aggregate of $22.7 million. The Company
received cash of $19.2 million and a subordinated promissory note of $3.5
million, secured by a pledge of the equity interest of the borrower. As a
result, the Company recorded a deferred gain of $2.5 million which is being
accounted for under the cost recovery method. The Company also purchased two
office properties containing 115,000 net rentable square feet and one land
parcel containing 9.0 acres for an aggregate of $17.2 million.
4. INVESTMENT IN UNCONSOLIDATED REAL ESTATE VENTURES
-------------------------------------------------
As of September 30, 2003, the Company had an aggregate investment of
approximately $13.2 million in nine Real Estate Ventures (net of returns of
investment received by the Company). The Company formed these ventures with
unaffiliated third parties to develop office properties or to acquire land in
anticipation of possible development of office properties. Eight of the Real
Estate Ventures own eight office buildings that contain an aggregate of
approximately 1.2 million net rentable square feet and one Real Estate Venture
developed a hotel property that contains 137 rooms.
The Company accounts for its non-controlling interests in the Real Estate
Ventures using the equity method. Non-controlling ownership interests generally
range from 6% to 65%, subject to specified priority allocations in certain of
the Real Estate Ventures. The Company's investments, initially recorded at cost,
are subsequently adjusted for the Company's net equity in the ventures' income
or loss and cash contributions and distributions.
The following is a summary of the financial position of the unconsolidated Real
Estate Ventures in which the Company had interests as of September 30, 2003 and
December 31, 2002 (in thousands):
September 30, December 31,
2003 2002
------------------- -------------------
Net property $ 191,926 $ 193,552
Other assets 17,618 20,163
Liabilities 2,411 3,186
Debt 152,940 149,129
Equity 54,193 61,400
Company's share of equity 13,154 14,842
The following is a summary of results of operations of the unconsolidated Real
Estate Ventures in which the Company had interests as of September 30, 2003 and
2002 (in thousands):
11
Three-month periods Nine-month periods
ended September 30, ended September 30,
--------------------------------------- ---------------------------------------
2003 2002 2003 2002
------------------ ------------------- ------------------ ------------------
Revenue $ 6,253 $ 6,536 $ 20,395 $ 20,249
Operating expenses 2,493 2,726 9,636 7,496
Interest expense, net 1,949 1,742 6,026 3,748
Depreciation and amortization 1,395 1,439 4,019 6,457
Net (loss) income 416 629 714 2,548
Company's share of income (531) 359 38 1,052
During the three-month period ended September 30, 2003, the Company recorded an
impairment charge of $861,000 associated with a non-operating real estate
venture. This amount consisted primarily of legal and acquisition costs related
to a parcel of land that ultimately was not acquired.
The following is a summary of the financial position as of September 30, 2003
and the results of operations for the nine-month period ended September 30, 2003
for each of the unconsolidated Real Estate Ventures in which the Company had
interests as of September 30, 2003:
12
Chesterbrook Two Tower Four Tower Five Tower Six Tower Eight Tower Tower
Boulevard Bridge Bridge Bridge Bridge Bridge Bridge Inn
Partnership Associates Associates Associates Associates Associates Associates
------------- ---------- ---------- ---------- ---------- ----------- ----------
Assets
Net Property $31,178 $9,530 $10,623 $42,260 $12,403 $58,197 $15,350
Other Assets 3,229 148 3,453 4,001 3,836 892 811
------- ------ ------- ------- ------- ------- -------
Total Assets $34,407 $9,678 $14,076 $46,261 $16,239 $59,089 $16,161
======= ====== ======= ======= ======= ======= =======
Liabilities and Equity
Other Liabilities $ 243 $ 7 $ 184 $ 1,078 $ 188 $ 295 $ 189
Debt 27,968 7,195 11,000 30,600 15,755 37,829 11,625
------- ------ ------- ------- ------- ------- -------
Total Liabilities 28,211 7,202 11,184 31,678 15,943 38,124 11,814
Equity 6,196 2,476 2,892 14,583 296 20,965 4,347
------- ------ ------- ------- ------- ------- -------
Total Liabilities and Equity $34,407 $9,678 $14,076 $46,261 $16,239 $59,089 $16,161
======= ====== ======= ======= ======= ======= =======
Revenues
Revenues $ 3,459 $1,648 $ 1,825 $ 4,627 $ 2,240 $ 797 $ 2,814
Tenant reimbursements and other 408 256 260 226 337 70 --
------- ------ ------- ------- ------- ------- -------
Total Revenue 3,867 1,904 2,085 4,853 2,577 867 2,814
Operating Expenses
Property Operating Expenses 760 617 666 1,740 724 1,248 1,714
Real Estate Taxes 209 118 98 252 159 243 127
Depreciation and Amortization 598 245 488 150 557 1,242 474
Interest 1,288 353 485 1,307 1,001 705 662
Administrative Expenses 5 96 107 89 126 41 --
------- ------ ------- ------- ------- ------- -------
Total Operating Expenses 2,860 1,429 1,844 3,538 2,567 3,479 2,977
------- ------ ------- ------- ------- ------- -------
Net Income $ 1,007 $ 475 $ 241 $ 1,315 $ 10 $(2,612) $ (163)
======= ====== ======= ======= ======= ======= =======
[STUBBED]
TBFA PJP PJP
Partners, Building Building
LP Two, LC Five, LC Total
--------- -------- -------- -----
Assets
Net Property $ -- $5,628 $6,757 $191,926
Other Assets -- 645 603 17,618
----- ------ ------ --------
Total Assets $ -- $6,273 $7,360 $209,544
===== ====== ====== ========
Liabilities and Equity
Other Liabilities $ -- $ 128 $ 99 $ 2,411
Debt -- 5,169 5,799 152,940
----- ------ ------ --------
Total Liabilities -- 5,297 5,898 155,351
Equity -- 976 1,462 54,193
----- ------ ------ --------
Total Liabilities and Equity $ -- $6,273 $7,360 $209,544
===== ====== ====== ========
Revenues
Revenues $ -- $ 622 $ 589 $ 18,621
Tenant reimbursements and other -- 7 210 1,774
----- ------ ------ --------
Total Revenue -- 629 799 20,395
Operating Expenses
Property Operating Expenses -- 202 222 7,893
Real Estate Taxes -- 33 40 1,279
Depreciation and Amortization -- 117 148 4,019
Interest -- 112 113 6,026
Administrative Expenses -- -- -- 464
----- ------ ------ --------
Total Operating Expenses -- 464 523 19,681
----- ------ ------ --------
Net Income $ -- $ 165 $ 276 $ 714
===== ====== ====== ========
13
As of September 30, 2003, the aggregate maturities of non-recourse debt of Real
Estate Ventures payable to third-parties was as follows (in thousands):
2003 $ 367
2004 6,655
2005 39,453
2006 8,452
2007 and thereafter 98,013
--------
$152,940
========
As of September 30, 2003, the Company had guaranteed repayment of approximately
$1.6 million of loans for the Real Estate Ventures. The Company also guaranteed
a $16.2 million loan on behalf of a former Real Estate Venture. Payment under
the guaranty, which expires in January 2004, would be required only in the event
of a default on the loan and if and to the extent the collateral for the loan
were insufficient to provide for payment in full of the loan. The Company also
provides customary environmental indemnities in connection with construction and
permanent financing both for its own account and on behalf of its Real Estate
Ventures.
5. INDEBTEDNESS
------------
The Company utilizes credit facility borrowings for general business purposes,
including the acquisition of properties and the repayment of other debt. The
Company maintains a $500 million unsecured credit facility (the "Credit
Facility") that matures in June 2004. Borrowings under the Credit Facility bear
interest at 30-day LIBOR (LIBOR was 1.12% at September 30, 2003) plus 1.5% per
annum, with the spread over LIBOR subject to reductions from .10% to .25% or
increases of .25% based on the Company's leverage. As of September 30, 2003, the
Company had $327.0 million of borrowings and $10.7 million of letters of credit
outstanding under the Credit Facility, leaving $162.3 million of unused
availability.
The Company also maintains a $100 million term loan. The term loan is unsecured
and matures on July 15, 2005, subject to two extensions of one year each upon
payment of an extension fee and the absence of any defaults at the time of each
extension. There are no scheduled principal payments prior to maturity. The term
loan bears interest at a spread over the one, two, three or six month LIBOR that
varies between 1.05% and 1.90% per annum (1.65% as of September 30, 2003), based
on the Company's leverage ratio. The average interest rate on the Company's term
loan was 3.0% per annum for the nine-month period ended September 30, 2003.
As of September 30, 2003, the Company had $517.6 million of mortgage notes
payable, secured by 93 of the Properties and certain land holdings. Fixed rate
mortgages, totaling $457.1 million, require payments of principal and/or
interest (or imputed interest) at rates ranging from 7.00% to 9.25% per annum
and mature on dates from February 2004 through July 2027. Variable rate
mortgages, totaling $60.5 million, require payments of principal and/or interest
at rates ranging from 30-day LIBOR plus .76% to 1.75% per annum or 75% of prime
(prime rate was 4.00% at September 30, 2003) and mature on dates from March 2004
through July 2027. The weighted-average interest rate on the Company's mortgages
was 7.11% per annum for the nine-month period ended September 30, 2003 and 7.28%
per annum for the nine-month period ended September 30, 2002.
During the three- and nine-month periods ended September 30, 2003 and 2002, the
Company paid interest (net of capitalized interest) totaling $12.5 million and
$40.3 million in 2003 and $15.2 million and $46.5 million in 2002.
6. 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
on its interest-bearing liabilities. Credit risk is the risk of inability or
unwillingness of tenants to make contractually required payments. Market risk is
the risk of declines in the value of properties due to changes in rental rates,
interest rates or other market factors affecting the valuation of properties
held by the Company.
14
Use of Derivative Financial Instruments
- ---------------------------------------
The Company's use of derivative instruments is limited to the utilization of
interest rate agreements or other instruments to manage interest rate risk
exposures and not for speculative purposes. 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 transactions.
The counterparties to these 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
non-performance by these counterparties. However, because of the high credit
ratings of the counterparties, the Company does not anticipate that any of the
counterparties will fail to meet these obligations as they come due. The Company
does not hedge credit or property value market risks.
The Company formally assesses, both at inception of the hedge and on an on-going
basis, whether each derivative is highly-effective in offsetting changes in cash
flows of the hedged item. If management determines that a derivative is not
highly-effective as a hedge or if a derivative ceases to be a highly-effective
hedge, the Company will discontinue hedge accounting prospectively.
The following table summarizes the terms and fair values of the Company's
derivative financial instruments at September 30, 2003 (in thousands).
Notional Fair
Hedge Product Hedge Type Amount Strike Maturity Value
- ---------------- ------------ ---------- ------- --------- -------
Cap Cash flow $ 28,000 8.700% 7/12/2004 $ -
Swap Cash flow 100,000 4.230% 6/29/2004 (2,542)
Swap Cash flow 50,000 4.215% 6/29/2004 (1,265)
Swap Cash flow 25,000 4.215% 6/29/2004 (632)
-------
$(4,439)
=======
The Company has entered into interest rate swap and rate cap agreements
designated as cash flow hedges that are designed to reduce the impact of
interest rate changes on its variable rate debt. At September 30, 2003, the
Company had interest rate swap agreements for notional principal amounts
aggregating $175 million. The swap agreements effectively fix the 30-day LIBOR
interest rate on $100 million of Credit Facility borrowings at 4.230% per annum
and on $75 million of Credit Facility borrowings at 4.215% per annum, in each
case until June 2004. The weighted-average interest rate on borrowings under the
Credit Facility, including the effect of cash flow hedges, was 4.57% per annum
for the nine-month period ended September 30, 2003 and 5.47% per annum for the
nine-month period ended September 30, 2002. The interest rate cap agreement
effectively limits the interest rate on a mortgage with a notional value of $28
million at 8.7% per annum until July 2004. The notional amount at September 30,
2003 provides an indication of the extent of the Company's involvement in these
instruments at that time, but does not represent exposure to credit, interest
rate or market risks.
As of September 30, 2003, the maximum length of time until which the Company was
hedging its exposure to the variability in future cash flows was through June
2004. There was no gain or loss reclassified from accumulated other
comprehensive loss into earnings during the three- and nine-month periods ended
September 30, 2003 as a result of the discontinuance of a cash flow hedge due to
the probability of the original forecasted transaction not occurring.
Over time, the unrealized gains and losses held in Other Comprehensive Income
("OCI") will be reclassified to earnings in the same period(s) in which the
hedged items are recognized in earnings. The current balance held in OCI is
expected to be reclassified to earnings over the lives of the current hedging
instruments, or for realized losses on forecasted debt transactions, over the
related term of the debt obligation, as applicable.
The Company recorded a benefit of $1.3 million and $2.8 million in OCI to
recognize the change in value of derivatives accounted for as cash flow hedges
during the three- and nine-month periods ended September 30, 2003 as compared to
a loss of $2.4 million and $2.6 million for the comparable periods in 2002. The
unrealized gains/losses and the transition adjustment recorded in accumulated
OCI will be reclassified into earnings as the underlying hedged items affect
earnings, such as when the forecasted interest payments occur. The Company
expects that $4.4 million of net losses will be reclassified into earnings over
the next twelve months.
Concentration of Credit Risk
- ----------------------------
Concentrations of credit risk arise when a number of tenants related to the
Company's investments or rental operations are engaged in similar business
activities, or are located in the same geographic region, or have similar
economic features that would cause their inability to meet contractual
obligations, including those to the Company, to be similarly affected. The
Company regularly monitors its tenant base to assess potential concentrations of
credit risk. Management believes the current credit risk portfolio is reasonably
well diversified and does not contain any unusual concentration of credit risk.
No tenant accounted for 5% or more of the Company's rents during the nine-month
periods ended September 30, 2003 and 2002. See Note 10 for geographic segment
information.
15
7. DISCONTINUED OPERATIONS
-----------------------
For the three- and nine-month periods ended September 30, 2003 and 2002, income
from discontinued operations relates to 47 properties containing 2.4 million net
rentable square feet that the Company sold between January 1, 2002 and September
30, 2003 and seven properties containing 339,000 net rentable square feet that
the Company has designated as "held-for-sale" as of September 30, 2003. The
following table summarizes information for the seven properties designated as
held-for-sale as of September 30, 2003 (in thousands):
Real Estate Investments:
Operating Properties $ 29,754
Accumulated depreciation (5,786)
--------
23,968
Construction-in-progress 221
--------
24,189
Accrued rent receivable 315
Deferred costs, net 407
Other assets 126
--------
$ 25,037
========
Tenant security deposits and deferred rents $ 275
========
The following table summarizes revenue and expense information for the 47
properties sold since January 1, 2002 and the seven properties designated as
held-for-sale as of September 30, 2003 (in thousands):
Three-month periods Nine-month periods
ended September 30, ended September 30,
------------------------------ -------------------------------
2003 2002 2003 2002
Revenue:
Rents $ 1,387 $ 1,903 $ 4,614 $ 12,596
Tenant reimbursements 224 187 587 1,972
Other 3 136 19 660
------- ------- ------- --------
Total revenue 1,614 2,226 5,220 15,228
Expenses:
Property operating expenses 492 649 1,861 3,981
Real estate taxes 267 299 798 1,950
Depreciation and amortization 99 192 709 2,340
------- ------- ------- --------
Total operating expenses 858 1,140 3,368 8,271
Income from discontinued operations before net gain on sale
of interests in real estate and minority interest 756 1,086 1,852 6,957
Net gain on sales of interest in real estate 1,741 - 2,692 8,562
Minority interest (111) (55) (209) (859)
------- ------- ------- --------
Income from discontinued operations $ 2,386 $ 1,031 $ 4,335 $ 14,660
======= ======= ======= ========
Discontinued operations have not been segregated in the condensed consolidated
statements of cash flows. Therefore, amounts for certain captions will not agree
with respective data in the condensed consolidated statements of operations.
8. BENEFICIARIES EQUITY
--------------------
On September 23, 2003, the Company declared a distribution of $0.44 per Common
Share, totaling $16.6 million, which was paid on October 15, 2003 to
shareholders of record as of October 6, 2003. The Operating Partnership
simultaneously declared a $0.44 per unit cash distribution to holders of Class A
Units totaling $.8 million.
16
On September 23, 2003, the Company and the Operating Partnership, respectively,
also declared distributions to holders of Series A Preferred Shares, Series B
Preferred Shares and Series B Preferred Units, which are currently entitled to a
cumulative preferential return of 7.25%, 8.75% and 7.25%, respectively.
Distributions paid on October 15, 2003 to holders of Series A Preferred Shares,
Series B Preferred Shares and Series B Preferred Units totaled $.7 million, $2.3
million and $1.8 million, respectively.
9. COMPREHENSIVE INCOME
--------------------
Comprehensive income represents net income, plus the results of certain
non-shareholders' equity changes not reflected in the Condensed Consolidated
Statements of Operations. The components of comprehensive income are as follows
(in thousands):
Three-month periods Nine-month periods
Ended September 30, Ended September 30,
------------------------------------ -------------------------------
2003 2002 2003 2002
------------------ ----------------- ----------------- -------------
Net income $ 17,400 $ 13,968 $ 44,841 $ 50,237
Other comprehensive income (loss):
Reclassification adjustments for losses reclassified
into operations 1,366 1,816 3,928 5,574
Unrealized derivative loss on cash flow hedges (17) (4,232) (1,146) (8,194)
Unrealized gain (loss) on available-for-sale securities 27 (75) 73 40
-------- --------- -------- --------
Comprehensive income $ 18,776 $ 11,477 $ 47,696 $ 47,657
======== ========= ======== ========
10. SEGMENT INFORMATION
-------------------
The Company currently manages its portfolio within three segments: (1)
Pennsylvania, (2) New Jersey (including New York in 2002 periods) and (3)
Virginia. Corporate is responsible for cash and investment management and
certain other general support functions.
Segment information for the three-month periods ended September 30, 2003 and
2002 is as follows (in thousands):
Pennsylvania New Jersey Virginia Corporate Total
------------ ---------- --------- --------- -----------
As of September 30, 2003:
- -------------------------
Real estate investments, at cost
Operating properties $ 1,200,849 $488,903 $ 215,043 $ - $ 1,904,795
Construction-in-progress 29,464 3,841 3,537 - 36,842
Land held for development 25,870 10,809 8,975 - 45,654
Assets held for sale, at cost 7,594 17,443 - - 25,037
As of December 31, 2002:
- ------------------------
Real estate investments, at cost:
Operating properties $ 1,169,919 $506,818 $ 213,272 $ - $ 1,890,009
Construction-in-progress 51,469 3,619 3,039 - 58,127
Land held for development 25,051 10,023 8,001 - 43,075
Assets held for sale, at cost - 7,666 - - 7,666
For three months ended September 30, 2003:
- ------------------------------------------
Total revenue $ 45,930 $ 21,981 $ 7,185 $ 2,114 $ 77,210
Property operating expenses
and real estate taxes 15,701 8,374 2,538 - 26,613
----------- -------- --------- ------- -----------
Net operating income $ 30,229 $ 13,607 $ 4,647 $ 2,114 $ 50,597
=========== ======== ========= ======= ===========
For three months ended September 30, 2002:
- ------------------------------------------
Total revenue $ 45,637 $ 21,255 $ 6,937 $ 618 $ 74,447
Property operating expenses
and real estate taxes 15,177 7,779 2,611 - 25,567
----------- -------- --------- ------- -----------
Net operating income $ 30,460 $ 13,476 $ 4,326 $ 618 $ 48,880
=========== ======== ========= ======= ===========
17
Segment information for the nine-month periods ended September 30, 2003 and 2002
is as follows (in thousands):
Pennsylvania New Jersey Virginia Corporate Total
---------------- ---------------- ---------------- ---------------- ----------------
For nine months ended September 30, 2003:
- -----------------------------------------
Total revenue $ 137,702 $ 65,346 $ 21,038 $ 2,893 $ 226,979
Property operating expenses
and real estate taxes 47,777 25,154 7,509 - 80,440
--------- -------- -------- ------- ---------
Net operating income $ 89,925 $ 40,192 $ 13,529 $ 2,893 $ 146,539
========= ======== ======== ======= =========
For nine months ended September 30, 2002:
- -----------------------------------------
Total revenue $ 131,639 $ 62,662 $ 19,943 $ 1,828 $ 216,072
Property operating expenses
and real estate taxes 43,897 22,533 7,109 - 73,539
--------- -------- -------- ------- ---------
Net operating income $ 87,742 $ 40,129 $ 12,834 $ 1,828 $ 142,533
========= ======== ======== ======= =========
Net operating income is defined as total revenue less property operating
expenses and real estate taxes. Below is a reconciliation of consolidated net
operating income to consolidated income from continuing operations (in
thousands):
Three-month periods Nine-month periods
ended September 30, ended September 30,
------------------------ -------------------------
2003 2002 2003 2002
-------- -------- -------- --------
Consolidated net operating income $ 50,597 $ 48,880 $146,539 $142,533
Less:
Interest expense 13,746 16,329 44,293 48,164
Depreciation and amortization 15,311 13,652 45,004 41,085
Administrative expenses 3,630 3,971 10,953 11,812
Minority interest attributable to continuing
operations 2,365 2,350 6,973 6,947
Plus:
Equity in income of real estate ventures (531) 359 38 1,052
Net gains on sales of interests in real estate - - 1,152 -
-------- -------- -------- --------
Consolidated income from continuing operations $ 15,014 $ 12,937 $ 40,506 $ 35,577
======== ======== ======== ========
11. EARNINGS PER COMMON SHARE
-------------------------
The following table details the number of shares and net income used to
calculate basic and diluted earnings per share (in thousands, except share and
per share amounts):
Three-month periods ended September 30,
-------------------------------------------------------------
2003 2002
--------------------------- ----------------------------
Basic Diluted Basic Diluted
----------- ----------- ----------- -----------
Income from continuing operations $ 15,014 $ 15,014 $ 12,937 $ 12,937
Income from discontinued operations 2,386 2,386 1,031 1,031
Income allocated to Preferred Shares (2,976) (2,976) (2,976) (2,976)
----------- ----------- ----------- -----------
14,424 14,424 10,992 10,992
Preferred Share discount amortization (369) (369) (369) (369)
----------- ----------- ----------- -----------
Net income available to common shareholders $ 14,055 $ 14,055 $ 10,623 $ 10,623
=========== =========== =========== ===========
Weighted-average shares outstanding 37,359,385 37,359,385 35,449,414 35,449,414
Options and warrants - 161,423 - 34,981
----------- ----------- ----------- -----------
Total weighted-average shares outstanding 37,359,385 37,520,808 35,449,414 35,484,395
=========== =========== =========== ===========
Earnings per Common Share:
Continuing operations $ 0.32 $ 0.31 $ 0.27 $ 0.27
Discontinued operations 0.06 0.06 0.03 0.03
----------- ----------- ----------- -----------
$ 0.38 $ 0.37 $ 0.30 $ 0.30
=========== =========== =========== ===========
18
Nine-month periods ended September 30,
-------------------------------------------------------------
2003 2002
--------------------------- ----------------------------
Basic Diluted Basic Diluted
----------- ----------- ----------- -----------
Income from continuing operations $ 40,506 $ 40,506 $ 35,577 $ 35,577
Income from discontinued operations 4,335 4,335 14,660 14,660
Income allocated to Preferred Shares (8,928) (8,928) (8,930) (8,930)
----------- ----------- ----------- -----------
35,913 35,913 41,307 41,307
Preferred Share discount amortization (1,107) (1,107) (1,107) (1,107)
----------- ----------- ----------- -----------
Net income available to common shareholders $ 34,806 $ 34,806 $ 40,200 $ 40,200
=========== =========== =========== ===========
Weighted-average shares outstanding 36,095,349 36,095,349 35,610,699 35,610,699
Options and warrants - 137,251 - 36,991
----------- ----------- ----------- -----------
Total weighted-average shares outstanding 36,095,349 36,232,600 35,610,699 35,647,690
=========== =========== =========== ===========
Earnings per Common Share:
Continuing operations $ 0.84 $ 0.84 $ 0.72 $ 0.72
Discontinued operations 0.12 0.12 0.41 0.41
----------- ----------- ----------- -----------
$ 0.96 $ 0.96 $ 1.13 $ 1.13
=========== =========== =========== ===========
Securities (including Series A Preferred Shares and Series B Preferred Shares of
the Company, and Series B Preferred Units and Class A Units of the Operating
Partnership) totaling 11,206,543 and 11,235,800 for the three- and nine-month
periods ended September 30, 2003 and 11,267,463 and 11,422,018 for the three-
and nine-month periods ended September 30, 2002 were excluded from the earnings
per share computations above as their effect would have been antidilutive.
12. SUBSEQUENT EVENTS
-----------------
In October 2003, the Company consummated a public offering and sold 2,587,500
Common Shares for net proceeds (after deduction of transaction costs) of $64.1
million. In addition, the Company sold six office properties containing 302,000
net rentable square feet for an aggregate of $29.7 million and acquired four
office properties containing 248,000 net rentable square feet for an aggregate
of $44.8 million.
19
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
-----------------------------------------------------------------------
The following discussion and analysis should be read in conjunction with the
financial statements and notes thereto appearing elsewhere herein. This Form
10-Q contains forward-looking statements for purposes of the Securities Act of
1933 and the Securities Exchange Act of 1934 and as such may involve known and
unknown risks, uncertainties and other factors that may cause the actual
results, performance or achievements of the Company to be materially different
from results, performance or achievements expressed or implied by such
forward-looking statements. Although the Company believes that the expectations
reflected in such forward-looking statements are based upon reasonable
assumptions, there can be no assurance that these expectations will be realized.
The Company assumes no obligation to update or supplement forward-looking
statements that become untrue because of subsequent events. Factors that could
cause actual results to differ materially from management's current expectations
include, but are not limited to, changes in general economic conditions, changes
in local real estate conditions (including changes in rental rates and the
number of competing properties), changes in the economic conditions affecting
industries in which the Company's principal tenants compete, the Company's
failure to lease unoccupied space in accordance with the Company's projections,
the failure of the Company to re-lease occupied space upon expiration of leases,
the bankruptcy of major tenants, changes in prevailing interest rates, the
unavailability of equity and debt financing, unanticipated costs associated with
the acquisition and integration of the Company's acquisitions, costs to complete
and lease-up pending developments, increased costs for, or lack of availability
of, adequate insurance, including for terrorist acts, demand for tenant services
beyond those traditionally provided by landlords, potential liability under
environmental or other laws, the existence of complex regulations relating to
the Company's status as a REIT and to the Company's acquisition, disposition and
development activities, the adverse consequences of the Company's failure to
qualify as a REIT and the other risks identified in the Company's Annual Report
on Form 10-K for the year ended December 31, 2002.
OVERVIEW
The Company currently manages its portfolio within three segments: (1)
Pennsylvania, (2) New Jersey and (3) Virginia. As of September 30, 2003, the
Company's portfolio consisted of 207 office properties, 25 industrial facilities
and one mixed-use property that contain an aggregate of approximately 16.0
million net rentable square feet. As of September 30, 2003, the Company held
economic interests in nine Real Estate Ventures.
The Company receives income primarily from rental revenue (including tenant
reimbursements) from the Properties and, to a lesser extent, from the management
of properties owned by third parties and from investments in the Real Estate
Ventures.
The Company's financial performance is dependent upon the demand for office and
other commercial space in its markets. Current economic conditions, including
recessionary pressures and capital market volatility, have enhanced the
challenges facing the Company.
In the current economic climate, the Company continues to seek revenue growth
through an increase in occupancy of its portfolio (90.7% at September 30, 2003).
However, with a downturn in general leasing activity, owners of commercial real
estate, including the Company, are experiencing longer periods in which to lease
unoccupied space, and may face higher capital costs and leasing commissions to
achieve targeted tenancies.
As the Company seeks to increase revenues, management also focuses on strategies
to minimize operating risks, including (i) tenant rollover risk, (ii) tenant
credit risk and (iii) development risk.
Tenant Rollover Risk:
- ---------------------
The Company is subject to the risk that, upon expiration, leases may not be
renewed, the space may not be relet, or the terms of renewal or reletting
(including the cost of renovations) may be less favorable than the current lease
terms. Leases totaling approximately 3.4% of the net rentable square feet of the
Properties as of September 30, 2003 expire without penalty through the end of
2003. In addition, leases totaling approximately 12.8% of the net rentable
square feet of the Properties as of September 30, 2003 are scheduled to expire
without penalty in 2004. The Company maintains an active dialogue with its
tenants in an effort to achieve a high level of lease renewals. The Company's
retention rate for leases that were scheduled to expire in the nine-month period
ended September 30, 2003 was 81.1%. If the Company is unable to renew leases for
a substantial portion of the space under expiring leases, or promptly relet this
space at anticipated rental rates, the Company's cash flow could be adversely
impacted.
20
Tenant Credit Risk:
- -------------------
In the event of a tenant default, the Company may experience delays in enforcing
its rights as a landlord and may incur substantial costs in protecting its
investment. Management regularly evaluates its accounts receivable reserve
policy in light of its tenant base and general and local economic conditions.
The accounts receivable allowances were $4.2 million or 10.7% of total
receivables (including accrued rent receivable) as of September 30, 2003
compared to $4.6 million or 12.5% of total receivables (including accrued rent
receivable) as of December 31, 2002.
Development Risk:
- -----------------
As of September 30, 2003, the Company had in development three office properties
and had in redevelopment four office properties. These seven properties
aggregate 472,000 square feet. The total cost of these projects is estimated to
be $35.7 million of which $9.4 million had been incurred as of September 30,
2003. As of September 30, 2003, these projects were approximately 44% leased.
While the Company is actively marketing space at these projects to prospective
tenants, management cannot provide assurance as to the timing or terms of any
leases of such space. As of September 30, 2003, the Company owned approximately
424 acres of undeveloped land and held options to purchase approximately 61
additional acres. The Company continues to pursue potential development
opportunities, including an office tower (Cira Center) adjacent to Amtrak's 30th
Street Station in University City, Philadelphia and an office complex on
approximately 20 acres of land owned by the Company in Plymouth Meeting,
Pennsylvania. Through September 30, 2003, the Company had invested approximately
$9.6 million in furtherance of these two potential development projects
(excluding land). Risks associated with development include construction cost
overruns, construction delays, insufficient occupancy rates and inability to
obtain necessary zoning, land-use, building, occupancy and other required
governmental approvals. If one of more of the Company's assumptions regarding
the successful efforts of development and leasing are incorrect, the resulting
adjustments could impact earnings.
RECENT ACTIVITY
The Company sold or disposed of the following properties during the nine-month
period ended September 30, 2003:
Sale # of Rentable Sales/Disposition
Date Property/Portfolio Name Location Bldgs. Square Feet Price
- ---- ------------------------------------ ---------------- -------- ------------ -----------------
Feb-03 Greentree Executive Campus (3 units) Mount Laurel, NJ - 28,444 $ 2,559,960
May-03 200 Nationwide Drive Harrisburg, PA 1 2,500 875,000
Jul-03 1000 Lincoln Drive East Mount Laurel, NJ 1 40,600 1,950,000
Jul-03 Greentree Executive Campus (1 unit) Mount Laurel, NJ 1 10,506 1,025,000
Sep-03 55 Ames Court Long Island, NY 1 90,000 5,350,000
----- --------- ------------
Total Properties Sold 4 172,050 $ 11,759,960
===== ========= ============
During the nine-month period ended September 30, 2003, the Company also sold one
parcel of land containing an aggregate of 3.1 acres for $1.2 million.
Subsequent to September 30, 2003, the Company sold or disposed of the following
properties:
Sale # of Rentable Sales/Disposition
Date Property/Portfolio Name Location Bldgs. Square Feet Price
- ---- ------------------------------------ ---------------- -------- ------------ -----------------
Oct-03 104 Windsor Drive Lawrenceville, NJ 1 65,980 $ 8,400,000
Oct-03 1105 Berkshire Boulevard Reading, PA 1 68,985 6,213,000
Oct-03 1150 Berkshire Boulevard Reading, PA 1 26,781 2,412,000
Oct-03 3000 Lincoln Drive Mount Laurel, NJ 1 36,070 3,303,000
Oct-03 4000/5000 Lincoln Drive Mount Laurel, NJ 1 60,091 5,408,000
Oct-03 9000 Lincoln Drive Mount Laurel, NJ 1 43,719 3,935,000
----- --------- ------------
Total Properties Sold 6 301,626 $ 29,671,000
===== ========= ============
Subsequent to September 30, 2003, the Company acquired the following properties:
21
Sale # of Rentable Acquisition
Date Property/Portfolio Name Location Bldgs. Square Feet Price
- ---- ------------------------------------ ---------------- -------- ------------ -----------------
Oct-03 565 Swedesford Road King of Prussia, PA 1 55,789 $ 10,082,000
Oct-03 575 Swedesford Road King of Prussia, PA 1 66,503 12,018,000
Oct-03 585 Swedesford Road King of Prussia, PA 1 43,635 7,891,000
Oct-03 595 Swedesford Road King of Prussia, PA 1 81,890 14,809,000
----- --------- ------------
Total Properties Acquired 4 247,817 $ 44,800,000
===== ========= ============
The Company has entered into an agreement to contribute two of its office
properties containing an aggregate of 633,000 square feet (One and Three
Christina Centres) in Wilmington, Delaware to a joint venture that would be
owned by the Company and an institutional investor. The transaction would
provide for payment to the Company at closing of approximately $112.8 million
and ownership by the Company of 20% of the joint venture. The Company intends to
use the proceeds to re-pay existing indebtedness on the properties, provide its
equity contribution to the joint venture and re-pay borrowings under the Credit
Facility. The Company would also provide management and leasing services to the
venture in exchange for market rate fees. Although management expects this
transaction to close in the fourth quarter of 2003, closing is subject to
customary conditions and to receipt of a mortgage loan in the amount of $74.5
million. Accordingly, there can be no assurance that this transaction will be
completed.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Management's Discussion and Analysis of Financial Condition and Results of
Operations discusses the Company's condensed consolidated financial statements,
which have been prepared in accordance with accounting principles generally
accepted in the United States of America. The preparation of these financial
statements requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and the disclosure of contingent
liabilities at the date of the financial statements and the reported amounts of
revenue and expenses during the reporting period. Management bases its estimates
and assumptions on historical experience and current economic conditions. On an
on-going basis, management evaluates its estimates and assumptions including
those related to revenue, impairment of long-lived assets, allowance for
doubtful accounts, deferred costs, contingencies and litigation. Actual results
may differ from those estimates and assumptions.
The Company's Annual Report on Form 10-K for the year ended December 31, 2002
contains a discussion of the Company's critical accounting policies. See also
Note 2 in the Company's unaudited condensed consolidated financial statements
for the nine-month period ended September 30, 2003 as set forth herein.
Management discusses the Company's critical accounting policies and estimates
with the Company's Audit Committee.
22
RESULTS OF OPERATIONS
Comparison of the Three Months Ended September 30, 2003 and September 30, 2002
Three-month period ended
September 30, Dollar Percent
2003 2002 Change Change
---------- ------------ ----------- ----------
(amounts in thousands)
Revenue:
Rents $ 64,512 $ 63,367 $ 1,145 1.8%
Tenant reimbursements 9,094 8,637 457 5.3%
Other 3,604 2,443 1,161 47.5%
-------- -------- --------
Total revenue 77,210 74,447 2,763 3.7%
Operating Expenses:
Property operating expenses 19,267 18,918 349 1.8%
Real estate taxes 7,346 6,649 697 10.5%
Interest 13,746 16,329 (2,583) -15.8%
Depreciation and amortization 15,311 13,652 1,659 12.2%
Administrative expenses 3,630 3,971 (341) -8.6%
-------- -------- --------
Total operating expenses 59,300 59,519 (219) -0.4%
-------- -------- --------
Income from continuing operations before equity in
income of unconsolidated real estate ventures,
net gain on sales and minority interest 17,910 14,928 2,982 20.0%
Equity in income of unconsolidated real estate ventures (531) 359 (890) -247.9%
-------- -------- --------
Income from continuing operations before net gain
on sales and minority interest 17,379 15,287 2,092 13.7%
Minority interest (2,365) (2,350) (15) -0.6%
-------- -------- --------
Income from continuing operations 15,014 12,937 2,077 16.1%
Income from discontinued operations (including gains on
dispositions), net of minority interest 2,386 1,031 1,355 131.4%
-------- -------- --------
Net income $ 17,400 $ 13,968 $ 3,432 24.6%
======== ======== ========
23
Of the 233 Properties owned by the Company as of September 30, 2003, a total of
228 Properties containing an aggregate of 15.4 million net rentable square feet
("Same Store Properties") were owned for the entire three-month periods ended
September 30, 2003 and 2002. The following table sets forth revenue and expense
information for these Same Store Properties for the three-month periods ended
September 30, 2003 and 2002:
Three-month period ended
September 30,
------------------------------- Dollar Percent
2003 2002 Change Change
---------- ------------ ----------- ----------
(amounts in thousands)
Revenue:
Rents $ 63,404 $ 62,142 $ 1,262 2.0%
Tenant reimbursements 9,193 8,697 496 5.7%
Other 499 323 176 54.5%
-------- -------- -------
Total revenue 73,096 71,162 1,934 2.7%
Operating Expenses:
Property operating expenses 21,544 21,175 369 1.7%
Real estate taxes 6,915 6,699 216 3.2%
-------- -------- -------
Total operating expenses 28,459 27,874 585 2.1%
-------- -------- -------
Net operating income $ 44,637 $ 43,288 $ 1,349 3.1%
======== ======== =======
The following table is a reconciliation of income from continuing operations to
Same Store net operating income:
Three-month period ended
September 30,
-------------------------------
2003 2002
--------- ---------
(amounts in thousands)
Income from continuing operations $ 15,014 $ 12,937
Add/(deduct):
Interest expense 13,746 16,329
Depreciation and amortization 15,311 13,652
Adminstrative expenses 3,630 3,971
Equity in income of Real Estate Ventures 531 (359)
Minority interest attributable to continuing operations 2,365 2,350
Income from discontinued operations 2,386 1,031
-------- --------
Consolidated net operating income 52,983 49,911
Less: Net operating income of non-same store properties (8,346) (6,623)
-------- --------
Same Store net operating income $ 44,637 $ 43,288
======== ========
Revenue increased to $77.2 million for the three-month period ended September
30, 2003 as compared to $74.4 million for the comparable period in 2002,
primarily due to increased occupancy in 2003. The straight-line rent adjustment,
which reflects the difference between rents accrued in accordance with generally
accepted accounting principles and rents billed, increased revenues over
contract rents by $1.5 million for the three-month period ended September 30,
2003 and $1.3 million for the comparable period in 2002. Other revenue includes
lease termination fees, leasing commissions, third-party management fees and
interest income. Other revenue increased to $3.6 million for the three-month
period ended September 30, 2003 as compared to $2.4 million for the comparable
period in 2002 primarily due to bankruptcy settlement proceeds received during
2003. Revenue for Same Store Properties increased to $73.1 million for the three
months ended September 30, 2003 as compared to $71.2 million for the comparable
period in 2002. This increase was the result of increased occupancy in 2003 as
compared to 2002. Average occupancy for the Same Store Properties for the three
months ended September 30, 2003 increased to 92.2% from 91.1% for the comparable
period in 2002.
Property operating expenses increased to $19.3 million for the three-month
period ended September 30, 2003 as compared to $18.9 million for the comparable
period in 2002, primarily due to increased repairs and maintenance expense in
2003. Property operating expenses for the Same Store Properties increased to
$21.5 million for the three months ended September 30, 2003 as compared to $21.2
million for the comparable period in 2002 as a result of increased repairs and
maintenance expense in 2003.
24
Real estate taxes increased to $7.3 million for the three-month period ended
September 30, 2003 as compared to $6.6 million for the comparable period in
2002, primarily due to higher tax rates, property assessments and additional
properties in 2003. Real estate taxes for the Same Store Properties increased to
$6.9 million for the three months ended September 30, 2003 as compared to $6.7
million for the comparable period in 2002 as a result of higher tax rates and
property assessments in 2003.
Interest expense decreased to $13.7 million for the three-month period ended
September 30, 2003 as compared to $16.3 million for the comparable period in
2002, primarily due to decreased interest rates and decreased average
borrowings. Average outstanding debt balances for the three months ended
September 30, 2003 were $942.2 million as compared to approximately $1.0 billion
for the comparable period in 2002. The Company's weighted-average interest rate
after giving effect to hedging activities on unsecured credit facility decreased
to 4.68% per annum for the three months ended September 30, 2003 from 5.47% per
annum for the comparable period in 2002. The weighted-average interest rate on
mortgage notes payable decreased to 7.10% per annum for the three months ended
September 30, 2003 from 7.33% per annum for the comparable period in 2002.
Depreciation expense increased to $13.5 million for the three-month period ended
September 30, 2003 as compared to $12.3 million for the comparable period in
2002 primarily due to additional depreciation recorded from increased tenant
improvements during 2003. Amortization expense, related to deferred leasing
costs, increased to $1.8 million for the three-month period ended September 30,
2003 as compared to $1.3 million for the comparable period in 2002, primarily
due to increased leasing activity.
Administrative expenses decreased to $3.6 million for the three-month period
ended September 30, 2003 as compared to $4.0 million for the comparable period
in 2002 primarily due to decreased professional fees in 2003.
Equity in income of Real Estate Ventures decreased to a loss of $531,000 for the
three-month period ended September 30, 2003 as compared to income of $359,000
for the comparable period in 2002. During the third quarter of 2003, the Company
recorded an impairment charge of $861,000 associated with the write-down of the
investment in a non-operating joint venture.
Minority interest from continuing operations represents the equity in income
attributable to the portion of the Operating Partnership not owned by the
Company. Minority interest was $2.4 million for the three-month periods ended
September 30, 2003 and 2002.
Discontinued operations increased to $2.4 million for the three-month period
ended September 30, 2003 as compared to $1.0 million for the comparable period
in 2002 primarily due to 43 properties sold during 2002. During the three-month
period ended September 30, 2003, the Company sold three properties containing
141,000 net rentable square feet for $8.3 million, realizing a gain of $1.7
million.
25
Comparison of the Nine Months Ended September 30, 2003 and September 30, 2002
Nine-month period ended
September 30,
------------------------- Dollar Percent
2003 2002 Change Change
--------- ---------- ---------- ---------
(amounts in thousands)
Revenue:
Rents $ 193,044 $ 183,946 $ 9,098 4.9%
Tenant reimbursements 26,248 24,098 2,150 8.9%
Other 7,687 8,028 (341) -4.2%
-------- -------- --------
Total revenue 226,979 216,072 10,907 5.0%
Operating Expenses:
Property operating expenses 59,748 55,115 4,633 8.4%
Real estate taxes 20,692 18,424 2,268 12.3%
Interest 44,293 48,164 (3,871) -8.0%
Depreciation and amortization 45,004 41,085 3,919 9.5%
Administrative expenses 10,953 11,812 (859) -7.3%
-------- -------- --------
Total operating expenses 180,690 174,600 6,090 3.5%
-------- -------- --------
Income from continuing operations before equity in
income of unconsolidated real estate ventures,
net gain on sales and minority interest 46,289 41,472 4,817 11.6%
Equity in income of unconsolidated real estate ventures 38 1,052 (1,014) -96.4%
-------- -------- --------
Income from continuing operations before net gain
on sales and minority interest 46,327 42,524 3,803 8.9%
Net gain on sales of interest in real estate 1,152 - 1,152 100.0%
Minority interest (6,973) (6,947) (26) -0.4%
-------- -------- --------
Income from continuing operations 40,506 35,577 4,929 13.9%
Income from discontinued operations (including gains on
dispositions), net of minority interest 4,335 14,660 (10,325) -70.4%
-------- -------- --------
Net income $ 44,841 $ 50,237 $ (5,396) -10.7%
======== ======== ========
Revenue increased to $227.0 million for the nine-month period ended September
30, 2003 as compared to $216.1 million for the comparable period in 2002,
primarily due to properties added to the portfolio since the first quarter of
2002 and increased occupancy. The straight-line rent adjustment, which reflects
the difference between rents accrued in accordance with generally accepted
accounting principles and rents billed, increased revenues over contract rents
by $4.4 million for the nine-month period ended September 30, 2003 as compared
to $4.1 million for the comparable period in 2002. Other revenue includes lease
termination fees, leasing commissions, third-party management fees and interest
income. Other revenue decreased to $7.7 million for the nine-month period ended
September 30, 2003 as compared to $8.0 million for the comparable period in 2002
primarily due to decreased lease termination fee income offset by $2.3 million
in recoveries from bankruptcy settlements in 2003.
Property operating expenses increased to $59.7 million for the nine-month period
ended September 30, 2003 as compared to $55.1 million for the comparable period
in 2002, primarily due to increased snow removal costs and additional properties
in 2003. Property operating expenses included a provision for doubtful accounts
of $.3 million for the nine-month period ended September 30, 2003 and $.9
million for the comparable period in 2002 to provide for increased credit risk.
Real estate taxes increased to $20.7 million for the nine-month period ended
September 30, 2003 as compared to $18.4 million for the comparable period in
2002, primarily due to higher tax rates, property assessments and additional
properties in 2003.
Interest expense decreased to $44.3 million for the nine-month period ended
September 30, 2003 as compared to $48.2 million for the comparable period in
2002, primarily due to decreased interest rates and decreased average
borrowings. Average outstanding debt balances for the nine months ended
September 30, 2003 were $968.9 million as compared to approximately $1.0 billion
for the comparable period in 2002. The Company's weighted-average interest rate
after giving effect to hedging activities on unsecured credit facility decreased
to 4.57% per annum for the nine-month period ended September 30, 2003 from 5.47%
per annum for the comparable period in 2002. The weighted-average interest rate
on mortgage notes payable decreased to 7.11% per annum for the nine-month period
ended September 30, 2003 from 7.28% per annum for the comparable period in 2002.
26
Depreciation expense increased to $39.9 million for the nine-month period ended
September 30, 2003 as compared to $37.3 million for the comparable period in
2002 primarily due to additional properties in 2003. Amortization expense,
related to deferred leasing costs, increased to $5.1 million for the nine-month
period ended September 30, 2003 as compared to $3.8 million for the comparable
period in 2002, primarily due to increased leasing activity.
Administrative expenses decreased to $11.0 million for the nine-month period
ended September 30, 2003 as compared to $11.8 million for the comparable period
in 2002 primarily due to decreased advertising and marketing expenses and
professional fees in 2003 as compared to 2002.
Equity in income of Real Estate Ventures decreased to $38,000 for the nine-month
period ended September 30, 2003 as compared to $1.1 million for the comparable
period in 2002. During the third quarter of 2003, the Company recorded an
impairment charge of $861,000 associated with the write-down of the investment
in a non-operating joint venture.
During the nine-month period ended September 30, 2003, the Company sold one
parcel of land containing an aggregate of 3.1 acres for $1.2 million, realizing
a net gain of $1.2 million.
Minority interest from continuing operations represents the equity in income
attributable to the portion of the Operating Partnership not owned by the
Company. Minority interest increased to $7.0 million for the nine-month period
ended September 30, 2003 as compared to $6.9 million for the comparable period
in 2002.
Discontinued operations decreased to $4.3 million for the nine-month period
ended September 30, 2003 as compared to $14.7 million for the comparable period
in 2002 primarily due to 43 properties sold during 2002. During the nine-month
period ended September 30, 2003, the Company sold four properties containing
172,000 net rentable square feet for an aggregate of $11.8 million, realizing a
net gain of $2.7 million.
LIQUIDITY AND CAPITAL RESOURCES
Cash Flows
During the nine-month period ended September 30, 2003, the Company generated
$85.3 million in cash flow from operating activities. Other sources of cash flow
for the nine-month period consisted of: (i) $96.0 million of proceeds from draws
on the Credit Facility, (ii) $47.0 million in net proceeds from share issuances,
(iii) $6.8 million of proceeds from sales of properties, (iv) $3.0 million of
escrowed cash, (v) $1.9 million from payments on employee loans and (vi) $1.3
million of cash distributions from Real Estate Ventures. During the nine-month
period ended September 30, 2003, cash out-flows consisted of: (i) $80.2 million
of mortgage note repayments, (ii) $76.0 million of Credit Facility repayments,
(iii) $64.5 million of distributions to shareholders and minority interest
holders, (iv) $33.5 million to fund development and capital expenditures, (v)
$5.9 million of leasing costs, (vi) $.5 million of additional investment in Real
Estate Ventures and (vii) $.1 million of debt financing costs.
During the nine-month period ended September 30, 2002, the Company generated
$93.2 million in cash flow from operating activities. Other sources of cash flow
consisted of: (i) $115.0 million of proceeds from draws on the Credit Facility,
(ii) $78.0 million of proceeds from sales of properties, (iii) $13.9 million of
proceeds of additional mortgage notes, (iv) $4.1 million of escrowed cash, (v)
$1.7 million from repayments of employee loans and (vi) $.8 million of cash
distributions from Real Estate Ventures. During the nine-month period ended
September 30, 2002, cash out-flows consisted of: (i) $102.3 million of Credit
Facility repayments, (ii) $64.4 million of distributions to shareholders and
minority interest holders, (iii) $46.5 million of mortgage note repayment, (iv)
$29.0 million to fund development and capital expenditures, (v) $25.1 million
for property acquisitions, (vi) $20.2 million to repurchase Common Shares and
minority interest units, (vii) $10.4 million of leasing costs, (viii) $.6
million of debt financing costs and (ix) $.4 million of additional investments
in unconsolidated Real Estate Ventures.
27
Capitalization
As of September 30, 2003, the Company had approximately $944.6 million of debt
outstanding, consisting of $327.0 million of borrowings under the Credit
Facility, $100 million under the Term Loan and $517.6 million of mortgage notes
payable. The mortgage notes payable consists of $457.1 million of fixed rate
loans and $60.5 million of variable rate loans. Additionally, the Company has
entered into interest rate swap and cap agreements to fix the interest rate on
$203.0 million of the Credit Facility and variable rate loans through July 2004.
The mortgage loans mature between February 2004 and July 2027. As of September
30, 2003, the Company also had $10.7 million of letters of credit outstanding
under the Credit Facility and $162.3 million of unused availability under the
Credit Facility. For the nine-month period ended September 30, 2003, the
weighted-average interest rate under the Company's Credit Facility and the
related swap agreements was 4.57% per annum, the average interest rate for the
Term Loan was 3.0% per annum and the weighted-average interest rate for
borrowings under mortgage notes payable and the related cap agreements was 7.11%
per annum.
The following table outlines the timing of payment requirements related to the
Company's commitments as of September 30, 2003:
Payments by Period (in thousands)
---------------------------------------------------------------------------------
2008 and
Total 2003 2004 - 2005 2006 - 2007 Beyond
-------------- --------------- ------------- -------------- -------------
Mortgage notes payable:
Fixed rate $ 457,121 $ 1,827 $ 70,548 $ 38,041 $ 346,705
Variable rate 24,911 40 364 767 23,740
Construction loans 35,523 - 35,523 - -
--------- ------- -------- -------- ---------
517,555 1,867 106,435 38,808 370,445
Revolving credit facility 327,000 - 327,000 - -
Term loan 100,000 - 100,000 - -
Other liabilities 11,673 646 11,027 - -
--------- ------- -------- -------- ---------
$ 956,228 $ 2,513 $ 544,462 $ 38,808 $ 370,445
========= ======= ========= ======== =========
The Company intends to refinance its mortgage notes payable as they become due
or repay those that are secured by properties being sold. The Company expects to
renegotiate its Credit Facility and Term Loan prior to maturity or extend their
terms.
As of September 30, 2003, the Company's debt-to-market capitalization ratio was
43.1%. As a general policy, the Company intends, but is not obligated, to adhere
to a policy of maintaining a debt-to-market capitalization ratio of no more than
50%.
The Company's Board of Trustees approved a share repurchase program authorizing
the Company to repurchase up to 4,000,000 of its outstanding Common Shares.
Through September 30, 2003, the Company had repurchased 3.2 million of its
Common Shares at an average price of $17.75 per share. Under the share
repurchase program, the Company has the authority to repurchase an additional
762,000 shares. No time limit has been placed on the duration of the share
repurchase program. The following table summarizes the share repurchases during
the nine-month periods ended September 30, 2003 and 2002:
Nine-month period ended
September 30,
------------------------
2003 2002
------ ------
Repurchased amount (shares) - 491,074
Repurchased amount ($, in thousands) $ - $ 11,053
Average price per share $ - $ 22.51
28
The following table summarizes the Class A Units tendered for redemption in cash
during the nine-month periods ended September 30, 2003 and 2002:
Nine-month period ended
September 30,
------------------------
2003 2002
------ ------
Repurchased amount (units) - 364,222
Repurchased amount ($, in thousands) $ - $ 8,536
Average price per share $ - $ 23.44
29
Short- and Long-Term Liquidity
The Company believes that its cash flow from operations is adequate to fund its
short-term liquidity requirements. Cash flow from operations is generated
primarily from rental revenues and operating expense reimbursements from tenants
and management services income from providing services to third parties. The
Company intends to use these funds to meet short-term liquidity needs, which are
to fund operating expenses, debt service requirements, recurring capital
expenditures, tenant allowances, leasing commissions and the minimum
distributions required to maintain the Company's REIT qualification under the
Internal Revenue Code.
On September 23, 2003, the Company declared a distribution of $0.44 per Common
Share, totaling $16.6 million, which was paid on October 15, 2003 to
shareholders of record as of October 6, 2003. The Operating Partnership
simultaneously declared a $0.44 per unit cash distribution to holders of Class A
Units totaling $.8 million.
On September 23, 2003, the Company and the Operating Partnership, respectively,
also declared distributions to holders of Series A Preferred Shares, Series B
Preferred Shares and Series B Preferred Units, which are currently entitled to a
preferential return of 7.25%, 8.75% and 7.25%, respectively. Distributions paid
on October 15, 2003 to holders of Series A Preferred Shares, Series B Preferred
Shares and Series B Preferred Units totaled $.7 million, $2.3 million and $1.8
million, respectively.
The Company expects to meet its long-term liquidity requirements, such as for
property acquisitions, development, investments in real estate ventures,
scheduled debt maturities, major renovations, expansions and other significant
capital improvements, through cash from operations, borrowings under its Credit
Facility, other long-term secured and unsecured indebtedness, the issuance of
equity securities and the proceeds from the disposition of selected assets.
Non-GAAP Supplemental Financial Measure: Funds from Operations (FFO)
FFO is a widely recognized measure of REIT performance. Although FFO is a
non-GAAP financial measure, the Company believes that information regarding FFO
is helpful to shareholders and potential investors. The Company computes FFO in
accordance with standards established by the National Association of Real Estate
Investment Trusts (NAREIT), which may not be comparable to FFO reported by other
REITs that do not compute FFO in accordance with the NAREIT definition, or that
interpret the NAREIT definition differently than the Company. NAREIT defines FFO
as net income (loss) before minority interest of unitholders (preferred and
common) and excluding gains (losses) on sales of depreciable operating property
and extraordinary items (computed in accordance with GAAP); plus real estate
related depreciation and amortization (excluding amortization of deferred
financing costs and depreciation of non-real estate assets), and after
adjustment for unconsolidated joint ventures. The GAAP measure that the Company
believes to be most directly comparable to FFO, net income, includes
depreciation and amortization expenses, gains or losses on property sales and
minority interest. In computing FFO, the Company eliminates substantially all of
these items because, in the Company's view, they are not indicative of the
results from the Company's property operations. To facilitate a clear
understanding of the Company's historical operating results, FFO should be
examined in conjunction with net income (determined in accordance with GAAP) as
presented in the financial statements included elsewhere in this Quarterly
Report on Form 10-Q. FFO does not represent cash generated from operating
activities in accordance with GAAP and should not be considered to be an
alternative to net income (loss) (determined in accordance with GAAP) as an
indication of the Company's financial performance or to be an alternative to
cash flow from operating activities (determined in accordance with GAAP) as a
measure of the Company's liquidity, nor is it indicative of funds available for
the Company's cash needs, including its ability to make cash distributions to
shareholders.
30
The following table summarizes FFO for the three- and nine-month periods ended
September 30, 2003 and 2002 (in thousands, except share data):
Three-month period ended Nine-month period ended
September 30, September 30,
---------------------------- ---------------------------
2003 2002 2003 2002
----------- ----------- ----------- -----------
Net income $ 17,400 $ 13,968 $ 44,841 $ 50,237
Add/(deduct):
Minority interest attributable to continuing operations 2,365 2,350 6,973 6,947
Net gain on sale of interests in real estate - - (1,152) -
Minority interest attributable to discontinued operations 111 55 209 859
Net gain on disposition of discontinued operations (1,741) - (2,692) (8,562)
----------- ----------- ----------- -----------
Income before net gains on sales of interests in real estate and
minority interest 18,135 16,373 48,179 49,481
Add (deduct):
Depreciation:
Attributable to real property 13,590 12,544 40,489 39,419
Attributable to real estate ventures 876 463 1,889 1,783
Amortization attributable to leasing costs 1,820 1,300 5,224 4,006
----------- ----------- ----------- -----------
Funds from operations $ 34,421 $ 30,680 $ 95,781 $ 94,689
=========== =========== =========== ===========
Weighted-average Common Shares (including Common
Share equivalents) and Operating Partnership units 48,727,360 46,751,866 47,468,409 47,069,717
=========== =========== =========== ===========
Inflation
A majority of the Company's leases provide for separate escalations of real
estate taxes and operating expenses either on a triple net basis or over a base
amount. In addition, many of the office leases provide for fixed base rent
increases. The Company believes that inflationary increases in expenses will be
significantly offset by expense reimbursement and contractual rent increases.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
----------------------------------------------------------
Market risk is the exposure to loss resulting from changes in interest 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. Changes in
the general level of interest rates prevailing in the financial markets may
affect the spread between the Company's yield on invested assets and cost of
funds and, in turn, the Company's ability to make distributions or payments to
its shareholders. While the Company has not experienced any significant credit
losses, in the event of a significant rising interest rate environment and/or
economic downturn, defaults could increase and result in losses to the Company
which adversely affect its operating results and liquidity.
There have been no material changes in Quantitative and Qualitative disclosures
in 2003 from the disclosures included in the Company's Annual Report on Form
10-K for the year ended December 31, 2002. Reference is made to Item 7 included
in the Company's Annual Report on Form 10-K for the year ended December 31, 2002
and the caption "Liquidity and Capital Resources" under Item 2 of this Quarterly
Report on Form 10-Q.
Item 4. Controls and Procedures
-----------------------
The Company's Chief Executive Officer and its Chief Financial Officer, after
evaluating the effectiveness of the Company's disclosure controls and procedures
(as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act
of 1934) as of the end of the period covered by this quarterly report, have
concluded that the Company's disclosure controls and procedures are effective to
ensure that information required to be disclosed by the Company in the reports
that it files under the Securities Exchange Act of 1934 is recorded, processed,
summarized and reported within the time periods specified in rules and forms of
the Securities and Exchange Commission.
31
Part II. OTHER INFORMATION
Item 1. Legal Proceedings
-----------------
As indicated in the Company's Annual Report on Form 10-K for the year ended
December 31, 2002, the Company is a defendant in a case in which the plaintiffs
allege that the Company breached its obligation to purchase a portfolio of
properties for approximately $83.0 million. On July 9, 1999, the Superior Court
of New Jersey, Camden County, dismissed the complaint against the Company with
prejudice. The plaintiffs subsequently filed a motion for reconsideration, which
motion the Superior Court denied. Plaintiffs then appealed to the Appellate
Division, which is the intermediate appellate level court in New Jersey. In
December 2000, the Appellate Division affirmed in part and reversed in part the
Chancery Division's earlier dismissal of the entire action. The Appellate
Division affirmed the dismissal of the fraud and other non-contractual counts in
the Complaint, but reversed the contract and reformation counts and remanded
these to the lower court for further proceedings. The Company sought review of
this decision by the Supreme Court of New Jersey, but in March 2001 that Court
declined to consider the appeal. The case thereafter returned to the Chancery
Division, where written and oral discovery was conducted in 2002 and in the
first quarter of 2003. Discovery terminated on February 14, 2003. The Company
filed a motion for summary judgment on all counts, seeking dismissal of all
counts against it, and judgment for the Company on its counterclaim. The
Chancery Division granted the Company's summary judgment motion on March 25,
2003. By order dated May 9, 2003, the Chancery Division dismissed the
plaintiffs' remaining claims and entered judgment in favor of the Company on its
counterclaims. Also on May 9, 2003, the plaintiffs filed a Notice of Appeal with
the Appellate Division seeking review of the Chancery Division's March 25, 2003
ruling (and resulting May 9, 2003 Order) and two earlier procedural decisions.
Plaintiff filed their brief in support of their appeal on August 27, 2003; the
Company filed its opposition to this appeal on October 24, 2003; Plaintiff's
reply is expected to be filed in November 2003; and a decision is expected in
2004.
Item 6. Exhibits and Reports on Form 8-K
--------------------------------
(a) Exhibits
--------
31.1 Certification Pursuant to 13a-14 of the Securities Exchange Act of 1934
31.2 Certification Pursuant to 13a-14 of the Securities Exchange Act of 1934
32.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002
32.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002
(b) Reports on Form 8-K:
--------------------
During the three months ended September 30, 2003 and through November 12, 2003,
the Company filed the following:
(i) Current Report on Form 8-K filed July 25, 2003 (reporting under Items 7 and
12).
(ii) Current Report on Form 8-K filed September 18, 2003 (reporting under
Items 5).
(iii) Current Report on Form 8-K filed October 14, 2003 (reporting under Items
5 and 7).
(iv) Current Report on Form 8-K filed October 15, 2003 (reporting under Items 5
and 7).
(v) Current Report on Form 8-K filed October 24, 2003 (reporting under Items 7,
9 and 12).
32
BRANDYWINE REALTY TRUST
------------------------
SIGNATURES OF REGISTRANT
------------------------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
BRANDYWINE REALTY TRUST
(Registrant)
Date: November 12, 2003 By: /s/ Gerard H. Sweeney
----------------- -------------------------------
Gerard H. Sweeney, President and Chief
Executive Officer (Principal Executive
Officer)
Date: November 12, 2003 By: /s/ Christopher P. Marr
----------------- --------------------------------
Christopher P. Marr, Senior Vice President
and Chief Financial Officer (Principal
Financial Officer)
Date: November 12, 2003 By: /s/ Bradley W. Harris
----------------- --------------------------------
Bradley W. Harris, Vice President and
Chief Accounting Officer (Principal
Accounting Officer)
33